Cañaveral, Rhia Pixie T.

2nd Yr. BS Accountancy

Assignment: Land and Building, Machinery, Depreciation,
Depletion, Revaluation and Impairment of Asset
Intermediate Accounting 1

Land Account
Land used as a plant site shall be treated as property, plant and equipment. Land held for a currently
undetermined use is treated as an investment property. However, if the land is held definitely as a
future plant site, it is classified as owner-occupied property and not an investment property and
therefore shall be included in property, plant and equipment.
Land held for long-term capital appreciation is treated as an investment property. Land held for
current sale by a real estate developer as in the case of subdivided lots is treated as current asset as
part of inventory.
Costs chargeable to land
a. Purchase price
b. Legal fees and other expenditures for establishing clean title
c. Broker or agent commission
d. Escrow fees
e. Fees for registration and transfer of title
f. Cost of relocation or reconstruction of property belonging to others in order to acquire
possession
g. Mortgages, encumbrances and interest on such mortgages assumed by buyer
h. Unpaid taxes up to date of acquisition assumed by buyer
i. Cost of survey
j. Payments to tenants to induce them to vacate the land in order to prepare the land for the
intended use but not to make room for the construction of new building
k. Cost of permanent improvements such as cost of clearing, cost of grading, leveling and
landfill
l. Cost of option to buy the acquired land. If the land is not acquired, the cost of option is
expensed outright.
Land improvements
Land improvements not subject to depreciation are charged to the land account. On the other hand,
depreciable land improvements are charged to a special account "land improvements.". Land
improvements of this type should be depreciated over their useful life.
Special assessments
Special assessments are taxes paid by the landowner as a contribution to the cost of public
improvements. Special assessments are treated as part of the cost of the land. Special assessments
are capitalized as cost of land because public improvements increase definitely the value of the land.
Real property taxes
As a rule, real property taxes are treated as outright expense. However, if unpaid real property taxes
are assumed by the buyer in acquiring land, the taxes are capitalized but only up to the date of
acquisition. The real property taxes subsequent to the date of acquisition should be treated as
expense.
Building Account
The following expenditures are normally charged to the building account when building is acquired by
purchase:
a. Purchase price
b. Legal fees and other expenses incurred in connection with the purchase
c. Unpaid taxes up to date of acquisition d. Interest, mortgage, liens and other encumbrances
on the building assumed by the buyer
d. Payments to tenants to induce them to vacate the building f. Any renovating or remodeling
costs incurred to put a building purchased in a condition suitable for the intended use such
as lighting installations, partitions and repairs.
The following expenditures are normally charged to the building when acquired by means of
construction:
a. Materials used, labor employed and overhead incurred during the construction
 b. Building permit or license
c. Architect fee
d. Superintendent fee.
e. Cost of excavation
f. Cost of temporary buildings used as construction offices and tools or materials shed
g. Expenditures incurred during the construction period such as interest on construction loans
and insurance. h. Expenditures for service equipment and fixtures made a permanent part
of the structure.
h. Cost of temporary safety fence around construction site and cost of subsequent removal
thereof.
However, the construction of a permanent fence after the completion of the building is recognized as
land improvement. Safety inspection fee
Sidewalks, pavements, parking lot, driveways
a. If the such expenditures are part of the blueprint for the construction of a new building,
these are charged to the building account.
b. On the other hand, the expenditures that are occasionally made or incurred not in
connection with the construction of a new building are charged to land improvements.
Claims for damages
Where insurance is taken during the construction of a building, the cost of insurance is charged to the
building because it is a necessary and a reasonable cost of bringing the building into existence.
However, where insurance is not taken and the entity is required to pay claims for damages for
injuries sustained during the construction, the payment for damages should be expensed outright
because the damages represent management failure or negligence in procuring insurance and are not
a reasonable and necessary cost of construction. To charge the damages to the building would be
tantamount to concealment of the management failure or negligence.
Building fixtures
Expenditures for shelves, cabinets and partitions that are immovable in the sense that these are
attached to the building in such a manner that the removal thereof may destroy the building should
be charged to the building account. On the other hand, expenditures for shelves, cabinets and
partitions that are movable should be charged to furniture and fixtures and depreciated over their
useful life.
Ventilating system, lighting system, elevator
a. If installed during construction, the ventilating system, lighting system and elevator should
be charged to the building account.
b. Otherwise, the expenditures should be charged to building improvements and depreciated
over their useful life or remaining life of the building, whichever is shorter.
PIC Interpretation on land and building
1. Land and an old building are purchased at a single cost:
a) If the old building is usable, the single cost is allocated to land and building based on
relative fair value.
b) If the old building is unusable, the single cost is allocated to land only.
2. The old building is demolished immediately to make room for construction of a new building:
a) Any allocated carrying amount of the usable old building is recognized as a loss if the new
building is accounted for as property, plant and equipment or investment property.
b) Any allocated carrying amount of the usable old building is capitalized as cost of the new
building if the new building is accounted for as inventory.
c) The demolition cost minus salvage value is capitalized as cost of the new building whether
the new building is accounted for as property, plant and equipment, investment property
or inventory.
d) Needless to say, the net demolition cost is capitalized as cost of the land if the old building
is demolished to prepare the land for the intended use but not to make room for the
construction of new building.
3. A building is acquired and used in a prior period but demolished in the current period to make
room for construction of a new building:
a) The carrying amount of the old building is recognized as a loss, whether the new building is
property, plant and equipment, investment property or inventory.
 b) The net demolition cost is capitalized as cost of the new building whether the new building
is accounted for as property, plant and equipment, investment property or inventory.
c) If the old building is subject to a contract of lease, any payments to tenants to induce them
to vacate the old building shall be charged to the cost of the new building.

Machinery
When machinery is purchased, the cost normally includes the following:
a. Purchase price
b. Freight, handling, storage and other cost related to the acquisition
c. Insurance while in transit HATS HD
d. Installation cost, including site preparation and assembling
e. Cost of testing and trial run, and other cost necessary in preparing the machinery for its
intended use.
f. Initial estimate of cost of dismantling and removing the machinery and restoring the site on
which it is located and for which the entity has a present obligation as required by law or
contract.
g. Fee paid to consultants for advice on the acquisition of the machinery.
h. Cost of safety rail and platform surrounding machine. i. Cost of water device to keep
machine cool.
If machinery is removed and retired to make room for the installation of a new one, the removal cost
not previously recognized as a provision is charged to expense. The value added tax or VAT on the
purchase of machinery is not capitalizable but charged to input tax to be offset against output tax.
However, any irrecoverable or nonrefundable purchase tax is capitalized as cost of the machinery.
Tools
Tools are classified as machine tools and hand tools. Machine tools include drills and punches. Hand
tools include hammer and saws. Tools should be segregated from the machinery account.
Patterns and dies
Patterns and dies are used in designing or forging out a particular product. Patterns and dies used for
the regular product are recorded as assets. Patterns and dies are depreciated over the useful life.
However, patterns and dies used for specially ordered product form part of the cost of the special
product.
Equipment
The term "equipment" includes delivery equipment, store equipment, office equipment and furniture
and fixtures. The cost of such equipment includes the purchase price, freight and other handling
charges, insurance while in transit, installation costs and other costs necessary in preparing them for
the intended use.
Delivery equipment includes cars, trucks and other vehicles used in business operations. Motor
vehicle registration fees should be expensed and not be included as part of the cost of the delivery
equipment. Store and office equipment include computers, typewriters, adding machines, cash
register and calculator.
Assets identified with the selling function are classified as store equipment. Otherwise, the assets are
charged to office equipment. Furniture and fixtures include showcases, counters, shelves, display
fixtures, cabinets, partitions, safes, desks and tables. In a broad sense, furniture and fixtures may
include store and office equipment.
Returnable containers
Returnable containers include bottles, boxes, tanks, drums and barrels which are returned to the
seller by the buyer when the contents are consumed or used. Containers in big units or of great bulk
as in the case of tanks, drums and barrels are classified as property, plant and equipment.
On the other hand, containers that are small and individually involve small amount as in the case of
bottles and boxes are classified as other non-current assets. Needless to say, containers that are not
returnable are charged outright to expense.
Capital expenditure and revenue expenditure
An expenditure that benefits only the current period is a revenue expenditure and therefore reported
as an expense. An expenditure that benefits the current period and future periods is a capital
expenditure and therefore reported as an asset.
Recognition of subsequent cost
The recognition of subsequent cost is subject to the same recognition criteria for the initial cost of
property, plant and equipment.
Accordingly, the subsequent cost incurred for property, plant and equipment shall be recognized as
an asset when:
a. It is probable that future economic benefits associated with the subsequent cost will flow
to the entity.
b. The subsequent cost can be measured reliably.
In other words, if the subsequent cost will increase the future service potential of the asset, the cost
should be capitalized. If the subsequent cost merely maintains the existing level of standard
performance, the cost should be expensed when incurred.
Future economic benefit
In general, a subsequent cost on an item of property, plant and equipment will benefit future periods
or increase the future service potential of an asset when:
a. The expenditure extends the life of the property.
b. The expenditure increases the capacity of the property and quality of output, for example,
by upgrading machine parts.
c. The expenditure improves the efficiency and safety of the property, for example, by
adopting a new production process leading to large reduction in operating cost.
Subsequent cost
Generally, the following expenditures are incurred during ownership of existing property, plant and
equipment.
a. Additions
b. Improvements or betterments
c. Replacements
d. Repairs e. Rearrangement cost
Additions
Additions are modifications or alterations which increase the physical size or capacity of the asset.
Such expenditures are of two types, namely:
a. An entirely new unit
b. An expansion, enlargement or extension of the old asset
The construction of a new building is an addition of the first type but the addition of a wing to a
building or the construction of a third storey on a two-storey building is an addition of the second
type. In either case, the cost is capitalized in the usual manner. The cost of an addition which is a new
unit is depreciated over the useful life. But the cost of an expansion should be depreciated over the
useful life of the expansion or remaining useful life of the asset of which it is part, whichever is
shorter.
Improvements or betterments
Improvements or betterments are modifications or alternations which increase the service life or the
capacity of the asset. Improvements may represent replacement of an asset or part thereof with one
of a better or superior quality. Such expenditures are normally capitalized. The improvements that do
not involve replacement of parts are simply added to the cost of the existing asset.
Examples of improvements are:
a. A tile roof is substituted for wooden shingles
b. A shatter proof glass is substituted for ordinary glass
c. An old motor in a machine is replaced by a new and powerful one
d. Galvanized iron roofing is substituted for nipa roofing
e. Replacement of wooden floor by concrete flooring
Replacements
Replacements also involve substitution but the new asset is not better than the old asset when
acquired.
The basic difference between an improvement and replacement is that an improvement is a
substitution of a better or superior quality whereas a replacement is a substitution of an equal or
lesser quality.
Replacements may be classified into three:
a. Replacement of the old asset by a new one. This is the replacement contemplated.
b. Replacement of major parts or extraordinary repairs.
c. Replacement of minor parts or ordinary repairs.
Repairs
Repairs are those expenditures used to restore assets to good operating condition upon their
breakdown or replacement of broken parts. Repairs may be classified as extraordinary repairs and
ordinary repairs. Extraordinary repairs are material replacement of parts, involving large sums and
normally extend the useful life of the asset. Extraordinary repairs are usually capitalized.
Ordinary repairs are minor replacement of parts, involving small sums and are frequently
encountered. Ordinary repairs are normally charged to expense when incurred. Accordingly, an entity
does not include in the carrying amount of property, plant and equipment the cost of day-to-day
servicing of the property. Rather, such cost of day-to-day servicing is recognized as expense when
incurred.
Repair and maintenance
Repair is different from maintenance in that repair restores the asset in good operating condition
while maintenance keeps the asset in good condition. Thus, repair is or curative while maintenance is
preventive. The theoretical distinction is difficult to maintain in practice, hence the two are combined
in a single account "repair and maintenance."
Rearrangement cost
Rearrangement cost is the relocation or redeployment of an existing property, plant and equipment.
PAS 16, paragraph 20, provides that recognition of costs in the carrying amount of property, plant and
equipment ceases when the asset is in the location and condition for the intended use.
In other words, IFRS expressly mandates that the costs of relocating existing property, plant and
equipment or costs of reorganizing part or all of an entity's operations are not capitalized but
expensed as incurred. The rearrangement merely maintains the existing level of standard
performance of the asset.
Accounting for major replacement
An important consideration in determining the appropriate accounting treatment for a replacement is
whether the original part of an existing asset is separately identifiable. If separate identification is
practicable, the major replacement is debited to the asset account. The cost of the part eliminated
and the related accumulated depreciation are removed from the accounts and the remaining carrying
amount of the old part is treated as a loss.
If it is not practicable for an entity to determine the carrying amount of the replaced part, it may use
the cost of the replacement as an indication of the "likely original cost of the replaced part at the time
it was acquired or constructed. However, the current replacement cost shall be discounted.

Depreciation
Introduction
Property, plant and equipment, except land, normally are usable for a number of years after which
the assets have relatively little value either for service or for sale. The difference between the original
cost of a property and any remaining value when it is retired or worn out is an expense that should be
distributed to the periods during which the asset is used. The portion that is allocated to expense in a
particular period is referred to by three different terms namely:
a. Depreciation
b. Depletion
c. Amortization
The three terms are similar in meaning. The only difference lies in the type of asset involved.
Technically, depreciation refers to property, plant and equipment, depletion to wasting assets and
amortization to intangible assets.
CONCEPT OF DEPRECIATION
Depreciation is defined as the systematic allocation of the depreciable amount of an asset over the
useful life. Depreciation is not so much a matter of valuation. Depreciation is a matter of cost
allocation in recognition of the exhaustion of the useful life of an item of property, plant and
equipment. The objective of depreciation is to have each period benefiting from the use of the asset
bear an equitable share of the asset cost.
Depreciation in the financial statements
Depreciation is an expense. It may be a part of the cost of goods manufactured or an operating
expense. The depreciation charge for each period shall be recognized as expense unless it is included
in the carrying amount of another asset. Except for non-exhaustible land, all property shall be
depreciated on a systematic basis over the useful life of the asset irrespective of the earnings of the
entity. The financial statements would be misstated if depreciation is omitted when the entity has a
loss and recognized when the entity has a gain. The omission of depreciation may somehow impair
legal capital if and when dividends are declared out of earnings before provision for depreciation.
Depreciation period
Depreciation of an asset begins when it is available for use, meaning, when the asset is in the location
and condition necessary for it to be capable of operating in the manner intended by management.
Depreciation ceases when the asset is derecognized. Therefore, depreciation does not cease when
the asset becomes idle temporarily. Temporary idle activity does not preclude depreciating the asset
as future economic benefits are consumed not only through usage but also through wear and tear
and obsolescence.
PFRS 5, paragraph 25, provides that if the asset is classified as held for sale depreciation shall be
discontinued.
Kinds of depreciation
There are two kinds of depreciation, namely physical depreciation and functional or economic
depreciation. Physical depreciation is related to the depreciable asset's wear and tear and
deterioration over a period.
Physical depreciation may be caused by:
a. Wear and tear due to frequent use
b. Passage of time due to non-use
c. Action of the elements such as wind, sunshine, rain or dust natural disaster animals
and wooden buildings.
d. Casualty or accident such as fire, flood, earthquake and other
e. Disease or decay - This physical cause is applicable to animals and wooden buildings.
Accordingly, physical depreciation results to the ultimate retirement of the property or termination of
the service life of the asset. Functional or economic depreciation arises from inadequacy,
supersession and obsolescence. Inadequacy arises when the asset is no longer useful to the entity
because of an increase in the volume of operations. Supersession arises when a new asset becomes
available and the new asset can perform the same function more efficiently and economically or for
substantially less cost. Obsolescence is the catchall for economic or functional depreciation.
Obsolescence encompasses inadequacy and supersession. An asset becomes obsolete if it is
inadequate or superseded.
Factors of depreciation
In order to properly compute the amount of depreciation, three factors are necessary, namely
depreciable amount, residual value and useful life.
Depreciable amount
Depreciable amount or depreciable cost is the cost of an asset or other amount substituted for cost,
less the residual value.
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. The entity also depreciates separately the
remainder of the item and the remainder consists of the parts of the item that are individually not
significant.
Residual value
Residual value is the estimated net amount currently obtainable if the asset is at the end of the useful
life. The residual value of an asset shall be reviewed at least at each financial year-end and if
expectation differs from previous estimate, the change shall be accounted for as a change in an
accounting estimate. In practice, the residual value of an asset is often insignificant and therefore
immaterial in the calculation of the depreciable amount. The residual value of an asset may increase
to an amount equal to or greater than the carrying amount. If it does, the depreciation charge is zero
unless and until the residual value subsequently decreases to an amount below the carrying amount.
Depreciation is recognized even if the fair value of the asset exceeds the carrying amount as long as
the residual value does not exceed the carrying amount.
Useful life
Useful life is either the period over which an asset is expected to be available for use by the entity, or
the number of production or similar units expected to be obtained from the asset by the entity.
Accordingly, the useful life of an asset is expressed as:
a. Time periods as in years
b. Units of output or production
 c. Service hours or working hours
Factors in determining useful life
a. Expected usage of the asset - Usage is assessed by reference to the asset's expected
capacity or physical output.
b. Expected physical wear and tear depends on the operational factors such as the number of
shifts the asset is used, the repair and maintenance program, and the care and
maintenance of the asset while idle.
c. Technical or commercial obsolescence arises from changes or improvements in production,
or change in the market demand for the product output of the asset.
d. Legal limits for the use of the asset, such as the expiry date of the related lease.
Incidentally, the service life of an asset should be distinguished from physical life. Service life is the
period of time an asset shall be used by an entity. The service life is the equivalent of useful life.
Physical life refers to how long the asset shall last.
Depreciation method
The depreciation method shall reflect the pattern in which the future economic benefits from the
asset are expected to be consumed by the entity. The depreciation method shall be reviewed at least
at every year-end. The method shall be changed if there is a significant change in the expected
pattern of future economic benefits. Such change in depreciation method shall be accounted for as
change in accounting estimate.
Methods of depreciation
1. Equal or uniform charge methods
a) Straight line
b) Composite method
c) Group method
2. Variable charge or use-factor or activity methods
a) Working hours or service hours
b) Output or production method
3. Decreasing charge or accelerated or diminishing balance methods
a) Sum of years' digits
b) Declining balance method
c) Double declining balance
4. Other methods
a) Inventory or appraisal
b) Retirement method
c) Replacement method
Straight line method
Under the straight line method, the annual depreciation charge is calculated by allocating the
depreciable amount equally over the number of years of estimated useful life. In other words, straight
line depreciation is a constant charge over the useful life of the asset. The formula for the
computation of the annual depreciation following the straight line method is as follows:
Annual depreciation =Cost minus residual value/Useful life in years
Cost minus residual value equals depreciable amount.
Straight line rate
Depreciable amount multiplied by the straight line rate of depreciation also gives the amount of
annual depreciation. The straight line rate is determined by dividing 100% by the life of the asset in
years.
Rationale for straight line
The straight line method is adopted when the principal cause of depreciation is passage of time. The
straight line approach considers depreciation as a function of time rather than as a function of usage.
Although use and obsolescence contribute to the depreciation of such assets, such causes are
insignificant compared to the effects of time. The straight line method is widely used in practice
because of simplicity.
Composite and group method
Large entities own various individual depreciable assets. For these entities, making detailed
depreciation computation for each individual asset referred to as unit depreciation is time consuming
and costly. Therefore, large entities find it more practical to compute depreciation by treating many
individual assets as though they were a single asset. The two methods of depreciating various
individual assets as a single asset are composite method and group method.
Under the composite method, assets that are dissimilar in nature or assets that have different
physical characteristics and vary widely in useful life, are grouped and treated as a single unit.
Under the group method all assets that are similar in nature and in estimated useful life are grouped
and treated as a single unit. The accounting procedure and the method of computation for the
composite and group method are essentially the same.
In other words, the average useful life and the composite or group rate are computed, and the assets
in the group are depreciated on that basis.
Accounting procedures
a. Depreciation is reported in a single accumulated depreciation account. Thus, the
accumulated depreciation account is not related to any specific asset account.
b. The composite or group rate is multiplied by the total cost of the assets in the group to get
the periodic depreciation.
c. When an asset in the group is retired, no gain or loss is reported. The asset account is
credited for the cost of the asset retired and the accumulated depreciation account is
debited for the cost minus salvage proceeds.
d. When the asset retired is replaced by a similar asset, the replacement is recorded by
debiting the asset account and crediting cash or other appropriate account. Subsequently,
the composite or group rate is multiplied by the balance of the asset account to get the
periodic depreciation.
Variable charge or activity methods
The variable or activity methods assume that depreciation is more a function of use rather than
passage of time. The useful life of the asset is considered in terms of the output it produces or the
number of hours it works. Thus, depreciation is related to the estimated production capability of the
asset and is expressed in a rate per unit of output or per hour of use.
There are two variable methods, namely:
a. Working hours method
b. Output or production method
Rationale for variable depreciation
The variable methods are adopted if the principal cause of depreciation is usage.
The use of these methods is based on the following:
a. Assets depreciate more rapidly if they are used full time or overtime.
b. There is a direct relationship between utilization of assets and realization of revenue.
If assets are used more intensively in production, greater revenue is expected.
The variable methods are found to be appropriate for assets such as machineries. The major objection
to these methods is that the units of output or service hours which serve as the basis of depreciation
may be difficult to estimate.
Decreasing Charge or Accelerated Methods
The decreasing charge or accelerated methods provide higher depreciation in the earlier years and
lower depreciation in the later years of the useful life of the asset. Thus, these methods result in a
decreasing depreciation charge over the useful life.
Rationale for accelerated depreciation
The accelerated depreciation is on the philosophy that new assets are generally capable of producing
more revenue in the earlier years than in the later years.
Another argument for the use of decreasing charge method is that the cost of using an asset includes
not only depreciation but also repairs on such assets. Such repair cost should be allocated over the
useful life of the asset on a systematic and uniform basis. It has been observed that repairs tend to
increase with the age of the asset, hence repairs are small in the earlier years and large during the
later years.
Therefore, following the decreasing charge method, the overall effect would be a uniform charge
because the decreasing amount of depreciation and the increasing repairs will tend to equalize each
other.
There are three decreasing charge methods, namely:
a. Sum of years' digits
b. Declining balance
c. Double declining balance
Sum of years' digits
The sum of years' digits method provides for depreciation that is computed by multiplying the
depreciable amount by a series of fractions whose numerator is the digit in the useful life of the asset
and whose denominator is the sum of the digits in the useful life of the asset. The fractions are
developed by getting the sum of the digits in the useful life of the asset.
sum of years' digit (SYD) as follows:
SYD = Life (Life +1 / 2)
Sum of half years' digits
If the useful life of the asset is 2 1/2 years, the procedure is to multiply the useful life by 2 in order to
get the useful life of the asset in half years. Thus, the useful life of the asset in half years would be 5 (2
1/2 years x 2). The sum of half years' digits would then be 15 or 1+2+3+4+5.

First year Two fractions: 5/15 and 4/15 (each fraction pertaining to half year or six months)

Second year Two fractions: (3/15 and 2/15)

Third year One fraction: 1/15

Declining balance method
Under the declining balance method, a fixed or uniform rate is multiplied by the declining carrying
amount of the asset in order to arrive at the annual depreciation. Because of the use of a fixed rate,
this method is also known as fixed rate on diminishing carrying amount method. The problem in this
method is the determination of the fixed rate to be applied against the carrying amount.
Formula for fixed rate
Rate = 1- √n Residual value ÷Cost
The "n" in the formula is the useful life of the asset. Observe that the nature of the method is such
that the value of the asset cannot be reduced to zero and that the formula cannot be used unless
there is a residual value. Thus, a residual value must always be assigned to the asset. In the absence of
any residual value, a nominal amount of P1should be assumed.
Double declining balance method
The common application of the declining balance method is the double declining balance. The
procedure for the double declining balance method is the same as the declining balance method in
that a fixed rate is multiplied by the declining carrying amount of the asset to arrive at the annual
depreciation. Actually, the double declining balance method is an approximation of the declining
balance method. The difference between the two lies in the determination of the rate to be used.
Under the declining balance method, the fixed rate is determined following a mathematical formula.
But under the double declining balance method, the straight line rate is simply doubled to get the
fixed rate. The term "double declining balance" came to its name because the straight line rate is
simply doubled. This method is also known as "200% declining balance method".
Inventory method
The inventory method consists of merely estimating the value of the asset at the end of the period.
The difference between the balance of the asset account and the value at the end of the year is then
recognized as depreciation for the year:
In recording depreciation, no accumulated depreciation account is maintained. The depreciation is
credited directly to the asset account.
This depreciation approach is applied generally to assets which are small and relatively inexpensive
such as hand tools or utensils. The approach is defended on practical grounds.
Retirement and replacement method
Under the retirement method of depreciation, no depreciation is recorded until the asset is retired.
The amount of depreciation is equal to the original cost of the asset retired minus salvage proceeds.
Under the replacement method, no depreciation is recorded until the asset is retired and replaced.
The amount of depreciation is equal to the replacement cost of the asset retired, minus salvage
proceeds. If the asset retired is not replaced, the original cost of the asset retired but not replaced is
recognized as depreciation. The retirement and replacement method may be used in much the same
situations as the inventory method.
Change in useful life
Unexpected physical deterioration or technological improvement may indicate that the useful life of
the asset is less than that originally estimated. On the other hand, improved maintenance procedures
or revision of operating procedures may prolong the useful life of the asset beyond the original
estimate. The useful life of an item of property, plant and equipment shall be reviewed at least at
each financial year-end and if expectations are significantly different from previous estimate, the
change shall be accounted for as a change in accounting estimate. Therefore, the depreciation charge
for the current and future periods shall be adjusted.
Change in depreciation method
Depreciation method used shall reflect the pattern in which the asset's economic benefits are
expected to be consumed by the entity. The depreciation method shall be reviewed at least at each
financial year-end and if there has been a significant change in the expected pattern of economic
benefits embodied in the asset, the method shall be changed to reflect the new pattern. When such a
change in depreciation method is necessary, the change shall be accounted for as a change in
accounting estimate, and the depreciation charge for the current and future periods shall be adjusted.

Depletion
IFRS 6
The objective of this standard is to specify the financial reporting for the exploration and evaluation of
mineral resources. Mineral resources include minerals, oil, natural gas and similar non-regenerative
resources.
Exploration and Evaluation
The term exploration and evaluation of mineral resources is defined as the search for mineral
resources after the entity has legal right to explore in a specific area as well as the determination of
the technical feasibility and commercial viability of extracting the mineral resources. The expenditures
incurred by an entity in connection with the exploration and evaluation of mineral resources before
the technical feasibility and commercial viability of extracting a mineral resource are known as
exploration and evaluation expenditures. Accordingly, exploration and evaluation expenditures do not
include expenditures incurred:
a. Before an entity has obtained the legal right to explore a specific area.
b. After the technical feasibility and commercial viability of extracting a mineral resource are
demonstrable.
This pertains to development expenditure.
Expenditures related to development of mineral resources, for example, preparation for commercial
production, such as building roads and tunnels, cannot be recognized as exploration and evaluation
expenditures.
Exploration and evaluation expenditures
a. Acquisition of rights to explore
b. Topographical, geological, geochemical and geophysical studies
c. Exploratory drilling
d. Trenching
e. Sampling
f. Activities in relation to evaluating the technical feasibility and commercial viability of
extracting a mineral resource.
g. General and administrative costs directly attributable to exploration and evaluation
activities.
Exploration and evaluation asset
The exploration and evaluation expenditures may qualify as exploration and evaluation asset.
However, the standard does not provide a clearcut guidance for the recognition of exploration and
evaluation asset. Accordingly, an entity must develop its own accounting policy for the recognition of
such asset. As a matter of fact, IFRS 6 permits an entity to continue to apply its previous accounting
policy provided that the resulting information is relevant and reliable.
Measurement and classification
Exploration and evaluation asset shall be measured initially at cost. After initial recognition, an entity
shall apply either the cost model or the revaluation model. Exploration and evaluation asset is
classified either as tangible asset or an intangible asset.
Wasting Assets
Wasting assets are material objects of economic value and utility to man produced by nature.
Actually, wasting assets are natural resources. Natural resources usually include coal, oil, ore, precious
metals like gold and silver, and timber. Wasting assets are so called because these are physically
consumed and once consumed, the assets cannot be replaced anymore. If ever, the wasting assets
can be replaced only by the process of nature. Natural resources cannot be produced by man.
Thus, wasting assets are characterized by two main features:
a. The wasting assets are physically consumed.
b. The wasting assets are irreplaceable.
Cost of wasting asset
Entities follow a wide variety of practices in accounting for an extractive industry. At present, IFRS
does not address wasting assets. There is no comprehensive standard that is applicable to the
extractive or mining industry. The only standard related to the mining industry is IFRS 6 on the
reporting of exploration and evaluation expenditures. In general, the cost of wasting asset can be
divided into four categories, namely:
a. Acquisition cost
b. Exploration cost
c. Development cost
d. Estimated restoration cost
Acquisition cost
Acquisition cost is the price paid to obtain the property containing the natural resource.
Unquestionably, this is the initial cost of the wasting asset. Generally, the acquisition cost is charged
to any descriptive natural resource account. If there is a residual land value after the extraction of the
natural resource, the portion of the acquisition cost applicable to the land may be included in the
natural resource account. The land may be set up in a separate account and the remaining cost should
be charged to the natural resource account. Actually, the land value is the residual value of a wasting
asset for purposes of computing depletion. Thus, the land value should be deducted from the total
acquisition cost to get the depletable amount.
Exploration cost
Exploration cost is the expenditure incurred before the technical feasibility and commercial viability of
extracting a mineral resource are demonstrated. Simply stated, the exploration cost is the cost
incurred in an attempt to locate the natural resource that can economically be extracted or exploited.
Exploration cost includes acquisition of right to explore, geological study, exploratory drilling,
trenching and sampling. The exploration may result in either success or failure.
Two methods of accounting for exploration cost
1. Successful effort method
The exploration cost directly related to the discovery of commercially producible
natural resource is capitalized as cost of the resource property. The exploration cost related to
"dry holes" or unsuccessful discovery is expensed in the period incurred.
2. Full cost method
All exploration costs, whether successful or unsuccessful, are capitalized as cost of the
successful resource discovery. This is on the theory that any exploration cost is a "wild goose
chase" and therefore necessary before any commercially producible and profitable resource can
be found. The cost of drilling dry holes is part of the cost of locating productive holes.
Both methods are used in practice. Most large and successful oil entities follow the successful effort
method. The full cost method is popular among small oil entities.
Development cost
Development cost is the cost incurred to exploit or extract the natural resource that has been located
through successful exploration. Development cost may be in the form of tangible equipment and
intangible development cost. Tangible equipment includes transportation equipment, heavy
machinery, tunnels, bunker and mine shaft. The cost of tangible equipment is not capitalized as cost
of natural resource but set up in a separate account and depreciated in accordance with normal
depreciation policies. Intangible development cost is capitalized as cost of the natural resource. Such
cost includes drilling, sinking mine shaft and construction of wells.
Restoration cost
Estimated restoration cost is the cost to be incurred in order to bring the property to its original
condition. Such restoration cost may be added to the cost of resource property or "netted" against
the expected residual value of the resource property.
PAS 16, paragraph 16, provides that the estimated cost of restoring the property to its original
condition is capitalized only when the entity incurs the obligation when the asset is acquired. In other
words, the estimated restoration cost must be an existing present obligation required by law or
contract. The estimated restoration cost must be "discounted".
Depletion
The removal, extraction or exhaustion of a natural resource is called depletion. Depletion is the
systematic allocation of the depletable amount of a wasting asset over the period the natural
resource is extracted or produced. In essence, however, depletion is recognized as the cost of the
material used in production and thus becomes the finished product of the extractive entity since the
wasting asset is conceived as the total cost of the materials available for production.
Depletion method
Normally, depletion is computed using the output or production method. The depletable amount of
the wasting asset is divided by the units estimated to be extracted to obtain a depletion rate per unit.
The depletion rate per unit is then multiplied by the units extracted during the year to arrive at the
depletion for the period.
Revision of depletion rate
Not frequently, the original estimate of the resource deposit has to be changed either because new
information is available or because production processes have become more sophisticated. The
revision of the original estimate of recoverable resource deposit gives rise to the same problem faced
in accounting for change in estimate concerning the useful life of property, plant and equipment.
Changes in estimate are to be handled currently and prospectively, if necessary. Accordingly, the
procedure is to revise the depletion rate on a prospective basis, that is, by dividing the remaining
depletable cost of the wasting asset by the revised estimate of the productive output.
Depreciation of mining property
Tangible equipment such as transportation equipment, heavy machinery, mine shaft and other
equipment used in mining operations shall be reported in separate accounts and depreciated
following normal depreciation policies.
Generally, the depreciation of equipment used in mining operations is based on the useful life of the
equipment or the useful life of the wasting asset, whichever is shorter. If the useful life of the
equipment is shorter, the straight line method of depreciation is normally used. But if the useful life
of the wasting asset is shorter, the output method of depreciation is frequently used.
However, if the mining equipment is movable and can be used in future extractive project, the
equipment is depreciated over its useful life using the straight line method.
Shutdown
When the output method is used in depreciating mining property, in the event of shutdown, such
method cannot be used. In this case, the depreciation in the year of shutdown is based on the
remaining life of the equipment following the straight line method.
The remaining carrying amount of the equipment is divided by the remaining life of the equipment to
arrive at the depreciation in the year of shutdown.
Trust fund doctrine
Under the trust fund doctrine, the share capital of a corporation is conceived as a trust fund for the
protection of creditors. Consequently, such capital cannot be returned to shareholders during the
lifetime of the corporation. However, the corporation can pay dividends to shareholders but limited
only to the balance of retained earnings. Accordingly, the corporation cannot pay dividends if it has a
deficit because this would be tantamount to a return of capital to shareholders.
Wasting asset doctrine
Under the wasting asset doctrine, a wasting asset corporation or an entity engaged in the extraction
of a natural resource, can legally return capital to shareholders during the lifetime of the corporation.
Accordingly, a wasting asset corporation can pay dividend not only to the extent of retained earnings
but also to the extent of accumulated depletion. The amount paid in excess of retained earnings is
accounted for as a liquidating dividend or return of capital.
Philosophy of the wasting asset doctrine
The wasting asset doctrine authorizes the declaration of dividends in excess of the retained earnings
of the corporation. This is based on the legal philosophy that to limit dividend declaration to the
retained earnings balance would have the effect of retaining in the business funds which are not
needed because the wasting asset is irreplaceable.
The funds then would only be given to the shareholders when the corporation is finally dissolved and
liquidated. The unnecessary and undue retention of funds is unfair to shareholders because such
funds actually represent costs already recovered. Moreover, the creditors are aware of the decreasing
capital requirements which are peculiar to corporations engaged in the exploitation or extraction of
natural resources.

Revaluation
Measurement Of Property, Plant And Equipment
Initially, an item of property, plant and equipment that qualifies for recognition shall be measured at
cost. After recognition, an entity shall choose either the cost model or revaluation model as an
accounting policy and shall apply that policy to an entire class of property, plant and equipment.
Cost model
An item of property, plant and equipment shall be carried at cost less any accumulated depreciation
and any accumulated impairment losses.
Revaluation model
After recognition as an asset, an item of property, plant and equipment whose fair value can be
measured reliably can be carried at a revalued amount. The revalued amount is the fair value at the
date of the revaluation less any subsequent accumulated depreciation and subsequent accumulated
impairment losses.
Frequency of revaluation
Under IFRS, there is no clearcut rule on the frequency of revaluation. The frequency of revaluation
depends upon the changes in the fair value of property, plant and equipment being revalued. When
the fair value of a revalued asset differs materially from the carrying amount, a further revaluation is
necessary. Some property, plant and equipment may experience significant and volatile changes in
fair value thus necessitating annual revaluation. Such frequent or annual revaluations are unnecessary
for property, plant and equipment with only insignificant changes in fair value. Revaluation every
three to five years may be sufficient. IFRS does not mandate that revaluation must be done every
three to five years.
Revaluation of all items in an entire class
When property, plant and equipment are revalued, the entire class of property, plant and equipment
should be revalued. A class of property, plant and equipment is a grouping of assets of a similar
nature and use in an entity's operations.
Examples of separate classes are:
a. Land e. Motor vehicles
b. Aircraft f. Furniture and fixtures
c. Land and buildings g. Office equipment
d. Machinery h. Ships
The assets within a class of property, plant and equipment are revalued simultaneously in order to
avoid selective revaluation of assets and the reporting of amounts which are a mixture of cost and
value at different dates. However, a class of assets may be revalued on a rolling basis provided
revaluation of the class of assets is completed within a short period of time and provided the
revaluations are kept up to date.
Basis of revaluation
The revalued amount of property, plant and equipment is based on the following:
a. Fair value - The fair value is determined by appraisal normally undertaken by professional
qualified valuers. Fair value is the price that would be received to sell an asset in an orderly
transaction between market participants at the measurement date.
b. Depreciated replacement cost - Where market value is not available, depreciated
replacement cost shall be used.
Depreciated replacement cost is the replacement cost or current purchase price of the asset minus
the corresponding accumulated depreciation. The depreciated replacement cost is actually the sound
value of the asset.
Two approaches in recording the revaluation
a. Proportional approach - The accumulated depreciation at the date of revaluation is
restated proportionately with the change in the gross carrying amount of the asset so that
the carrying amount of the asset after revaluation equals the revalued amount.
 b. Elimination approach - The accumulated depreciation is eliminated against the gross
carrying amount of the asset and the net amount restated to the revalued amount of the
asset.
Carrying amount
is equal to historical cost minus the corresponding accumulated depreciation.
Appreciation or revaluation
increase is the excess of the replacement cost over the historical cost. 
Net appreciation
is equal to appreciation minus corresponding accumulated depreciation
Revaluation surplus
is equal to the fair value or depreciated replacement cost or sound value minus the carrying amount
of the property, plant and equipment. The revaluation surplus is also known as the revaluation
increment.
Proportional approach
is the preferable method because it preserves the gross and net amounts after revaluation. Moreover,
this will prove useful in providing subsequent annual depreciation on cost and on the revaluation
increase and the consequent piecemeal realization of the revaluation surplus.
Elimination approach
The accumulated depreciation is eliminated or offset against the gross carrying amount of the
machinery.
Query
What is the treatment of the revaluation surplus?
When an asset's carrying amount is increased as a result of the revaluation, the increase shall be
credited to revaluation surplus as a component of other comprehensive income. The revaluation
surplus may be transferred directly to retained earnings when the surplus is realized.
The whole surplus may be realized on the retirement or disposal of the asset. However, if the
revalued asset is being depreciated, part of the surplus is being realized as the asset is used. The
revaluation surplus is allocated or realized over the remaining useful life of the asset and reclassified
through retained earnings
Reversal of a revaluation surplus
A revaluation decrease shall be charged directly against any revaluation surplus to the extent that the
decrease is a reversal of a previous revaluation and the balance is charged to expense.
Sale of revalued asset
When a revalued asset is sold, all accounts relating thereto shall be closed. The difference between
the sale price and the carrying amount of the revalued asset is recognized as gain or loss on the sale.
Disclosures related to revaluation
a. The effective date of revaluation.
b. Whether an independent valuer was involved.
c. Method and assumptions applied in estimating fair value.
d. Whether the fair value was determined directly by reference to observable prices in an
active market or recent market transactions using other valuation technique.
e. Historical cost and carrying amount of each class of revalued property, plant and
equipment.
f. Revaluation surplus, indicating the movement for the period and any restrictions on the
distribution of the balance to shareholders.

Impairment
Impairment is a fall in the market value of an asset so that the recoverable amount is now less than
the carrying amount in the statement of financial position. The carrying amount is the amount at
which an asset is recognized in the statement of financial position after deducting accumulated
depreciation and accumulated impairment loss.
Basic principle
The basic principle underlying impairment of asset is relatively straightforward. There is an
established principle that an asset shall not be carried at above the recoverable amount. An entity
shall write down the carrying amount of an asset to the recoverable amount if the carrying amount is
not recoverable in full. If the carrying amount is higher than the recoverable amount, the asset is
judged to have suffered an impairment loss. The asset shall therefore be reduced by the amount of
the impairment loss.
Accounting for impairment
In this regard, there are three main accounting issues to consider, namely:
a. Indication of possible impairment
b. Measurement of the recoverable amount
c. Recognition of impairment loss
Indication of impairment
An entity shall assess at each reporting date whether there is any indication that an asset may be
impaired. If any such indication exists, the entity shall estimate the recoverable amount of the asset.
However, irrespective of whether there is any indication of impairment, a an entity shall test an
intangible asset with an indefinite useful life or an intangible asset not yet available for use for
impairment annually by comparing the carrying amount with the recoverable amount.
The events and changes in circumstances that lead to an impairment of assets may be classified as
external and internal sources of information.
External sources
a. Significant decrease or decline in the market value of the asset as a result of passage of
time or normal use or a new competitor the market.
b. Significant change in the technological, market, legal or economic environment of the
business in which the asset is employed.
This could be as simple as a change in customer taste.
c. An increase in the interest rate or market rate of return on investment which will likely
affect the discount rate used in calculating the value in use.
d. The carrying amount of net assets of the entity is more than the "market capitalization." In
other words, the carrying amount exceeds the fair value of the net assets. The market
capitalization simply means the fair value of the net assets of the entity.
Internal sources
a. Evidence of obsolescence or physical damage of an asset.
b. Significant change in the manner or extent in which the is used an adverse effect on the
entity.
c. Evidence that the economic performance of a asset will be worse than expected.
The external and internal sources of information are not exhaustive. An entity may identify other
indications that an asset may be impaired.
Measurement of recoverable amount
After establishing evidence that an asset has been impaired, the next step is to determine the
recoverable amount preparatory to the recognition of an impairment loss. The recoverable amount of
an asset is the fair value less cost of disposal or value in use, whichever is higher.
Fair value less cost of disposal
Fair value of an asset is the price that would be received to sell the asset in an orderly transaction
between market participants at the measurement date. Cost of disposal is an incremental cost
directly attributable to the disposal of an asset or cash generating unit, excluding finance cost and
income tax expense. In simple terms, fair value less cost of disposal is equal to the exit price or selling
price of an asset minus cost of disposal.
Value in use
Value in use is measured as the present value or discounted value of future net cash flows (inflows
minus outflows) expected to be derived from an asset. The cash flows are pretax cash flows and
pretax discount rate is applied in determining the present value.
Calculation of value in use
The following should be considered in determining value in use:
a. Cash flow projections shall be based on reasonable and supportable assumptions.
b. Cash flow projections shall be based on the most recent budgets on financial forecasts,
usually up to a maximum period of 5 years, unless a longer period can be justified.
c. Cash flow projections beyond the 5-year period shall be estimated by extrapolating the 5-
year projections using a steady or declining growth rate each subsequent year, unless an
increasing rate can be justified.
Composition of estimates of future cash flows
Estimates of future cash flows include:
 a. Projections of cash inflows from the continuing use of the asset.
b. Projections of cash outflows necessarily incurred to generate the cash inflows from the
continuing use of the asset.
c. Net cash flows received on the disposal of the asset at the end of the useful life in an arm's
length transaction.
Estimates of future cash flows do not include:
a. Future cash flows relating to restructuring to which the entity is not yet committed
b. Future costs of improving or enhancing the asset's performance
c. Cash inflows or outflows from financing activities
d. Income tax
Reversal of an impairment loss
PAS 36, paragraph 114, provides that an impairment loss recognized for an asset in prior years shall
be reversed if there has been a change in the estimate of the recoverable amount
In other words, if the recoverable amount of an asset that has previously been impaired turns out to
be higher than the current amount, the carrying amount of the asset shall be increased to new
recoverable amount.
However, PAS 36, paragraph 117, provides that "the increased carrying amount of an asset due to a
reversal of an impairment loss shall not exceed the carrying amount that would have been
determined had no impairment loss been recognized for the asset in prior years."
As a simple guide, the increased carrying amount is the carrying amount had no impairment loss been
recognized or the recoverable amount, whichever is lower.
The reversal of the impairment loss shall be recognized immediately as income in the income
statement. But any reversal of an impairment loss on a revalued asset shall be credited to income to
the extent that it reverses a previous revaluation decrease and any excess credited directly to
revaluation surplus.
Cash generating unit (CGU)
A cash generating unit is the smallest identifiable group of assets that generate cash inflows from
continuing use that are largely independent of the cash inflows from other assets or group of assets.
In practice, a cash generating unit may be a department, a product line, or a factory for which the
output of product and the input of raw materials, labor and overhead can be identified.
As a basic rule, the recoverable amount of an asset shall be determined for the asset individually.
However, if it is not possible to estimate the recoverable amount of the individual asset, an entity
shall determine the recoverable amount of the cash generating unit to which the asset belongs.
The cash generating unit must be the smallest aggregation of assets for which cash flows can be
identified and which are independent of cash flows from other assets or group of assets.
An aggregation that is "too high" is prohibited. If aggregation is done at the "entity level", there would
be no impairment to be recognized.
On the other hand, if the impairment testing is done at the "department or product line level", then
some "loss-producing assets" would be written down to recoverable amount. The "cash generating
assets" would continue to be accounted for at carrying amount.
Allocation of impairment loss
Since there is no goodwill, the impairment loss is allocated across the assets based on carrying
amount.
Cash generating unit with goodwill
Goodwill does not generate cash flows independently from other assets or group of assets, and
therefore, the recoverable amount of goodwill as an individual asset cannot be determined.
As a consequence, if there is an indication that goodwill may be impaired, recoverable amount is
determined for the cash generating unit to which goodwill belongs.
Determination of impairment
PAS 36, paragraph 90, provides that a cash generating unit to which goodwill has been allocated shall
be tested for impairment at least annually by comparing the carrying amount of the unit, including
the goodwill, with the recoverable amount.
a. If the recoverable amount of the unit exceeds the carrying amount of the unit, the unit and
the goodwill allocated to that unit shall be regarded as not impaired.
b. If the carrying amount of the unit exceeds the recoverable amount of the unit, the entity
must recognize an impairment loss.
Carrying amount of CGU
Observe that the liabilities of the cash generating unit are ignored in determining carrying amount of
the CGU.
PAS 36, paragraph 76, provides that the carrying amount of a cash generating unit includes the
carrying amount of only those assets that can be attributed directly or allocated on a reasonable and
consistent basis to the cash generating unit and can generate the future cash inflows used in
determining the value in use of the cash generating unit.
Paragraph 76 further provides that the carrying amount of the cash generating unit does not include
the carrying amount of any recognized liability, unless the recoverable amount of the cash generating
unit cannot be determined without consideration of this liability.
The reason is stated in Paragraph 43 of PAS 36 which mandates that to avoid double counting,
estimates of future cash flows do not include cash outflows that relate to obligations that have been
recognized as liabilities by the cash generating unit, such as payables and provisions.
Corporate assets
Corporate assets are assets other than goodwill that contribute to the future cash flows of both the
cash generating unit under review and other cash generating units. Corporate assets are group or
divisional assets such as head office building, EDP, equipment or a research center.
Essentially, corporate assets are assets do not generate cash inflows independently from other assets.
Thus, the recoverable amount of an individual corporate asset cannot be determined unless
management has decided to dispose of the asset.
As a consequence, if there is an indication that a corporate asset may be impaired, the recoverable
amount of the cash generating unit to which the corporate asset belongs is determined and
compared with the carrying amount of the cash generating unit.

Reference:
 Valix, C., Peralta, J., & Valix C. A. (2021). Intermediate Accounting. GIC Enterprises & Co., Inc.