CHAPTER 23- PROPERTY, PLANT AND EQUIPMENT

Property, plant and equipment are tangible assets that are held for use in production or supply of goods or services, for
rental in others, or for administrative purposes, and are expected to be used during more than one period.

Accordingly, the major characteristics in the definition of property, plant and equipment are:

a. The property, plant and equipment are tangible assets, meaning with physical substance.
b. The property, plant and equipment are used in business, meaning used in production or supply of goods or
services, for rental purposes and for administrative purposes.
c. The property, plant and equipment are expected to be used over a period of more than one year.

RECOGNITION OF PROPERTY, PLANT AND EQUIPMENT

An item of property, plant and equipment shall be recognized as an asset when:

a. It is probable that future economic benefits associated wine the asset will flow to the entity.
b. The cost of the asset can be measured reliably.

SPARE PARTS AND SERVICING EQUIPMENT

Most spare parts and servicing equipment are usually carried ca inventory and recognized as an expense when
consumed.

However, major spare parts and stand-by equipment qualify as property, plant and equipment when the entity expects
to use them during more than one period.

MEASUREMENT AT RECOGNITION

An item of property, plant and equipment that qualifies for recognition as an asset shall be measured at cost.

Cost is the amount of cash or cash equivalent paid and the fair value of the other consideration given to acquire an asset
at the time of acquisition or construction.

ELEMENTS OF COST

a. Purchase price, including import duties and nonrefundable purchase taxes, after deducting trade discounts and
rebates
b. Cost directly attributable to bringing the asset to the location and condition necessary for it to be capable of
operating in the manner intended by management
a. Initial estimate of the cost of dismantling and removing the item and restoring the site on which it is located, the
obligation for which an entity incurs

DIRECTLY ATTRIBUTABLE COSTS

Examples of directly attributable costs that qualify for recognition include:

a. Costs of employee benefits arising directly from the acquisition of property, plant and equipment
b. Cost of site preparation
c. Initial delivery and handling cost
 d. Installation and assembly cost
e. Professional fees
f. Costs of testing whether the asset is functioning properly

COSTS NOT QUALIFYING FOR RECOGNITION

Examples of costs that are expensed rather than recognized as element of cost of property, plant and equipment are:

a. Costs of opening a new facility

b. Costs of introducing a new product or service, including costs of advertising and promotion
c. Costs of conducting business in a new location or with a new class of customer, including costs of staff training
d. Administration and other general overhead costs
e. Costs incurred while an item capable of operating in the manner intended by management has yet to be brought
into use or is operated at less than full capacity
f. Initial operating losses
g. Costs of relocating or reorganizing part or all of an entity's operations.

MEASUREMENT AFTER RECOGNITION

After initial recognition, an entity shall choose either the cost model or the revaluation model as the accounting policy
for property, plant and equipment.

The entity shall apply such accounting policy to an entire class of property, plant and equipment.

The cost model means that property, plant and equipment are carried at cost less any accumulated depreciation and
any accumulated impairment loss.

The revaluation model means that property, plant and equipment are carried at revalued carrying amount.

The revalued carrying amount is the fair value at the date of revaluation less any subsequent accumulated depreciation
and subsequent accumulated impairment loss.

ACQUISITION OF PROPERTY

There are many ways of acquiring a property and each presents costing problem for accounting purposes, namely:

1. Cash basis 6. Exchange

2. On account subject to cash discount 7. Donation
3. Installment basis 8. Government grant
4. Issuance of share capital 9. Construction
5. Issuance of bonds payable

ACQUISITION ON A CASH BASIS

The cost of an item of property, plant and equipment is the cash price equivalent at the recognition date.

The cost of asset acquired on a cash basis simply includes the cash paid plus directly attributable costs such as freight,
installation cost and other cost necessary in bringing the asset to the location and condition for the intended use.
Moreover, when several assets are acquired at a “basket price" or “lump sum price”, it is necessary to apportion the
single price to the assets acquired on the basis of relative fair value.

ACQUISITION ON ACCOUNT

When an asset is acquired on account subject to a cash discount, the cost of the asset is equal to the invoice price minus
the discount, regardless of whether the discount is taken or not.

If the discount is not taken, the same is charged to purchase discount lost account which is shown as other expense. The
reason is that a reasonably wise management would take advantage of all discounts. Cash discounts are generally
considered as reduction of cost and not as income.
 ACQUISITION ON INSTALLMENT BASIS

When payment for item of property, plant and equipment is

deterred beyond normal credit terms, the cost is the cash price
equivalent.

In other words, if an asset is offered at a cash price and at an

installment price and is purchased at the installment price, the
asset shall be recorded at the cash price.

The excess of the installment price over the cash price is treated
as an interest to be amortized over the credit period.

NO AVAILABLE CASH PRICE

If an asset is acquired by installment and there is no available the price, the asset is recorded at an amount equal to
present value of all payments using an implied interest rate.

AMORTIZATION OF DISCOUNT ON NOTE PAYABLE

The effective interest method is used in amortizing the discount on note payable as interest expense.

Year Payment Interest Principal Present Value

January 1` 497,400
First Year 200,000 49,740 150,260 347, 140
Second Year 200,000 34,714 165,286 181,854
Third Year 200,000 18,146 181,854 ---

Explanation

The annual payment is equal to P200,000 computed by dividing the note of P600,000 by 3 years.

The annual interest expense is equal to the present value of the note multiplied by 10%. Thus, for the first year,
P497,400 times , 10% equals P49,740, and so on.

The principal payment is equal to the annual payment minus the applicable interest expense. Thus, for the first year,
P200,000 minus P49,740 equals P150,260, and so on.

The present value is equal to the preceding present value minus the principal payment. Thus, for the first year, P497,400
minus P150,260 equals P347,140, and so on.

Statement classification and presentation

If a statement of financial position is prepared at the end of the first year, the note payable is classified as follows:
Current liability:

Note payable 200,000

Discount on note payable ( 34,714)
Carrying amount 165,286

Noncurrent liability:
Note payable
200,000
Discount on note payable
( 18,146)
Carrying amount
181,854

ISSUANCE OF SHARE CAPITAL

Philippine GAAP provides that if shares are issued for

consideration other than actual cash, the proceeds shall
be measured at the fair value of the consideration
received.

Accordingly, where a property is acquired through the

issuance of share capital, the property shall be measured
at an amount equal to the following in the order of
priority:

a. Fair value of the property received

b. Fair value of the share capital
c. Par value or stated value of the share capital

ISSUANCE OF BONDS PAYABLE

When an entity acquires an asset by issuing bonds payable PFRS 9, paragraph 5.1.1, provides that the entity shall
measure the financial liability at fair value plus transactions costs that are directly attributable to the issue of the
financial liability. Accordingly, the asset acquired by issuing bonds payable is measured in the following order:

a. Fair value of bonds payable

b. Fair value of asset received
c. Face amount of bonds payable

EXCHANGE

PAS 16. paragraph 24, provides that the cost of an item of property, plant and equipment acquired in exchange for a
nonmonetary asset or a combination of monetary and nonmonetary asset is measured at fair value.

However, the exchange is recognized at carrying amount under the following circumstances:
a. The exchange transaction lacks commercial substance.
b. The fair value of the asset given or the fair value of the asset received is not reliably measurable.

COMMERCIAL SUBSTANCE

Commercial substance is a new notion and is defined as the event or transaction causing the cash flows of the entity to
change significantly by reason of the exchange.

An exchange transaction has commercial substance when the cash flows of the asset received differ significantly from
the cash flows of the asset transferred.

In assessing whether this has occurred, the entity shall consider if the amount, timing and risk of the cash flows from the
new asset are different from the cash flows of the old asset.

Moreover, the entity-specific value of the portion of the entity's operations affected by the transaction changes as a
result of the exchange.

Entity-specific value is the present value of the cash flows an entity expects to arise from the continuing use of an asset
and I the disposal at the end of useful life or expects to incur when settling a liability.
 EXCHANGE - WITH COMMERCIAL SUBSTANCE

If a property is acquired in an exchange, the cost of the property is equal to the following:

a. Fair value of asset given plus any cash payment - on the part of the payor
b. Fair value of asset given minus any cash received on the part of the recipient.

Aye and Bee exchanged equipment.

 EXCHANGE - NO COMMERCIAL SUBSTANCE

If the exchange transaction lacks commercial substance, the acquired item of property, plant and equipment is
measured at the carrying amount of the asset given. No gain or loss is recognized when the exchange lacks commercial
substance. Of course, any cash involved is added to the carrying amount on the part of the payor and deducted from
carrying amount on the part of the recipient.

Trade in is a form of exchange.

This means that a property is acquired by exchanging another property as part payment and the balance payable in cash
or any other form of payment in accordance with agreed terms.

Trade in involves a nondealer acquiring the asset from a dealer.

Trade in usually involves a significant amount of cash and therefore, the transaction has commercial substance.

As an exchange with commercial substance, the new asset is recorded at the following in the order of priority:
 a. Fair value of asset given plus cash payment
b. Trade in value of asset given plus cash payment (in effect, this is the fair value of the asset received)

FAIR VALUE APPROACH

The new asset is recorded at the fair value of the asset given plus cash payment.

Fair value of asset given 350,000

Cash payment 1,500,000
Cost of new asset 1,850,000
Fair value of asset given 350,000
Less: Carrying amount 400,000
Loss on exchange (50,000)
Equipment-new 1,850,000
Accumulated depreciation 1,000,000
Loss on exchange 50,000
Equipment-old 1,400,000
Cash 1,500,000

TRADE IN VALUE APPROACH

If the fair value of asset given is not clearly determinable, the new asset is recorded at the trade in value of the asset,
given plus cash payment.
Equipment-new 2,000,000
Accumulated depreciation 1,000,000
Equipment-old 1,400,000
Cash 1,500,000
Gain on exchange
100,000
Trade in value of asset given
500,000
Cash payment
1,500,000
Cost of new asset
2,000,000

Trade in value of asset given

500,000
Less: Carrying amount
400,000
Gain on exchange
100,000
Care should be exercised in determining the fair value of the new asset received. . The list price is often bloated to
permit the seller to increase the trade in value for a used asset. The cash price of the new asset is believed to be the fair
value.

DONATION

At present, IFRS does not address donation or contribution. However, IFRS explicitly addresses government grant In this
regard, reference is made to local GAAP in relation to
accounting for donation. Philippine GAAP provides that
contributions received from shareholders shall be
recorded at the fair value with the credit going to
donated capital.

Expenses incurred in connection with the donation, like

payment of registration fees and legal fees shall be
charged to the donated capital account.

The reason is that such expenses do not increase or

enhance the value of the asset.

However, directly attributable costs incurred

subsequently, such as installation and testing cost
necessary to bring the donated asset to the location and
condition for the intended use shall be capitalized.

Philippine GAAP further provides that entities sometimes

receive from nonshareholders gifts or grants of funds or other assets that are restricted for property and equipment
additions.
Capital gifts or grants shall be recorded at fair value when received or receivable.
Capital gifts or grants are generally subsidies and therefore recognized as income.
In the rare case when capital gifts or grants are not subsidies, the offsetting credit is a liability account until the initial
restrictions are met.
When the initial restrictions are met, the liability is transferred to income.

CONSTRUCTION

The cost of self-constructed asset is determined using the same principles as for an acquired asset.

The cost of self-constructed property, plant and equipment shall include:

1. Direct cost of materials

2. Direct cost of labor
3. Indirect cost and incremental overhead specifically identifiable or traceable to the construction.

If the incremental overhead is not specifically identifiable, allocation of overhead may be done on the basis of direct
labor cost or direct labor hours.
 SAVING OR LOSS ON CONSTRUCTION

Where the actual cost of construction is less than the price which the constructed asset can be purchased from outside
parties, the difference is not income but saving,

Any internal profit is eliminated in arriving at the cost of self-constructed asset.

Where the actual cost of construction is more than the price at which the asset can be purchased from outside parties,
still the constructed asset shall be recorded at actual cost. The difference is not loss on the construction.

The reason is that there is no assurance that the asset if purchased is the same as that constructed. However, if there is
clear evidence that the actual cost is materially excessive and this is due to construction inefficiencies or failures whether
due to temporary, idle capacity or industrial disputes, it is believed that the excess shall be treated as loss chargeable
against management.

Future periods shall not be burdened with management inefficiencies or errors.

PAS 16, paragraph 22, provides that the cost of abnormal amount of wasted material, labor or overhead incurred in the
production of self-constructed asset is not included in the cost of the asset.

INTERVENING OPERATIONS

Some operations occur in connection with the construction or development of an item of property, plant and equipment
but are not necessary to bring the item to the location and condition for the intended use. These operations may occur
before or during the construction or development activities. For example, income may be earned through using a
building site as a car park until construction starts.

Because incidental operations are not necessary to bring an item to the location and condition for the intended use, the
income and related expenses of incidental operations are recognized i profit or loss.

DERECOGNITION

Derecognition means that the cost of the property, plant and equipment together with the related accumulated
depreciation shall be removed from the accounts.

PAS 16, paragraph 67, provides that the carrying amount of an item of property, plant and equipment shall be
derecognized on disposal or when no future economic benefits are expected from the use or disposal.

The gain or loss from the derecognition of an item of property, plant and equipment shall be included in profit or loss.

The gain or loss arising from the derecognition of an item of property, plant and equipment shall be determined as the
difference between the net disposal proceeds and the carrying amount of the item.

FULLY DEPRECIATED PROPERTY

A property is said to be fully depreciated when the carrying amount is equal to zero, or the carrying amount is equal to
the residual value.
In such a case, the asset account and the related accumulated depreciation account are closed and the residual value is
set up in a separate account.
However, it is not uncommon for an entity to continue to use an asset after it has been fully depreciated.
The cost of fully depreciated asset remaining in service and the related accumulated depreciation ordinarily shall not be
removed from the accounts. .
However, entities are encouraged but not required to disclose fully depreciated property.

PROPERTY CLASSIFIED AS HELD FOR SALE

PFRS 5, paragraph 7, provides that an item of promo plant and equipment is classified as "held for sale asset is available
for immediate sale in the present condition within one year from the date of classification as bold * sale.
Such asset shall be excluded from property, plant and equipment but presented separately as current asset.
PFR8 5, paragraph 16, further provides that an entity shall measure a noncurrent asset classified as held for sale at the
lower of carrying amount or fair value less cost of disposal.
The writedown to fair value less cost of disposal is treated as an impairment loss.
PFRS 5, paragraph 25, further provides that a noncurrent asaet classified as held for sale shall not be depreciated.

IDLE OR ABANDONED PROPERTY

PFRS 5, paragraph 13, provides that an entity shall not classify as held for sale a noncurrent asset that is to be
abandoned.
This is because the carrying amount would be recovered principally through continuing use.
Temporary idle activity or abandonment does not prelude depreciating the asset as future benefits are congumed not
only through usage but also through wear and tear and obsolescence.
Noncurrent asset to be abandoned includes an item of properly plant and equipment that is to be used until the end of
economic life.

OPTIONAL DISCLOSURES
Entities are encouraged to disclose the following information which may prove relevant to the needs of financial
statement users:

a. The carrying amount of temporarily idle property, plant and equipment.

b. The gross carrying amount of any fully depreciated property, plant and equipment still in use.
c. The carrying amount of property, plant and equipment retired from active use and classified as held for sale.
d. When the cost model is used, the fair value of property, plant and equipment when this is materially different
from the carrying amount.