MODULE 4

PROPERTY, PLANT AND EQUIPMENT

OVERVIEW

A significant portion of most entities’ capitalization is tied up in noncurrent

operating assets, one of them is the group of property, plant and equipment.
Management is always tasked of evaluating the best options in acquiring them which
could be on a long-term payment, on lease, or some other arrangements that would
be beneficial to the entity. Inasmuch as these assets will be useful for the entity for a
number of years, financial impact will likewise be for a long period of time.

INTENDED LEARNING OUTCOMES

After reading this module, the related topic in the textbook, and the related
materials and links, the student is expected to

1. Define property, plant and equipment according to IAS 16;

2. Enumerate various items comprising the property, plant and equipment group;
3. Determine the proper amount at which items of property, plant and equipment
are measured upon initial recognition under different modes of acquiring them;
4. Record the costs incurred subsequent to acquisition of property, plant and
equipment;
5. Account for changes in accounting estimates and change in principle affecting
property, plant and equipment;
6. Account for the revaluation of property, plant and equipment at the date of
revaluation and in years subsequent to revaluation;
7. Account for the impairment losses on property, plant and equipment at the date
of impairment and in years subsequent to impairment;
8. Define wasting assets, determine measurement at time of initial recognition,
and account for its depletion; and
9. Know the required disclosures to accompany financial statements.
COURSE MATERIAL

DEFINITION AND COMPOSITION

Based on IAS 16, Property, Plant and Equipment, these are tangible assets
that are (a) held by an enterprise for use in the production of supply of goods or
services, for rental to others, or for administrative purposes; and (b) expected to be
used during more than one accounting period.

Assets of this nature include (a) property ordinarily not subject to depreciation
or depletion, such as land; (b) property subject to depreciation or amortization, such
as land improvements, buildings, machinery, equipment, furniture, improvements to
leased facilities, bookplates, breeding animals; and (c) property subject to depletion
such as timber tracts and mineral and oil deposits. Under the amended IAS 16 and
IAS 41, Agriculture, bearer plants belong to the category of property, plant and
equipment.

RECOGNITION AND MEASUREMENT

An item of property, plant and equipment should be recognized as an asset

when (a) it is probable that future economic benefits associated with the asset will flow
to the enterprise; and (b) the cost of the asset to the enterprise can be measured
reliably.

The cost of an item of property, plant and equipment comprises (a) purchase
price, including import duties and non-refundable purchase taxes; (b) any directly
attributable cost of bringing the asset to its working condition for its intended use, such
as cost of site preparation, initial delivery and handling costs, installation costs and
professional fees for architects and engineers; and (c) initial estimated cost of
dismantling and removing the asset and restoring the site

DIFFERENT ARRANGEMENTS FOR ACQUISITION OF ITEMS OF PROPERTY,

PLANT AND EQUIPMENT

Acquisition of multiple assets. When several items of property, plant and

equipment are acquired for a lump-sum price, the aggregate price is allocated to the
individual assets based on the best available indicator of market values of the assets.
If incidental costs are incurred and are related to all the assets acquired, the amount
is included in the aggregate price to be allocated. If incidental costs are incurred and
are attributable only to specific asset in the group, the incidental cost is not allocated
but rather charged in full to the specific asset.

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 Purchase under deferred payment plan. The cost of an asset acquired through
deferred payment plan is measured at either the cash equivalent price of the asset of
the present value of the future cash payments required by the debt arrangement,
whichever is more objective and clearly reliable. The discount rate is the prevailing
interest rate for that type of obligation at the time of acquisition.

Acquisition by issuance of the entity’s equity securities. The cost of an asset

acquired by issuance of equity securities is the asset’s fair value. In cases where the
fair value of the asset received cannot be reliably determined, reference is made to
the fair value of the equity instruments issued.

Acquisition under finance leases. The right-of-use asset shall be initially

recognized at cost, which is the sum of lease payments to the lessor at
commencement date, present value of lease payments not yet paid at
commencement, initial direct costs incurred by the lessee and present value of
decommissioning costs to the extent recognized as a provision.

Acquisition by self-construction. The cost of a self-constructed asset includes

all costs of materials, labor and overhead directly associated with the construction as
well as interest cost on borrowings actually incurred during the construction period.

Acquisition by donation. An item of property, plant and equipment received as

donation is recorded at its fair value at time of donation. The account credited will
depend on the donor of the property. If the donor is a shareholder, credit is made to
additional paid in capital appropriately described (paid in capital from donation or
donated capital); if the donor is a government unit, credit is made initially to unearned
income from government grant; if the donor is not a shareholder nor a government
unit, credit is made to a gain account.

Acquisition by exchange of non-monetary assets. The asset acquired by

exchange of non-monetary assets is generally recorded at the fair value of the asset
received, which is equivalent to the fair value of the asset given up adjusted by the
amount of any cash or cash equivalent transferred. Any gain or loss is recognized for
the full difference between the fair value and carrying value of the asset given up. If
the transaction lacks commercial substance, the asset acquired is recorded at the
carrying value of the asset given up.

EXPENDITURES SUBSEQUENT TO ACQUISITION

While the items of property, plant and equipment are used in operations,
expenditures may be incurred on them. These expenditures may be treated as
revenue expenditures or capital expenditures. Capital expenditures are added to the
carrying amount of the asset when it is probable that future economic benefits will flow

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to the enterprise and the expenditure significantly improves the condition of the asset
beyond its originally assessed standard of performance. Examples of these
expenditures are (a) modifications that extend useful economic life or increases the
asset’s capacity; (b) upgrade of machine parts to improve the quality of output; and (c)
adoption of new production process that substantially reduces operating costs. All
other subsequent expenditures should be recognized in the period incurred, such as
normal repairs and maintenance. When expenditures are incurred as a result of
accidents, neglect, intentional abuse and theft, they are recognized as losses.

DEPRECIATION

As the items of property, plant and equipment are utilized in operations, a

charge against revenue is recognized in the form of depreciation. Depreciation is the
process of allocating the depreciable amount of an asset over its useful life in a
systematic and rational manner. There are different depreciation methods but the
method should reflect the pattern in which the asset’s economic benefits are
consumed by the enterprise. The factors considered in determining the useful life of
an asset include (a) the expected usage of the asset by the entity; (b) the expected
physical wear and tear; (c) technical obsolescence; and (d) legal or similar limits on
the use of the asset.

Straight-line method. This is the simplest method of depreciation, recognizing

uniform amount of annual depreciation. The amount is obtained by dividing the
depreciable cost of the asset by estimated useful life in years. The depreciable cost
of the asset is its cost reduced by the estimated residual value.

Sum-of-the-years digits (SYD) method. This is a decreasing charge method

that recognizes the highest amount of depreciation in its early years of use. SYD is
particularly adopted for asset that provide the most benefits in its early years of use.
The annual depreciation is computed as:

Depreciable cost x Estimated useful life, beginning of year

Sum-of-the-years digits

Declining balance method. The declining balance method comes in three

forms: declining balance method, double-declining balance method and 150%
declining balance method. The difference simply lies in the manner the fixed rate is
obtained and this fixed rate is applied to the declining carrying amount of the asset.
The rates are computed as follows (where n = life in years):

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 n
________________
Declining balance method: rate = 1 - ÖCost- Residual value

Double declining balance method: rate = 2/n

150% declining balance method: rate = 1.5/n

Note that in the last two methods, the residual value of the asset is simply
ignored. In all instances, the amounts of depreciation are decreasing charges.

Productive-output method. Similar to straight line method, the amount of

depreciation is a uniform amount, not per year, but per unit of output, computed as

Depreciation per unit = Depreciable cost

Total expected output

Under this method, the depreciation expense is considered a variable expense

because its amount will vary with the production for the period, unlike in the other
methods, that depreciation expense is considered as a fixed expense.

Component depreciation. Under the concept of component depreciation, each

part of an item of property, plant and equipment with a cost that is significant in relation
to the total cost of the item shall be depreciated separately.

DEPRECIATION POLICY

Because depreciation is an internal transaction, an entity may set up its

depreciation policy for its property, plant and equipment items. The acquisition of the
different items of this group of assets may come at any date during the year.
Depreciation for the assets may come in any of the following:

(a) Depreciation is computed to the nearest month. Therefore, an asset acquired

on February 5 is depreciated for 11 months, as if acquired on February 1; if
acquired on September 20, it is depreciated for 3 months, as if acquired on
October 1.

(b) Depreciation is 50% in the year of acquisition and 50% in the year of disposal.
Therefore, whether an asset was acquired on February 5 or September 30, the
asset shall be depreciated at half its rate in the year of acquisition and also in
the year of disposal.

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(c) No depreciation is taken in the year of acquisition and full depreciation in the
year of disposal. Therefore, an asset acquired any time during 2020 shall not
be depreciation in the year 2020 and depreciation starts in 2021. However,
when the asset is sold or disposed, it shall be depreciated for full year,
regardless of the date of disposal.

(d) Full depreciation is taken in the year of acquisition and no depreciation in the
year of disposal. This is an exact reverse of (c).

REVIEW OF USEFUL LIFE AND DEPRECIATION METHODS

The useful life of an item of property, plant and equipment should be reviewed
periodically and, if expectations are significantly different from previous estimates, the
depreciation charge for the current and future periods should be adjusted. No
retrospective adjustment is required in the accounts.

Similarly, the depreciation method applied to property, plant and equipment

should be reviewed periodically and, if there has been significant change in the
expected pattern of economic benefits from those assets, the method should be
changed to reflect the changed pattern. When such a change is necessary, the
change should be accounted for as a change in estimate and depreciation charge for
the current and future periods should be adjusted.

MEASUREMENT SUBSEQUENT TO INITIAL RECOGNITION

Subsequent to initial recognition, an entity may choose either the cost model
or revaluation model as its accounting policy. Under the cost model, the item of
property, plant and equipment is carried at its cost less any accumulated depreciation
and any accumulated impairment losses. Under the revaluation model, the item of
property, plant and equipment is carried at its fair value at the date of the revaluation
less any subsequent accumulated depreciation and subsequent accumulated
impairment losses. Revaluations shall be made with sufficient regularity to ensure that
the carrying amount does not materially differ from that which would be determined
using fair value at the reporting date. It is emphasized that the choice of the model is
to be applied to an entire class of property, plant and equipment and not in an
individual asset.

IMPAIRMENT OF PROPERTY, PLANT AND EQUIPMENT

When an item of property, plant and equipment has suffered an impairment in

value, the entity should write down the carrying amount of such asset to its recoverable
amount. This reduction is recognized as an impairment loss in the profit or loss
statement in the period when the impairment occurs. The recoverable amount of an

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assets is measured as the higher value of the asset’s net selling price and the asset’s
value in use. The net selling price is the amount obtainable from the sale of the asset
in an arm’s length transaction between knowledgeable and willing parties, less costs
of disposal. The value in use is measured as the present value of the estimated future
cash flows expected from the continued use of the asset and from its disposal at the
end of its life.

When there is a reversal of previous impairment loss, the reversal should be

recognized immediately as income in the profit or loss statement and the carrying
amount of the asset is increased to its new recoverable amount. However, under the
cost model, the new recoverable amount should not exceed its carrying value as if no
impairment loss has been previously recorded.

DEPLETION OF NATURAL RESOURCES

Similar to property, plant and equipment, wasting assets (natural resources

and mineral rights) are subject to depletion which requires a systematic allocation of
its cost over the period that the natural resource is extracted or produced. The method
used for depletion takes the form of the productive output method, where the depletion
rate is computed as

Depletable cost (less estimated residual value)

Total estimated units that can be recovered from the asset

ASSESSMENT PROBLEMS

1. Heavy Machine Shop purchased the following used equipment at a special

auction sale for P400,000 cash: a drill press, a lathe machine and a heavy-
duty air compressor. The equipment was in excellent condition except for the
electric motor on the lathe machine, which will cost P9,000 to replace with a
new motor. Heavy Machine Shop has determined that the selling prices for
the used items in local outlets are approximately as follows: Drill press –
P84,000; Lathe machine, with good motor – P240,000; Air compressor –
P105,000.

How much is the allocated cost of drill press, lathe machine and air
compressor, respectively?

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2. On January 1, 2020, the records of Claireborne Company showed the following
accounts and balances in its property, plant and equipment category:

Land – P350,000
Land Improvements – P20,000
Buildings – P900,000

During 2020, the following data were gathered from an analysis of the
accounts:

Cash paid on purchase of land and old building (value of

old building is deemed insignificant) P1,250,000
15% Mortgage payable assumed on purchase of property 2,000,000
Realtor’s commission 150,000
Legal fees, realty taxes and documentation expenses 25,000
Payment to persons squatting on the property to relocate 50,000
them
Cost of demolishing the old building on the land 60,000
Recovery from the salvage of the building demolished 45,000
Cost of fencing the property 55,000
Payment to contractor for a building constructed 1,000,000
Building permit fees 10,000
Excavation expenses 25,000
Architect’s fees 25,000
Interest that could have been incurred if the money used
for the building construction were borrowed at the
prevailing interest rate of 12% 120,000

What are the balances of Land, Land Improvements and Buildings accounts,
respectively, at December 31, 2020?

3. Jean Company is constructing a building for its own use. Jean Company
capitalizes interest on an annual basis. The following cumulative
expenditures were reflected in its records during 2020:

January 1 - P1.5 M October 1 - P4.2 M

March 1 - P1.86 M December 1 - P4.5 M

The building was completed on December 31, 2020 and it became operational
in 2021. At the beginning of the construction period, Jean Company issued a
12% note for P1,500,000, specifically to finance the construction of the plant.
Prior to its disbursement, the some of the proceeds from the loan were
temporarily invested and earned interest income of P8,000.

(a) How much is the capitalized interest?

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 (b) Assume that in addition to the P1.5 million specific borrowing, Jean
Company had the following outstanding debts throughout the year.

16% Notes Payable - P1,000,000

13% Notes Payable - 500,000

How much is the total cost of the self-constructed building?

(c) Assume that Jean Company did not have any specific borrowing.
However, it had the following outstanding debts throughout the year,
proceeds of which were partly used for the construction of the plant.

16.25% Notes Payable - P1,000,000

14% Notes Payable - P3,500,000

How much is the interest expense reported in profit or loss for the year
2020?

4. The Armani Company takes a full year depreciation expense in the year of an
asset’s acquisition and no depreciation in the year of disposal. Data relating
to one of Armani’s depreciable assets at December 31, 2019 is as follows:

Year of acquisition - 2018

Estimated residual value - 15,000
Cost - P225,000
Estimated useful life - 10 years
Accumulated depreciation - P81,000

Using the same depreciation method as used in 2018 and 2019, how much
depreciation expense should be recorded for this asset in the year 2020?

5. On January 1, 2015, Davidoff Corporation acquired a building at a cost of P22

million. The building has been depreciated using straight-line on the basis of
a 20-year life, with a residual value of P2 million.

On January 1, 2020, an appraisal of the building by professional and competent

appraisers reported a fair value of P20 million with an estimated residual value
of P3 million and a remaining useful life of 10 years. It is the company’s policy
to transfer a portion of the revaluation surplus to retained earnings while the
asset is being used by the company.

Assume that the accumulated depreciation of the revalued asset is restated

proportionately with the change in the gross carrying amount of the asset.

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 (a) How much is the revaluation surplus recognized in the accounts at
January 1, 2020?

(b) How much is the annual depreciation charge for the building after
revaluation?

(c) Assuming that no further revaluation was recorded and the asset was
sold on January 1, 2024 for P1,350,000, what is the gain or loss
recognized by Davidoff upon the disposal of the asset?

READING MATERIALS

1. Chapter 2, Robles and Empleo, The Intermediate Accounting Series, Volume

2, 2019 ed
2. IAS 16: Property, Plant and Equipment, https://www.ifrs.org/issued-
standards/list-of-standards/ias-16-property-plant-and-equipment/
3. IAS 23: Borrowing Cost, https://www.ifrs.org/issued-standards/list-of-
standards/ias-23-borrowing-costs/
4. IAS 36: Impairment of Assets, https://www.ifrs.org/supporting-
implementation/supporting-materials-by-ifrs-standard/ias-36/
5. Chapter 1, Bergonia, Noel A., Dela Pena, Elvira V. and Lascano, Lyra,
Villareal V., Financial Accounting and Reporting 2(Workbook)
6. CIRC HF 5635 W37 2014, Warren, Carl S., Financial Accounting, 13th ed.,
2014
7. CIRC HF 5635 F56 2013, William, Jan R., Financial & Managerial Accounting:
The basis for business decisions, 16th ed., 2013
8. CIRC HF 5635 F5313 2013, William, Jan R., Financial Accounting, 15th 3d.
2013
9. REF HF 5626 1594 W55 2013, Wiley 2012 Interpretation and application of
international financial reporting standards, Bruce Mackenzie, 2013

ASSESSMENTS

1. Solve the problems at the end of Module 5.

2. Answer the discussion questions, problems and multiple-choice questions at
the end of Chapter 12, Textbook, Volume 2
3. Answer the exercises and problems in Chapter 2 of Workbook 2.
4. Quiz on the topic of Module 1 will be announced.

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