DEPRECIATION

Nature of Depreciation
u Systematic allocation of the asset’s depreciable amount over its useful life.
NOTE:
u The term “allocation” refers to manner of spreading the assets’ cost over the period (useful life) of its usage.
o This is to recognize the exhaustion of the life of a long-term asset.
u On the other hand, the term systematic refers to methods used in allocating the assets’ cost over its useful
life, in other words, it has basis in doing so, although mainly based on estimate, but at least, there is relatively
applied procedure.
u Each component of an item of PPE with a substantial cost in relation to the total cost of the item must be
depreciated separately.

Factors of Depreciation
u Useful life
o The amount of time the entity expects to use the asset.
o It could also mean the number of hours it is expected to work or the number of units it can generate or
manufacture.
o The following are the factors that should be considered in determining the useful life of an asset:
 Expected usage of the asset
 Expected physical wear and tear
 Technical obsolescence
 Legal limits for the use of the asset
u Residual value
o The amount expected to be recovered by an entity after the asset’s useful life.
NOTE:
u Usually, the value of the asset after its useful life is zero. If a third party is willing to acquire such asset at a
certain sum of money, then that amount is considered as the residual value, the value that is left after its
useful life.

u Depreciable amount
o Amount subject to depreciation.
o Formula:
Acquisition cost xx
Less: Residual value xx
Depreciable amount xx

u Recognition of Depreciation
o Depreciation is recognized as an expense unless it is included in the cost of producing another asset.
NOTE:
u If the PPE is used mainly in selling or administrative purposes, then the depreciation associated to it forms
part of the operating expenses since they are considered as period cost or cost that are expensed outright
when incurred.
u If the PPE is used mainly in manufacturing products, then the depreciation associated to it forms part of the
manufacturing overhead as indirect costs, thus, considered as inventoriable or product cost.

Commencement and Cessation of Depreciation

u Depreciation starts when the asset is available for use and stops when the asset is:
o Derecognized (i.e., sold or disposed of);
o Classified as held for sale (measured under PFRS 5); or
 o Fully depreciated
NOTE:
 When we say available for use, the moment the company took possession of the property, plant and
equipment and acquired its title, then that’s the time the depreciation will start even if not yet used. The main
basis is the time or aging of the asset. Again, even if the asset is being used or not, it is depreciated.
 When we say derecognized, it pertains to a manner of eliminating an asset from the record for some reasons
such as sale or retirement of the asset. Therefore, once an asset is derecognized, it is already out from the
books of the entity, thus, depreciation will now be stopped.
 When we say held for sale, a noncurrent asset is classified as current asset because the company expects it to
be sold within a short period of time.
o We only depreciate an asset if it is noncurrent asset, under property, plant and equipment section
and the said asset is not land.
 A fully depreciated asset is an asset whose carrying amount is zero or equal to its residual value.
u Depreciation does not cease when the asset becomes idle or is retired from active use.

Depreciation Methods
1. Straight-line method
Annual Depreciation = (Cost – Residual Value) / Estimated Useful life (in years)

2. Sum-of-the-years’ digits (SYD) method

Annual Depreciation = Depreciable amount x (Useful life as of the beginning of the period / SYD)
SYD = [n x (n + 1) / 2]
Where: n is the useful life

3. Double-declining balance method

o Also know as 200% declining balance method.
Annual depreciation = Carrying amount, beginning x (2/n)
Where: n is the useful life
NOTE: Under this method, the residual value is not considered when computing the depreciation expense per year
(except for the final year of the asset’s useful life). This will only be considered in computing the depreciation in the
final year of the asset’s useful life.

4. 150% declining balance method

Annual depreciation = Carrying amount, beginning x (2/n)
Where: n is the useful life
NOTE: Under this method, the residual value is not considered when computing the depreciation expense per year
(except for the final year of the asset’s useful life). This will only be considered in computing the depreciation in the
final year of the asset’s useful life.

5. Working hours method

o Under this method, the number of hours consumed in using the asset will be the basis for its
depreciation.
Annual Depreciation = Actual hours worked during the year x Depreciation per hour
Depreciation per hour = (Cost – Residual) / Estimated Useful life (in service hours)

6. Output method
o Under this method, the number of units produced by using the asset will be the basis for its deprecation.
The depreciation rate per hour shall be determined and it is computed by dividing the depreciable
amount by the estimated useful life in terms of number of output or units produced.
Annual Depreciation = Actual units produced during the year x Depreciation per unit
 Depreciation per unit = (Cost – Residual Value) / Estimated useful life (in units)

7. Composite or group method

o When a company has a large number of assets, calculating asset depreciation one by one becomes
complex. Entities can use the composite technique or the group technique:
 Composite Method – a method wherein, dissimilar in nature items are depreciated as if they
were a single unit.
 Group Method – a method wherein, similar in nature items are depreciated as if they were a
single unit.
o Important formulas used in composite/group method of depreciation:
 Composite life = Total Depreciable Amount / Total Annual Depreciation
 Composite rate = Total Annual Depreciation / Total Cost
o Only one accumulated depreciation account is needed because depreciation is calculated on the entire
group.
o When an asset in the group is derecognized, no gain or loss is recognized.
o The difference between the original cost of the asset sold and any proceeds received from the sale is
debited or credited to accumulated depreciation.
Journal Entry:
Cash xx
Accumulated Depreciation (balancing figure) xx
Asset xx
Accumulated depreciation (balancing figure) xx
o If an asset is retired but not sold, the asset’s original cost is deducted from the accumulated
depreciation.
Journal Entry:
Accumulated depreciation xx
Asset xx
o When an asset is replaced, the original cost of the replaced asset is deducted from accumulated
depreciation, and the cost of replacement is added to the group’s total cost.
Journal Entry:
Accumulated depreciation xx
Asset xx
Asset xx
Cash xx

8. Inventory method
Asset balance, end of the year xx
Less: Asset balance, before adjustment xx
Depreciation expense – current year xx

9. Retirement method
o No depreciation is recognized until the asset is retired.
o Formula:
Original cost of the asset retired xx
Less: Proceeds from disposal/retirement xx
Depreciation expense – current year* xx
*Applicable only when the asset is retired

10. Replacement method

 o No depreciation is recognized until the asset is retired and replaced.
o Formula:

When the asset is retired and replaced

Replacement cost of the asset xx
Less: Proceeds from disposal/retirement xx
Depreciation expense – current year xx

When the asset is retired but not replaced

Original cost of the asset retired xx
Less: Proceeds from disposal/retirement xx
Depreciation expense xx
NOTE:
u When depreciation is a function of time or driven by the passage of time rather than usage, time-
based depreciation approaches are acceptable.
u PAS 16 does not provide a particular method or approach in depreciating PPE.
o The method of depreciation to use depends on the judgment of the management.
 PAS 16 requires management to select the method that best reflects the expected
pattern of consumption of the future economic benefits embodied in the asset when
making the judgment, and to apply that method consistently from period to period
unless the expected pattern of consumption of those future economic benefits
changes.
u PAS 16 prohibits the use of a revenue-based depreciation approach.
u At each reporting period, PAS 16 requires a yearly assessment or review of the depreciation method,
as well as the estimation of useful life and residual value.
o Any adjustment is accounted for as a change in accounting estimate (prospective
application).
u the amount after recording depreciation on an asset is referred to as the carrying amount. This is the
amount to be presented in the financial statements in respect of PPE items. This is computed as
follows:
Cost xx
Less: Accumulated Depreciation xx
Less: Accumulated Impairment Loss xx
Carrying amount xx

Manner of depreciating leasehold improvements

u Leasehold improvements are changes made by a tenant to a property leased under an operating lease
u Leasehold improvements are depreciated over the useful life of the improvements or remaining term of the
lease, whichever is shorter.

Measurement after Initial Recognition

u An entity must adopt either the cost model or the revaluation model as the accounting policy for property,
plant and equipment after initial recognition.
o This accounting policy must be applied to an entire class of property, plant, and equipment by the entity.

Cost model
u Property, plant, and equipment are carried at cost less any accumulated depreciation and accumulated
impairment loss.

Revaluation model
 u Property, plant, and equipment are carried at a revalued carrying amount.
NOTE:
u The revalued carrying amount is the fair value at the date of revaluation less any subsequent accumulated
depreciation and subsequent accumulated impairment loss.
o Depreciated replacement cost may be used if the fair value is not available.

u Accounting methods for revaluation

o Proportionate Method
 Also known as restatement method.
 The gross carrying amount is restated proportionately to the change in the net carrying amount.
Cost Model Revaluation Model Adjustment
Cost xx xx xx
Less: Accumulated Depreciation xx xx xx
Carrying amount xx xx xx

Journal Entry:
Asset xx
Accumulated depreciation xx
Revaluation surplus xx

o Elimination Method
o The accumulated depreciation is eliminated against the gross carrying amount of the asset.

Journal Entry:
Accumulated depreciation xx
Asset* xx
Revaluation surplus xx
*If the increase is more than the balance of the accumulated depreciation account.

IMPAIRMENT OF ASSETS
u Impairment loss
o Is the amount by which the carrying amount of an asset or a cash-generating units exceeds its
recoverable amount.
SCENARIO # 1: Internal and External Indicators of
SCENARIO #2: ANNUAL IMPAIRMENT TESTING
Impairment
1. Items of property, plant and equipment 1. Intangible assets with indefinite lives
2. Intangible assets with definite useful lives 2. Intangible assets not available for use
3. Cash generating units that are tested for impairment 3. Cash generating units with allocated goodwill.
due to the unavailability of estimating the
recoverable amount of an asset that is impaired
included in the CGU.

Determining Recoverable Amount

a) Recoverable amount is the higher of fair value less costs to sell and value in use.
b) If fair value less costs to sell cannot be determined, then recoverable amount is value in use.
c) For assets to be disposed of, recoverable amount is fair value less costs to sell.

Fair value less costs to sell

a) If there is a binding sale agreement, use the price under that agreement less costs of disposal.
b) If there is an active market for that type of asset, use market price less costs of disposal.
 c) If there is no active market, use the best estimate of the asset’s selling price less costs of disposal.
d) Costs of disposal are the direct costs only.

Value in use
The calculation of value in use should reflect the following elements:
a) An estimate of the future cash flows the entity expects to derive from the asset in an arm’s length transaction.
b) Expectations about possible variations in the amount or timing of those future cash flows.

Recognition of Impairment Loss

 An impairment loss should be recognized whenever recoverable amount is below carrying amount.
 The impairment loss is an expense in the income statement unless it relates to a revalued asset where the value
changes are recognized directly in equity.
 Adjust depreciation or amortization charges for future periods.

Reversal of an impairment loss

 Internal and external indicators of reversal are identified.
External Sources
 Significant increase in market value.
 Changes in technological, market, economic or
legal environment.
 Changes in interest rates.
 Market interest rates have decreased
Internal Sources
 Changes in way asset is used or expected to be
used.
 Evidence from internal reporting indicates that
economic performance of the asset will be better
than expected.

 Individual asset – the difference of the increased recoverable amount is recognized in profit and loss unless
asset carried at revalued amount.
 CGUs – allocated to asset of CGUs on a pro-rata basis.
 Goodwill – impairment of goodwill is never reversed.
 Limitation – the revised carrying amount after reversal should not exceed the carrying amount of the individual
asset and assets within the CGU if impairment loss was not recognized.

WASTING ASSET AND DEPLETION (PFRS 6)

Wasting Assets
 Natural resources property in the form of land containing mineral deposits, precious stones and metals or trees
to be harvested as logs and lumber with a limited life and will be subject to depletion using the production
method.

The total cost of the wasting asset shall be:

 Acquisition cost Purchase price of the property.
 Exploration cost Cost incurred to locate the minerals and other resources beneath the
surface of the property
 Development cost Cost incurred for the actual production or extraction of the minerals
and other resources. Development cost is naturally incurred multiple
number times during the period of production and will usually cause
the recomputation of the rate.

Development cost related to other tangible assets should not be

capitalized as part of the wasting asset rather as other items of PPE
and depreciated separately, like equipment, machinery and processing
facilities.
  Restoration cost Future cost to be paid to restore the property back to its original
condition but recorded as a provision (liability that is estimated) at its
present value.

Subsequent Measurement
After recognition, an entity applies either the
1. Cost model or
2. Revaluation mode to the exploration and evaluation assets.

The journal entry assuming there is increase in value of wasting asset is:
Wasting asset xx
Revaluation surplus xx

Depletion
Units of Output Method is often used in computing the depletion base of a natural resource. The formula is:

Depletion = [(Total cost of the wasting asset – Units extracted – Residual Value) / Units estimated to be extracted] x
Units
extracted during the year

Changes in the units estimated to be extracted and additional development costs:

When there is a charge in the units estimated to be extracted or when the company incurs additional costs, these are
regarded as change in accounting estimate to be handled currently and prospectively. The company needs to compute
for the new depletion rate per unit using this formula:

New depletion rate/unit = Remaining depletion cost / Remaining revised estimate of the productive output
Depletion = Depletion rate per unit x Units of extracted during the year

Depreciation of mining equipment

Depreciation of mining equipment shall be systematically allocated over the asset’s useful life. The useful life of the
asset depends on whether that asset is immovable or movable. If the equipment is immovable, depreciation is based on
the life of the equipment or life of the wasting asset whichever is shorter, but if the equipment is movable; the
depreciation is based on the life of the equipment.

Immovable Equipment
1) If the life of the equipment is shorter and assuming the use of straight-line method
Depreciation = Depreciable cost / Useful life of the equipment

2) If the life of the wasting asset is shorter, the units of output method is often used
Depreciation = Depreciation rate per unit x Units extracted during the year

Movable Equipment
Assuming the use of straight-line method
Depreciation = Depreciable cost / Useful life of the equipment

Liquidating Dividends
Under the trust fund doctrine, the capital stock of a corporation is conceived as a trust fund for the protection of
creditors. Consequently, such capital cannot be returned to stockholders during the lifetime of the corporation.
However, the corporation can pay dividends to stockholders but limited only to the balance of retained earnings.

Exception to the trust fund doctrine:

Wasting asset doctrine – under this doctrine the wasting asset corporation or a company engaged in the extraction of a
natural resource, can legally return capital to stockholders 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.

Formula:
Accumulated profits – unappropriated xx
Add: Accumulated depletion xx
Total xx
Less: Capital liquidated in prior years xx
Depletion in ending inventory (Depletion per unit
x units in the ending inventory) xx
Maximum dividend xx
ACCOUNTING FOR BORROWING COST

Nature of Borrowing Costs

 These are interest and other costs that an entity incurs in connection with the borrowing of funds.
 Include the following:
o Interest expense calculated using the effective interest method;
o Interest (or finance cost) in respect of finance lease liabilities; and
o Exchange differences arising from foreign currency borrowings to the extent that they are regarded as
an adjustment to interest costs.
 This does not include the actual (or imputed) cost of equity.

Accounting for Borrowing Costs

 Borrowing costs that are directly attributable to the acquisition, construction or production of a qualifying asset
shall be capitalized as part of the cost of that asset.
o Other borrowing costs shall be expensed in the period it is incurred.
 The following are borrowing costs eligible for capitalization:
o Asset financed by specific borrowing;
o Asset financed by general borrowings;
o Asset financed by both specific and general borrowings

Computation of capitalizable borrowing cost on specific borrowings

Actual Interest Cost xx
Less: Investment income on temporary investment of the specific borrowings xx
Capitalizable borrowing cost on specific borrowings xx

Computation of capitalizable borrowing cost on general borrowings

Average (or
avoidable) borrowing
cost
Capitalizable
borrowing cost on Lower Amount
general borrowings
Actual borrowing cost

The average (or avoidable) borrowing cost is computed in the following manner:
Weighted average capital expenditures on the asset xx
X: Capitalization rate (or weighted average interest rate) x%
Average (or avoidable) borrowing cost xx

The capitalization rate (or weighted average interest rate) is determined as follows:

Capitalization rate = Actual borrowing cost on general borrowings / Total principal amount of general borrowings
Commencement of Capitalization
 Capitalization of borrowing costs as part of the cost of a qualifying asset shall begin on the commencement date.

Suspension of Capitalization
 Capitalization of borrowing costs shall be suspended during extended periods in which active development of a
qualifying asset is suspended.
o However, capitalization of borrowing costs shall be suspended when a temporary delay is necessary part
of the process of getting an asset ready for its intended use or sale.

Cessation of Capitalization
 Capitalization of borrowing costs shall cease when all the activities necessary to prepare the qualifying asset for
its intended use or sale are substantially complete.

Required Disclosures
 An entity shall disclose:
o The amount of borrowing costs capitalized during the period; and
o The capitalization rate used to determine the amount of borrowing costs eligible for capitalization.