CHAPTER TWO

Property, Plant & equipment, Intangible Assets and Natural Resources

2.1. Property, plant & Equipment (IAS 16)

i. Nature of PPE
• Property, Plant & equipment:- are assets which are of a permanent
nature used in the operation of business

• not held for sale in the ordinary course of the business

• are classified on the balance sheet as plant assets.

• We can also call them as fixed asset used either alone or in various
combinations. Example: equipment, furniture, tools, machinery,
building and land.

• Plant assets are ordinarily expected to last more than a year even
though there is no standard criterion as to the minimum length of life.
• Assets acquired for resale in the normal course of the business

can’t be characterized as plant assets, regardless of their durability

or the length of time they are held. For example, undeveloped land

or other real estate acquired, as speculation should listed on

balance sheet in the asset section entitled ―investment‖. Assets

acquired for resale in the normal course of the business can be

distinguished as inventories.
 ii. Cost of PPE (Measurement at the time of recognition)

• The cost of acquiring plant assets includes all expenditures

necessary to get it in place and ready for use. Purchase price, sales

tax, transportation charges and insurance on the asset while in

transit, and installation cost.

• When a secondhand asset is purchased, the initial cost of getting it

ready for use, such as expenditures for new parts, repairs and

painting are debited to the asset account.

• Cost not necessary for getting a fixed asset ready for use and do

not increase the asset’s usefulness. Such costs should not be

included as part of the assets total cost. For example the following

costs should be debited to an expense account.

• Carelessness or error in installation

• Vandalism (deliberate destruction)

• Uninsured theft

• Damage during unpacking and install

• Fines for not obtaining proper permits from government agencies

 Cost of land includes:

• Cash plus any note payable given (purchased price)

• Sales tax, title fee, brokers commission, surveying fees

• Delinquent real estate taxes assumed by the buyer

• If unwanted buildings are located on land acquired for a plant site,

the cost of their razing or removal (demolishing) the building less

any salvage recovered, is chargeable to the land account .

Cost of leveling or permanently changing the contour.

Paving a public street bordering the land

• Example 1) Lew Company Ltd. acquires real estate at a cash cost of $2,
000,000. The property contains an old warehouse that is razed at a net
cost of $60,000 ($75,000 in costs less $15,000 proceeds from
salvaged materials). Additional expenditures are the attorney’s fee,
$10,000, and the real estate broker’s commission, $80,000.

• Required: Determine the amount to be reported as the cost of the land

Cash price of property ……………..2,000000

• Net removal of old warehouse ……….60,000

• Attorneys fee ………………………….10,000

• Real state brokers commission ……….80,000

• Total cost of land………………………………………………2,150,000

• Entry to record the acquisition of the land:

• Land ………………………2,150,000

• Cash………………………………………..2,150,000

Those added to the land improvement account

• These are expenditures for improvement that are neither as

permanent as land nor directly associated with the building may be
set apart in the land improvement account and depreciated according
to their different life spans. Example, costs of fencing, paving parking
areas (lots), outdoor lightening, sprinkler system, and trees & shrubs,
private sidewalk & driveways.
 Cost of constructing a building includes:

• Fees paid to architects and engineers for plan and supervision

• Insurance incurred during construction

• Contractors charge

• Interest on money borrowed to finance the construction

• Payments for material, labor and overhead

 Cost of acquiring existing building (new or old) includes:

• The purchase price

• Sales and other taxes

• Brokerage commission

• Cash or credit expenditure for repairing and reconditioning the

building for its intended purpose

• v Expenditures related to the land may be charged to land, building

or land improvement account, depending up on the circumstance.

 Cost of machinery and equipment includes:

• Purchase price less any discount, transportation charges, insurance

while in transit, sales and other taxes, purchase commission, installation
costs, assembly costs and any expenditure to test the asset before
placing it in service and permits from government agencies. For
purchase of used equipment, costs include repair costs, reconditioning
and other costs.

• Illustration: Zhang Company purchases factory machinery at a cash

price of $500,000. Related expenditures are for sales taxes $30,000,
insurance during shipping $5,000, and installation and testing $10,000.
Compute the cost of the machinery.
• Cash price ……………………………50,000

• Sales taxes…………………………....30,000

• Insurance during shipping……………..5000

• Installation and testing……………….10,000

• Cost of machinery………………545,000
 iii. Measurement after recognition

• a. Depreciation of PPE

• IAS 16 allows revaluation of pant asset to fair value. Assets that are
experiencing rapid price changes must be revalued on the annual
basis; otherwise less frequent revaluation is acceptable. Land has an
unlimited life and therefore can provide unlimited service. On the
other hand, fixed assets such as equipment and others, loss their
ability overtime to provide services. As a result, the cost of the fixed
assets should be transferred to expense accounts in a systematic
manner during their estimated useful lives. This periodic transfer of
cost to expense is called depreciation.
• The cash account neither be increased nor decreased by the periodic entries that

transfer the cost of plant asset to depreciation account expense. The depreciation

expense, unlike most expenses, doesn’t require an equivalent outlay of cash in the

period in which the expense is recorded. The adjusting entry to record depreciation is

usually made at the end of each month or at the end of each year
•
Adjusting Entry:
•
Depreciation expense___.._______ XXX
•
Accumulated Depreciation____ ___XXX
• The use of contra plant asset account called accumulated

depreciation, allows the original cost to remain unchanged in the

plant asset account. Its common practice to report on balance

sheet both the original cost and the amount of accumulated

depreciation.

• Factors that cause decline in the ability of fixed asset to provide

service may be identified as physical depreciation and functional

depreciation.
• Physical depreciation occurs from tear and wears while in use

and from the action of the weather. Functional depreciation

usually occurs due to inadequacy &obsolescence.

• A plant asset becomes in adequate if its capacity is not sufficient

to meet ha demands of increased production& a plant asset is

obsolete if the commodity that it produces is no longer in

demand or if a newer machine can produce a commodity of

better quality or at a great reduction in cost

 Accounting for Depreciation

• If no or a very small value in comparison with the original cost is

expected, the depreciation cost equates the original value. But, if

the residual value is expected to have a significant value of the

depreciation cost will be the original cost of the asset minus

residual value of the asset. Three factors are considered in

determining the amount of depreciation expense to be recognized

each period. These are

• a) Initial cost b) Useful (service life) c) Residual value

• Initial cost: It includes all expenditures necessary to get the asset in
place and ready for use.

• Expected useful life: It is the length of service the business expects

from the asset. It may be expressed in years, units of output, miles or
other measures. For example the useful life of the building is stated
in years. The useful life of a bookbinding machine may be stated as a
number of books the machine is expected to bind that is its expected
output. A measure of a delivery trucks useful life is the total number
of miles the truck is expected to travel.
• C) Estimated residual value: is also called scrap value, salvage

value, or trade in value. It is the expected cash value of the asset

at the end of its useful life. In other words it is the part of the

asset’s cost that the company expects to be returned at the end

of assets useful life.

 Note:-

• In computing depreciation, residual value is not depreciated

because the business expects to receive this amount from

disposal of asset.

• The full cost of plant asset is depreciated if the asset expected

to have no residual value.

• Depreciable cost-It is a cost that will be spread over the assets

useful life as depreciation expense.

• Depreciable cost =plant asset cost – residual value

all fixed asset additions and deductions during the second half of a

month are treated as if the event occurred on the first day of the next

month. Depreciation methods

• Three basic methods exist for computing depreciation;

• a) Straight Line ,

• b) Units of production ,

• c) Declining balance method,

 1. Straight-Line Method

• Under this method, depreciation is the same for each year of the assets
useful life .It is measured solely by the passage of time

• In order to compute depreciation expense; it is necessarily to determine

depreciable cost.

• Assets cost __ Salvage value = Depreciable cost

• Depreciable cost / Useful life =Annual Depreciation Expense

• Example: The computations in this section use information about a

machine that inspects athletic shoes before packaging. Manufacturers
such as Converse, Reebok, Adidas, and Fila use this machine. Data for this
machine are
• If this machine is purchased on December 31, 2010, and used

throughout its predicted useful life of five years, the straight-line

method allocates an equal amount of depreciation to each of the

years 2011 through 2015. We make the following adjusting entry at

the end of each of the five years to record straight-line

depreciation of this machine.

• Dec. 31 Depreciation Expense . . . . . . . . . .1,800

• Accumulated Depreciation—Machinery . . . .. . . 1,800

• To record annual depreciation

• The $1,800 Depreciation Expense is reported on the income

statement among operating expenses. The $1,800 Accumulated

Depreciation is a contra asset account to the Machinery account in

the balance sheet

• We also can compute the straight-line depreciation rate, defined as

100% divided by the number of periods in the asset’s useful life.

For the inspection machine, this rate is 20% (100% /5, or 1/5 per

period). We use this rate, along with other information, to compute

the machine’s straight-line depreciation

 2. Units-of-Production Method

• The straight-line method charges an equal share of an asset’s cost to each

period.

• If plant assets are used up in about equal amounts each accounting period,
this method produces a reasonable matching of expenses with revenues.
However, the use of some plant assets varies greatly from one period to the
next. A builder, for instance, might use a piece of construction equipment for
a month and then not use it again for several months. When equipment use
varies from period to period, the units- of-production depreciation method
can better match expenses with revenues.

• Units-of- production depreciation charges a varying amount to expense for

each period of an asset’s useful life depending on its usage.
• A two-step process is used to compute units-of-production

depreciation. We first compute depreciation per unit by subtracting

the asset’s salvage value from its total cost and then dividing by the

total number of units expected to be produced during its useful life.

• Units of production can be expressed in product or other units such as

hours used or miles driven. The second step is to compute

depreciation expense for the period by multiplying the units

produced in the period by the depreciation per unit. Assume 7000

shoes are expected to be sold at first year, 8,000,9,000, 7000, and

fifth year 5,000.

 3. Double Declining-Balance Method

• An accelerated depreciation method yields larger depreciation expenses in the

early years of an asset’s life and less depreciation in later years.

• The most common accelerated method is the declining-balance method of

depreciation, which uses a depreciation rate that is a multiple of the straight-line
rate and applies it to the asset’s beginning-of-period book value.

• The amount of depreciation declines each period because book value declines
each period. A common depreciation rate for the declining-balance method is
double the straight-line rate. This is called the double-declining-balance (DDB)
method.

• This method is applied in three steps: (1) compute the asset’s straight-line
depreciation rate, (2) double the straight-line rate, and (3) compute depreciation
expense by multiplying this rate by the asset’s beginning-of-period book value
• The double-declining-balance depreciation schedule is shown in

the schedule follows the formula except for year 2015, when

depreciation expense is $296.

• This $296 is not equal to 40% * $1,296, or $518.40. If we had used

the $518.40 for depreciation expense in 2015, the ending book

value would equal $777.60, which is less than the $1,000 salvage

value. Instead, the $296 is computed by subtracting the $1,000

salvage value from the $1,296 book value at the beginning of the

fifth year (the year when DDB depreciation cuts into salvage value)
 Capital and Revenue Expenditures

• Expenditures for acquiring plant assets or for addition to plant assets

and expenditures that adds to the utility of for more than one
accounting period are called capital expenditures.

• Such expenditures are added to the asset account or to a related

accumulated depreciation account.

• Expenditures that benefit only the current period and that are made
in order to maintain normal operating efficiency are called revenue
expenditures. Such expenditures are debited to expense accounts.
 Capital expenditures

• The following are common capital expenditures related to plant

assets

• A) Initial acquisition: - includes all expenditures necessary to get in

place and ready for use.

• B) Addition to plant assets: - expenditures for addition to existing

plant assets would be debited to the plant asset accounts like the
initial cost of acquiring plant assets. The cost of additions would be
depreciated over the estimated useful life of the additions.
• Examples: - Cost of adding an air-conditioning system to the

building, Cost of adding a wing to a building.

C) Betterment: - expenditures that increase efficiency or capacity for

the remaining useful life of a plant asset are called betterments

such expenditures should be debited to the plant asset account. For

example, if the power unit attached to a machine is replaced by one

of greater capacity, its cost should be debited to a machine account.

Also the cost and the accumulated depreciation related to the old

power unit should be removed from the account.

• The cost of the new power unit should then be depreciated over its
estimated useful life.

D. Extraordinary repairs: - Expenditures that extends the assets

expected useful life beyond the original estimate are called
extraordinary repairs.

Accumulated depreciation---------xx

Cash --------------------xx

• The depreciation for future periods should be computed on the basis

of the revised book value of the asset and the revised estimates of the
remaining useful life.
 Revenue Expenditures

• These revenues maintain the assets in its existing conditions or

restore the asset to good working conditions, repair and

maintenance, the cost of repainting building.

• Small expenditures are usually treated as repair expenses, even

though they may have the characteristics of capital expenditures.

 iv. Disposal (De recognition) of PPE

• All plant assets except land eventually wear out or become

inadequate or obsolete and must be sold, discarding or treaded in

on a new asset.

• When an old plant asset is disposed of, both the asset’s cost

accumulate depreciation must be removed from the accounts.

Overall, then, all asset disposals have the following in common:

To record the disposal, you must

• i) Write off the asset`s cost

• ii) Write off the accumulate depreciation

• iii) Record any consideration (usually cash) received or to be

received

• iv) Record gain or loss on disposal

 Discarding Fixed Assets

• When plant assets are no longer useful to the business and have no
residual or market value, they are discarded. If the asset has been
fully depreciated, no loss is realized If not loss will be realized.

• Example 1) Assume that an item of equipment acquired at a cost of

$25,000 is fully depreciated at Dec 31, the end of the preceding fiscal
year. On February 14 the equipment is discarded.

• The entry to record this is as follows:

• Accumulated depreciation ------------ $ 25,0000

• equipment----------------------- $ 25,000
• Example 2) Assume that equipment costing $6, 000 is depreciated

at annual straight line rate of 10%. In addition, assume that on

December 31 of the preceding fiscal year, the accumulate

depreciation balance, after adjusting entries is $4,750.

• Finally, assume that the asset is removed (disposed) from service

on the following March 24.

• The entry to record the depreciation for three months of the

current period prior to the asset`s removal from the service is as

follows:
• Depreciation expense----------------$150

Accumulated depreciation- equipment----------$150

The discarding of the equipment is recorded as follows:

Accumulated Depreciation…………….$4,900

Loss on disposal of fixed assets…….1.100

Equipment……………………………$6,000

The loss of $1,100 is recorded because the balance of the accumulated

depreciation account ($4,900) less than the balance in the equipment
account ($6000)
 Selling Fixed Assets

• The entry to record the sale of fixed asset is similar to the entries

illustrated above, except that the cash or other asset received

must be recorded.

• If the selling price is more than the book value of the asset, the

transaction results in a gain.

• If the selling price is less than the book value, there is a loss. In

addition, if the selling price is equal to the book value, there will

be neither gain nor loss.

 Acquisition of Plant Assets through Leasing

• Instead of owing a plant asset, a business may acquire the use of

a plant asset through a lease.

• A lease is a contractual agreement that conveys the right to use

an asset for a stated period of time.

• The two parties to a lease contract are the lessor (owner of the

asset) and the lessee (who get the right to use the asset from

the lessor).
 Capital Leases:

• Leases which include one or more of the following provisions are

capital leases:

• 1) The lease transfers ownership of the leased asset to the lessee at

the end of the lease term,

2) The lease contains an option for a bargain purchase of the leased

asset by the lessee,

3) The lease term extends over most of the economic life of the leased
asset, or The lease requires rental payment which approximate the fair
market value of the leased asset..
4) When a lease is executed, the lessee would debit an asset account
for the fair market value of the leased asset and credit a long- term
lease liability account

Operating Leases:

• Leases which do not meet the preceding criteria for a capital lease are
classified as operating leases.

• Rent expense is recognized as the leased asset is used.

• Neither future lease obligation nor future rights to use the leased
asset is recognized in the account
 v. Internal controls of plant assets

• Like inventory on the previous chapter plant asset also need

internal control for the following purpose

• To protect the asset and provide accurate accounting record

• For management controlling

• To determine salvage value and depreciation amount

• To make correct entries for disposal and retirements

 Intangible Assets

• Nature and classification of Intangible assets with their recognition and

measurement at the time of acquisition

• An intangible asset is an identifiable non-monetary asset without

physical Substance.

• The basic principles of accounting for intangible assets are like those
for plant assets.

• The major concerns are the determination of the acquisition costs and
the recognition of periodic cost expiration, called amortization, due to
the passage of time or a decline in usefulness
• Patents, copyrights, trademarks, and goodwill are long-lived
assets that are used in the operations of a business and are not held
for sale. These assets are called intangible assets because they do not
exist physically.

• All costs of intangible assets are accounted for by the entity at the
time these costs are incurred. An intangible asset shall be recognized
if, and only if:

• It is probable that the expected future economic benefits that are

attributable to the asset will flow to the entity; and

• The cost of the asset can be measured reliably.

 Patents

• Manufacturers may acquire exclusive rights to produce and sell goods with
one or more unique features.

• Such rights are evidenced by patents, which are issued to inventors by the
federal government.

• They continue in effect for 17 years. The initial cost of a purchased patent
should be debited to an asset account and then amortized, over the years
of its expected usefulness.

• A separate contra asset account is normally not credited for the

amortization of patents. In most situations, the credit is recorded directly in
the patents account. This practice is common for all intangible assets.
Adjusting Entry

Dec. 31 Amortization Expense –Patent… … … … … … XXX

Patents… … … … … … … … … … … … … … … … … … … XXX
 Copyrights

• The exclusive right to publish and sell a literary, artistic or

musical composition is obtained by a copyright.

• Copyrights are issued by the federal government and extend

for 50 year beyond the author’s death.

 Good will

• In the sense that it is used in business, good will is an intangible

asset that attachés to a business because of such favorable

factors as location, product superiority, reputation, and

managerial skill.

• The value of good will eventually disappears and that the

recorded costs should be amortized over the years during which

the good will is expected to be of value.

• However, should not exceed 40 years.

 Measurement after acquisition.
Amortization of Intangible Assets

• The cost of an intangible asset with a definite life is allocated on

a straight-line basis each period over its useful life in a process

called amortization that is similar to depreciation and depletion

except goodwill.

• Amortization expense is included on the income statement each

period and the intangible assets are reported at cost less

accumulated amortization on the balance sheet.

A ssum e H eist C om pany purchases a patent for $800,000 and intends to use it for 20 years. T he

entry to record the purchase of patent is;

Patents … … … … … … … ..800,000

C ash… … … … … … … … … . 800,000

T he adjusting entry to record am ortization ex pense is;

A m ortization ex pense = $800,000/20 = $40,000

Patent A m ortization ex pense … … … … 40,000

Patents … … … … … … … … … … … … … .40,000
 • IMPAIRMENT OF INTANGIBLE ASSETS
•All definite intangible assets are amortized through their useful life. However,

Intangible assets with indefinite lives are not amortized.

•Instead, these assets are to be tested at least annually for

possible impairment, and the asset’s book value is written down

(decreased) to its fair value if

impaired.

•Goodwill is recorded only by an acquiring company when it

purchases another company and pays more for that company

than the value of the assets acquired.

•According to IFRS, goodwill is not amortized. Instead, the

acquiring company measures the current value of its goodwill

each year.
•If the goodwill has increased in value, there is nothing to record.

But if goodwill’s value has decreased, then the company records a

loss and writes the goodwill down

•For example, suppose Walmart’s company goodwill is about

purchase of Monterrey has goodwill of $2,000,000 is worth only $1,

500,000 on December 31, 2011. In that case, Walmart would make

the following entry:

•Loss on impairment of goodwill …………500,000

• Goodwill ($2,000,000 - $1,500,000) …….................500,000

 • Natural resources

• i. Nature of natural resources

• Natural resources are plant assets that come from the earth.

Natural resources are like inventories in the ground or on top of the

ground.

• Examples include iron ore, oil, natural gas, diamonds, coal, and

timber.

• Natural resources are expensed through depletion.

• It’s called depletion because the company is depleting (using up) a

natural resource such that at some point in time, there is nothing

left to dig out of the ground.

• The term depletion describes the process of allocating a natural

resource’s cost over the period of its exploitation.

• Depletion expense is computed by the units-of-production formula

• Recognition and measurement

• Depletion expense (UOP) = (Cost – RV) × 1 × No. of units
removed
• Estimated total units of natural resources Or Depletion is

determined as follows:

• Step 1. Determine the depletion rate as:

• Depletion Rate = Cost of Resource

Estimated Total Units of Resource

• Step 2. Multiply the depletion rate by the quantity extracted

from the resource during the period. Depletion Expense =

Depletion Rate × Quantity Extracted

• To illustrate, assume that Karst Company purchased mining rights of
an oil well may cost $700,000,000 and hold 70,000,000 barrels of oil.
Natural resources usually have no residual value. 3,000 barrels are
extracted during the month, and then depletion expense for that
month is;

• Step 1. Depletion Rate = $700,000,000/70,000,000 = $10 per barrel

• Step 2. Depletion Expense = $10 × 3,000 barrels = $30,000

• Depletion Expense…….……30,000

Accumulated Depletion–oil ……30,000

END OF CHAPTER TWO
GOOD LUCK