[ Principles of accounting ii ] Chapter 3

Chapter Three
Accounting for Plant Assets, Natural resources and Intangible Assets
Chapter Learning Objectives:
After studying this chapter, you should be able to:
 Describe how the historical cost principle applies to plant assets.
 Explain the concept of depreciation and how to compute it.
 Distinguish between revenue and capital expenditures, and explain the entries for each.
 Explain how to account for the disposal of a plant asset.
 Compute periodic depletion of extractable natural resources.
 Explain the basic issues related to accounting for intangible assets.
 Indicate how plant assets, natural resources, and intangible assets are reported

3.1. Nature of Plant Assets

Plant assets are resources that have physical substance (a definite size and shape), are used in
the operations of a business, and are not intended for sale to customers. They are also called
property, plant,and equipment (PPE).They are expected to provide service to the company
for a number of years.
Plant asset are not acquired for resale. Any asset that is acquired for resale purpose is not a plant
asset regardless of their durability, nature of the assets, and the length of time they are held.
Example land held for speculation purpose. They are subject to depreciation i.e. declining in
usefulness through passage of time.

3.2. Determining the Cost of Plant Assets (PPE) On Initial Recognition

In general, companies record plant assets at cost. As it stipulated in IAS 16 the cost of any plant
asset consists of all expenditures necessary to acquire theasset and make it ready for its
intended use. For example, the cost of factory machinery includes the purchase price, freight
costs paid by the purchaser, and installation costs. Once cost is established, the company
generally uses that amount as the basis of accounting for the plant asset over its useful life.
In the following sections, we explain the application of the historical cost principle to each of the
major classes of plant assets.
A. Land and Land Improvement
Companies often use land as a site for a manufacturing plant or office building. The cost of land
includes (1) the cash purchase price, (2) closing costs such as title and attorney’s fees, (3) real
estate brokers’ commissions, and (4) accrued property taxes and other liens assumed by the
purchaser.
For example, if the cash price is $50,000 and the purchaser agrees to pay accrued taxes of
$5,000, the cost of the land is $55,000. Companies record as debits (increases) to the Land
account all necessary costs incurred to make land ready for its intended use. When a company
acquires vacant land, these costs include expenditures for clearing, draining, filling, and grading.
Sometimes, the land has a building on it that must be removed before construction of a new

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building. In this case, the company debits to the Land account all demolition and removal costs,
less any proceeds from salvaged materials.On the other hand the cost of land improvement
includes, cost of driving ways, Fences, outdoor lighting system, Parking lots, Walkways if it
does last as long as the life of the building and Trees and Shrubs. Here land improvement is
subjected to depreciation over its estimated useful life but land is not subjected for depreciation.

Illustration 1
Assume that Lewi Company 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. The cost of the land is $2,150,000, computed as
shown below.
Cash price of property $ 2,000,000
Net removal cost of warehouse ($75,000 - $15,000) 60,000
Attorney’s fee 10,000
Real estate broker’s commission 80,000
Cost of land $2,150,000
When Lewi records the acquisition, it debits Land for $2,150,000 and credits Cash for
$2,150,000.

B. Buildings, Machinery, and Equipment

The cost of constructing a building includes architectural fees, building permits, contractors’
Charges, and payments for material, labor, and overhead. If the company constructs its own
building, the cost will also include the cost of interest on money borrowed to finance the
construction (if the recognition criteria in IAS 23—Borrowing Costs).

When an existing building (new or old) is purchased, its cost includes the purchase
price,brokerage commission, sales and other taxes paid, and all expenditures to repair and
renovate thebuilding for its intended purpose.
Cost of equipment includes all costs incurred in acquiring the equipment and preparing it for
use such as purchase price, non-refundable Sales taxes, freight charges, insurance during transit
paid by the purchaser and expenditures required in assembling, installing, and testing the unit.

Note: Expenditures resulting from carelessness or errors in installing the assets, from vandalism,
or from other unusual occurrences don’t increase the usefulness of the asset and should be
treated as an expense.
Illustration 2
Assume Zhang Company purchases factory machinery at cash price of $500,000. Related
expenditures are for sales taxes $30,000, insurance during shipping $5,000, and installation and
testing $10,000. The cost of the factory machinery is $545,000, computed as follows;

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Factory Machinery
Cash price $ 500,000
Sales taxes 30,000
Insurance during shipping 5,000
Installation and testing10,000
Cost of factory machinery $545,000
Zhang makes the following summary entry to record the purchase and related expenditures
Equipment 545,000
Cash 545,000
(To record purchase of factory machine)
For another example, assume that Huang Company purchases a delivery truck at a cash price
of $420,000. Related expenditures consist of sales taxes $13,200, painting and lettering
$5,000, motor vehicle license $800, and a three-year accident insurance policy $16,000. The
cost of the delivery truck is $438,200, computed as follows.
Delivery Truck
Cash price $ 420,000
Sales taxes 13,200
Painting and lettering 5,000
Cost of delivery truck $438,200
Huang treats the cost of the motor vehicle license as an expense, and the cost of the insurance
policy as a prepaid asset. Thus, Huang makes the following entry to record the purchase of
the truck and related expenditures:
Equipment 438,200
License expense 800
Prepaid Insurance 16,000
Cash 455,000
(To record purchase of delivery truck and related expenditures)

3.3. Measure and Record of Depreciation

Plant asset is expected to have a lower value or no value when it is retired from the service. This
is because plant assets decline in usefulness through the time which we call it depreciation. The
difference between the initial cost and the value remaining when it is retired (Residual Value or
Scrape Value or Salvage Value or Trade in Value) is called depreciable cost that is the cost that
should be allocated over the useful life the assets as a depreciation expense.
Depreciation is the process of allocating to expense the cost of a plant asset over its useful
(service) life in a rationaland systematic manner. Cost allocation enables companies to
properly matchexpenses with revenues in accordance with the expense recognition principle.
It is important to understand that depreciation is a process of cost allocation. It is not a
process of asset valuation.

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Depreciation applies to three classes of plant assets: land improvements, buildings, and
equipment. Each asset in these classes is considered to be a depreciable asset. Why? Because
the usefulness to the company and revenue-producing ability of each asset will decline over the
asset’s useful life. Depreciation does not apply to land because its usefulness and revenue-
producing ability generally remain intact over time. In fact, in many cases, the usefulness of land
is greater over time because of the scarcity of good land sites. Thus, land is not a depreciable
asset.

The causes of depreciation are divided into two broad classes:

1. Physical Usage – physical depreciation results from the wear and tear of plant assets due to
operating use and forces of nature such as earth quake, land slide, storm, etc
2. Functional or economic depreciation – results from obsolescence and inadequacy
 Obsolescence – is the process of becoming out of date because of technological
innovation. Example type writing equipment
 Inadequacy – refers to the effect of growth and change in the scale of a business
operation. Inability to meet the demand of customers. Example small machines held by
large business
Plant asset are reported on the balance Sheet at their carryingamounts or book values, which is:
Carrying amount = Cost - Accumulated Depreciation.
Factors that affect periodic depreciation expense are
 Initial cost or acquisition cost
 Residual value: also sometimes called scrap value or salvage valueof anasset is the
estimated amount that an entity would currently obtain from disposal of the asset,after
deducting the estimated costs of disposal, if the asset were already of the age and in
thecondition expected at the end of its useful life.
 Useful life or estimated economic life: is the length of service expected from using the
asset. Useful lifemay be expressed in years, units of output, miles, or some other measure
 Method of depreciation
3.3.1. Methods of Depreciation
It is a method of allocating the depreciable amount of an asset on a systematic basis over its
useful life. IAS 16 states that the depreciation method shouldreflect the pattern in which the
asset’s future economic benefits are expected to be consumedby the entity, and that
appropriateness of the method should be reviewed at least annually in case there has been a
change in the expected pattern. Beyond that, the standard leaves the choice of method to the
entity, even though it does cite the following methods. These are:
1. Straight line method
2. Units of production method
3. Declining balance method
4. Sum of the year’s digit method and
Here for PPE assets with a reasonably constant pattern of consumption, the allocation basis
shouldbe done using the straight-line method. The units-of-production method best fits those

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assets that wear out because of physical use rather than obsolescence. An accelerated method
(such as DDB) applies best to assets that generate more revenue earlier in their useful lives and
less in later years
1. Straight Line Method (SLM)
This method allocates depreciable cost to each period of the Estimated Economic Life of the
assets equally. It is measured solely by the passage of time. Depreciation per year is computed as
follows:
 Depreciable cost is the cost of the asset lessits residual value.
 Depreciation expense per year = ( Cost – Residual Value) / Estimated Economic Life
Illustration 2.1: Assume that XYZ Co. acquired a machine at the beginning of 2010(January 1)
for $ 13,000 cost and the residual value of the machine at the end of 5 years of economic life is
estimated at $ 1,000. Instruction: compute the amount of depreciation allocable to each year and
present the necessary adjustment at the end of each year.
Depreciation expense per Year = ($13,000– $1,000) / 5 Years = $ 12,000 / 5 = $2,400
Alternatively, we also can compute an annual rate of depreciation. In this case, the rate is 20%
(100% /5 years). When a company uses an annual straight-line rate, it applies the percentage rate
to the depreciable cost of the asset ($12,000 x20%= $2,400).
Depreciation expense......................2,400
Accumulated depreciation..................................2,400
Note that the depreciation expense of $2,400 is the same each year. The book
value (computed as cost minus accumulated depreciation) at the end of the useful life is equal to
the expected $1,000 residual value.

2. Units of Production Method

This method yields a depreciation charge that varies with the amount of usage. To apply this
method the life of the asset is expressed in terms of production capacity such as machine hours,
miles, kilo meters, or no of units, etc.
Under this method depreciation is computed as follows:
 Depreciation Rate = (Acquisition Cost – Residual Value) / Estimated Production
Capacity
 Depreciation Expense = Depreciation Rate * Actual Usage of the Asset
Illustration 2.2: XYZ Company purchased diesel powered generator on January 1, 2000 at
Br 55,000 and the generator has estimated economic life of 5 years or a production capacity of
500,000 machine hours with Br 5,000 residual value. Instruction: calculate the depreciation
expense for the year 2000 and 2001 assuming that the generator was used for 100,000 and
120,000 hours in year 2000 and 2001, respectively.
 Depreciation Rate = (Br 55,000 – Br 5,000) / 500,000 hours = Br 0.10 per hour
 Year 2000 depreciation expense = depreciation rate * actual usage

 Year 2000 depreciation expense = Br 0.10/ Hr. * 100,000 hours

 Year 2000 depreciation expense = Br 10,000

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 Year 2001 depreciation expense = depreciation rate * actual usage

 Year 2001 depreciation expense = Br 0.10/ Hr. * 120,000 hours
 Year 2001 depreciation expense = Br 12,000
3. Declining Balance Method
Declining balance method is the most common accelerated depreciation method of depreciation.
This method yields a decline in periodic depreciation charges over the estimated life of the
assets. The most common techniques are to double the straight line depreciation and multiply the
resulting rate to the cost of the asset less its accumulated depreciation. When twice the straight-
line rate is used, the method is usually called the double-declining balance method.

Depreciation per year = (2 / EEL) * (Acquisition Cost – Accumulated Depreciation)

Where EEL= estimated economic life of the plant asset.
Illustration 2.3: CC Corporation purchased equipment on January 1, 2000 for Br 20,000 which
has an expected life of 5 years and residual value of Br 1,000. Instruction: calculate the
declining balance rate and the amount of depreciation for its useful life.
 Cost = Br 20,000
 EUL = 5 years
 Residual Value = Br 1,000
Declining balance rate (DBR) =2 (1/EUL) = 2(1/5)= 40%
Annual depreciation expense=Declining balance rate x Book Value at the beginning of the year
(cost less accumulated depreciation)
Year 2000 = 40% * (Br 20,000 – 0) = 40% * Br 20,000 = Br 8,000
Year 2001 = 40% * (Br 20,000 – 8,000) = 40% * Br 12,000 = Br 4,800
Year 2002 = 40% * (Br 20,000 – 12,800) = 40% * Br 7,200 =Br 2,880
Year 2003 = 40% * (Br 20,000 – 15,680) = 40 % x Br 4,320= Br 1,728
Year 2004 = 40% * (Br 20,000 – 17,408) = 40% x Br =2,592 = Br 1,037
In the year 2004 the calculated amount of depreciation is Br 1,037 but the actual depreciation
expense is Br 1,592 (Br 2,592 – 1000). The 2,592 is the difference between Br 20,000 (cost) and
17,408 (accumulated depreciation). The estimated residual value does not enter into the
computation of depreciation expense until the very end. This is because this method provides an
automatic residual value. If an asset has a Residual Value, this depreciation method should
consider the stated residual value. Thus, in the above example the depreciation expense for year
2004 is Br 1,592 rather than Br 1,037.
4. The Sum Of Years Digits (SYD) Method
Under this method the periodic charge for depreciation declines steadily or continuously over the
estimated life of the asset because successive small action is applied each year to the original
cost less estimated residual value. The following steps are followed to determine the depreciation
charge under this method:
 Estimate the useful life of the asset in the years

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 Assign consecutive numbers for each year starting from 1

 Find the sum of these numbers using the following formula: SYD = [N (N + 1)] / 2. Where
N = estimated useful life of the asset in years
 Determine the numerator which is a number of the economic life of the asset remaining at the
beginning of each accounting period. Year 1= N, Year 2= N – 1, Year 2 = N – 2 , etc
 Compute depreciation using the formula:
Annual Depreciation = (Remaining useful life/ SYD) *(Acquisition cost – Residual Value)

Illustration 2.4: JK Company purchased building on January 1, 2010 for Br 105,000 and its
estimated life is 4 years with estimatedresidual value of Br 5,000 and the physical period ends on
December 31, 2010. Instruction: determine the amount of depreciation expensefor the building
for its useful life using SYD method of depreciation.
 SYD = [N (N + 1)]/ 2 = [4 (4 + 1)] / 2 = 10
Depreciation Expense
 2010 = 4/10 (105,000 – 5,000) = Br 40,000
 2011 = 3/10 (105,000 – 5,000) = Br 30,000
 2012 = 2/10 (105,000 – 5,000) = Br 20,000
 2013= 1/10 (105,000 – 5,000) = Br 10,000
3.3.2. Partial Year Depreciation
To calculate the partial year depreciation, the following are important:
The date of purchase must be known. The number of days in the month in which the purchase is
made affects the depreciation expense in the following manner:
 If it is higher than 50% of the days in the month of purchase, compute depreciation for the
whole month
 If it is less than 50% of the days, ignore the whole month
Illustration 2.KK Company purchases a delivery truck on April 13, 1991 for Br 180,400. The
expected life of the truck was 4 years or 200,000 Kilometers (KMs)and has an estimated residual
value of Br 6,400. During the year 1991 and 1992 the truck was driven for 60,000 and 40,000
KMs, respectively. The company’s fiscal period ends on December 31 of each year.
Instruction:Compute depreciation expense for the year 1991 and 1992 under all the methods of
depreciation.
Straight Line Method
 Annual Depreciation= (180,400 – 6,400)/4 =Br 43,500
 1991- Partial Year Depreciation= 9/12 * Br 43,500 = Br 32,625
 1992 Depreciation = 3/12 * Br 43,500 + 9/12 * Br 43,500 = Br 43,500
Declining Balance Method
 Annual Depreciation, 1st Year = 50% (Br 180,400 – 0)=Br 90,200
 Annual Depreciation, 2nd Year = 50% (Br 180,400 – 90,200)=Br 45,100
 1991- Partial Year Depreciation= 9/12 * 90,200=Br 67,650
 1992 Depreciation = 3/12 * 90,200 + 9/12 * 45,100 = 22,550 + 33,825 = Br 56,375

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SYD Method
 SYD = 4 (4 + 1)]/2= 10
 Annual Depreciation, 1st Year = 4/10 (Br 180,400 – 6,400)= Br 69,600
 Annual Depreciation, 2nd Year = 3/10 (Br 180,400 – 6,400)= Br 52,200
 1991- Partial Year Depreciation= 4/10(180,400-6400) =9/12* 69,600 = Br 52,200
 1992 Depreciation = 3/12 * 69,600 + 9/12 * 52,200= 17,400 + 39,150=Br 56,550
Units-of Production
 Depreciation Rate = (180,400 – 6,400) / 200,000KMs =Br 0.87/ km
 1991 Depreciation= 60,000 KMs * 0.87/km= Br 52,200
 1992 Depreciation= 40,000 KMs * 0.87/km = Br 34,800
3.4. Changes in Estimates and Revision of Periodic Depreciation
Residual value and estimated economic life are estimates. There may be an error in estimates.
Thus, estimates may be revised or changed. The change in estimates is applicable only to the
value or cost not depreciated so far ignoring the portion acquisition cost depreciated in the
previous accounting periods. Revision in estimates does not apply retroactively to the past
accounting periods.
Illustration 2.6: Assume that on January 1, 1992 AA Company purchased a delivery truck for
Br 52,000. At the time of purchase the truck was estimated to last 5 years with salvage value of
Br 2,000 and it was depreciated accordingly on the straight line method for two years and at the
beginning of the year 1994, the life was estimated to last 6 more years with a salvage value of Br
2,600. Determine the revised annual depreciation per annum.
 Givens: cost Br 52,000
 Salvage value= Br 2,000
 EEL = 5 Years
 Depreciation/Year = (52,000 – 2,000) / 5
 Depreciation /Year = Br 10,000
Depreciation from 1992 to 1993
 Accumulated Depreciation = Br 10,000 * 2 years
 Accumulated Depreciation = Br 20,000
Revised Depreciation starting from 1994
 Revised Cost (Carrying Amount) = Br 52,000 – 20,000
 Revised Cost (Carrying Amount) =Br 32,000
 Revised EEL = 6 years
 Revised RV = Br 2,600
 Revised Depreciation = Br 32,000 – 2,600 / 6 = Br 29,400/6=Br 4,900

3.5. Capital and Revenue Expenditures

IAS 16 states that an entity should not recognize the costs of the day-to-day servicing (which
typically comprises the costs of labor and consumables, or small parts of the item) in the carrying
amount of an item of PPE. These costs are expensed or charged to the Income Statement as
incurred. The purpose of these expenditures is often described as for the “repairs and

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maintenance” of the PPE and we called them as revenue expenditure. For example, Airbus may
perform regular maintenance of its motor vehicles.
On the other hand, capital expenditures are those expenditures incurred for acquiring plant asset
or for addition to such an asset and that will affect the utility of the plant asset for more than one
accounting period. In other words expenditures that increase the asset’s capacity or extend its
useful life are called capital expenditures. Such expenditures are debited to the asset account or
to the related accumulated depreciation account. The common capital expenditures in addition to
the initial cost includes the following: Additions, Betterments and Extraordinary Repairs
Additions:
 Are those expenditures or costs increase the service potential of the plant asset
 They are debited to the plant asset account
 They would be depreciated over the estimated useful life of the additions
 Example: cost of adding an air conditioning system or an elevator to the building
Betterments:
Betterments are expenditures that increase operating efficiency or capacity for the remaining
useful life of the plant asset. These costs will be added to the plant asset account. Example:
substituting the old power point by a new power unit, substituting the old engine by new one that
improves operating efficiency.
Extraordinary repairs:
These are expenditures that increase the useful life of an asset beyond the original estimate.
These costs are debited to the appropriate accumulated depreciation account and the periodic
depreciation for the future period will be determined on the basis of the revised book value.
The distinction between a capital expenditure and revenue expenditure (expenses) requires
judgment: Does the cost extend the asset’s usefulness or its useful life? If so, record an asset. If
the cost merely repairs the asset or returns it to its prior condition, then record an expense.

Illustration 2.7: assume a delivery truck costing 190,000 has estimated economic life of 9 years
with Br 10,000 residual value. It has been depreciated over the past 5 years on a straight line
basis. At the beginning of year 6 the engine was changed as an extraordinary repair at Br 40,000
which was expected to increase the estimated economic life the truck to 8 years with the same
salvage value. Required: determine the annual depreciation charge for the remaining life of the
asset.
 Initial Cost: Br 190,000
 Residual Life: Br 10,000
 Estimated Economic Life: 9 years
 Annual Depreciation: Br 190,000 – 10,000/ 9 years =Br 20,000
 Accumulated Depreciation: Br 20,000 * 5 years =Br 100,000
Extraordinary Repairs: - it is debited to accumulated depreciation account
Accumulated Depreciation ....................................................
40,000
Cash............................................................................40,000

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After extraordinary repairs:

 Cost ...........................................................................Br 190,000
 Accumulated Depreciation......................................... (60,000)
 Book Value................................................................ Br 130,000
 Annual Depreciation= (130,000 – 10,000) / 8=.........Br 15,000
3.6. Disposal of Plant Assets
When an asset is no longer useful to the business, it is retired from the service. This is called
disposal. Disposal refers to discarding, selling, or exchanging plant assets. To journalize the
necessary entries on the date of disposal the following information are required:
 The up-to-date balance of the accumulated depreciation account
 The book value of the asset
 The loss or gain on disposal
1. Retirement of Plant Assets
When a plant asset are no longer useful to the business and has no market or sales value, they are
discarded. Illustration 1: RR Company derecognizedmachinery on December 31, 2003, which
was fully depreciated. The machine was acquired at a cost of Br 150,000 before six years.
 BV = AC – Accumulated Depreciation
 BV = Br 150,000 – 150,000 = 0
The Accounting Entry for this disposal:
Accumulated Depreciation ....................................................
150,000
Machinery..................................................................150,000
Illustration 2: RR Company discarded equipment, which was purchased at a cost of Br 32,000,
after it has been depreciated for 4½ years under the straight line method with a consideration of
Br 2,000 residual value. The estimated economic life of the asset was 5 years. Journalize the
necessary transaction:
 Annual Depreciation = Br 32,000 – 2,000/ 5
 Annual Depreciation = Br 6,000
 Accumulated Depreciation = Br 6,000 * 4.5 years
 Accumulated Depreciation = Br 27,000
 Book Value = Br 32000 – 27,000=Br 5,000
The loss on disposal is Br 5,000 as the business discards an asset with a value of Br 5,000.
The Accounting Entry for this disposal:
Accumulated Depreciation ....................................................
27,000
Loss on Disposal....................................................................
5,000
Equipment.................................................................. 32,000
2. Selling Old Plant Asset
The entry to record the sale of a plant asset is like the entry of discarding a plant asset except that
the cash or other asset to be received must be accounted for.
 If the selling price > book value, there will be a gain on disposal
 If the selling price < book value, there will be a loss on disposal

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Illustration 2.9: RA Furniture Company purchased a computer system for Br 34,000 and the
system was expected to last 8 years with a salvage value of Br 2,000. The equipment was
depreciated for 6 years based on the straight line method and sold at the beginning of year 7.
Required: Journalize the necessary entries assuming that the asset was sold for:
A) Br 15000
B) Br 10000
C) Br 9000
Acquisition Cost = Br 34,000
Residual Value = Br 2,000
Estimated Economic Life = 8 years
Annual Depreciation = Br 34,000 – 2,000/ 8
Annual Depreciation = Br 4,000
Accumulated Depreciation = Br 4,000 * 6 Years
Accumulated Depreciation = Br 24,000
Book Value = Br 34,000 – 24,000 = Br 10,000
A. Br 15,000 disposal price implies a gain of Br 5,000
Accumulated Depreciation .......................................24,000
Cash...........................................................................15,000
Equipment...................................................... 34,000
Gain on Disposal........................................... 5,000
B. Br 10,000 disposal price implies is neither gain nor loss
Accumulated Depreciation .......................................24,000
Cash...........................................................................10,000
Equipment...................................................... 34,000
C. Br 9,000 disposal price a loss of Br 1,000
Accumulated Depreciation .......................................24,000
Cash...........................................................................9,000
Loss on Disposal........................................................1,000
Equipment...................................................... 34,000
3. Exchanging or Trading in
IAS 16 provides guidance on the accounting for nonmonetary exchanges of tangible assets. It
requires that the cost of an item of property, plant and equipment acquired in exchange for a
similar asset is to be measured at fair value, provided that the transaction has commercial
substance
Commercial is defined as the event or transaction causing the cash flows of the entity to change.
That is, if the expected cash flows after the exchange differ from what would have been expected
without this occurring, the exchange has commercial substance and is to be accounted for at fair
value.
If the transaction does not have commercial substance, or the fair value of neither the asset
received nor the asset given up can be measured reliably, then the asset acquired is valued at the

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carrying amount of the asset given up. Such situations are expected to be rare. If there is a settle-
up paid or received in cash or a cash equivalent, this is often referred to as boot; that term will be
used in the following example
Illustration: Jamok, Inc. exchanges an automobile with a carrying amount of €2,500 with
Springsteen& Co. for a tooling machine with a fair market value of €3,200 and the fair value of
the automobile is not readily determinable.
In this case, Jamok, Inc. has recognized a gain of €700 (= €3,200 – €2,500) on the exchange,and
the gain should be included in the determination of net income. The entry torecord the
transaction would be as follows:
Machine …………………………3,200
Automobile ………………………...….2, 500
Gain on exchange of automobile….……. 700

3.7. Other Accounting Issues Related to PPE

A. Impairment of Plant Assets (PPE)- IAS 36
An asset is impaired when its carrying amount is higher than its recoverable amount.
Recoverable amount is the higher of fair value less cost to sell and value-in-use. Impairment
loss is the excess of the carrying amount of an asset or a cash-generating unit over its recoverable
amount.
Recoverable amount is defined as the higher of fair value less costs to sell or value in-use. Fair
value less costs to sell means what the asset could be sold for after deducting costs of disposal.
Value-in-use is the present value of cash flows expected from the future use and eventual sale of
the asset at the end of its useful life.
If either the fair value less costs to sell or value-in-use is higher than the carrying amount, there
is no impairment. If both the fair value less-costs to sell and value-in-use are lower than the
carrying amount, a loss on impairment occurs. Here the exactdetermination of the recoverable
amount, and many other aspects of impairment of assets, is beyondan introductory accounting
course. However, it is important for you to know the basic concepts ofimpairment.
Illustration: Assume again that ABCs equipment has a carrying amount of HK$800,000
(HK$1,000,000 − HK$200,000). However, at the end of 2017, independent appraisers determine
that the asset has a fair value of HK$775,000, which results in an impairment loss of HK$25,000
(HK$800,000 − HK$775,000). To record the equipment at fair value and to record this loss,
ABC makes the following entry.
Accumulated Depreciation—Equipment 200,000
Impairment Loss 25,000
Equipment 225,000
The impairment loss of HK$25,000 reduces net income

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B. Subsequent Measurement to Initial Recognition of PPE

Under IAS 16, an entity selects one out of two measurement models for each class of property,
which is defined as a grouping of assets of similar nature and use in an entity’s operations.
Cost model:under this model acquisition or construction cost is used for initial recognition,
subject to depreciation over the expected useful life and to possible write-down in the event of a
permanent impairment in value. This is similar to what we have discussed so far in this chapter.
In many jurisdictions this is the only method allowed by statute. But a number of jurisdictions,
particularly those with significant rates of inflation, do permit either full or selective revaluation
and IAS 16 acknowledges this by also allowing what it calls the “revaluation model.”
Revaluation model: An item of PPE whose fair value can be measured reliably shall be carried
at a revalued amount, being its fair value at the date of the revaluation less any subsequent
accumulated depreciation and subsequent accumulated impairment losses.
As the basis for the revaluation method, the standard stipulates that it is fair value (defined as the
price that would be received to sell an asset or paid to transfer a liability in an orderly transaction
between market participants at the measurement date) that is to be used in any such revaluations.
Fair value is usually determined by appraisers, using market-based evidence.
If revaluation is used, it must be applied to all assets in a class of assets and if an assets
experiencing rapid price changes must be revalued on an annual basis.

Illustration: ABC Company applies revaluation to equipment purchased on January 1, 2017,

for HK$1,000,000. The equipment has a useful life of 5 years, and no residual value. ABC
Company makes the following entry to record depreciation for 2017, assuming straight-line
depreciation.

Depreciation Expense 200,000

Accumulated Depreciation—Equipment 200,000

At the end of 2017, independent appraisers determine that the asset has a fair value of
HK$850,000. The entry to record the revaluation is as follows.

Depreciation expense —Equipment 200,000

Accumulated depreciation- Equipment 150,000
Revaluation Surplus 50,000
Here revaluation adjustments increasing an asset’s carrying amount are recognized in other
comprehensive income and accumulated in equity as “revaluation surplus.

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Here: $850,000 is the new basis of the asset, Depreciation expense of HK$200,000 in the income
statement, HK$50,000 in other comprehensive income and assuming no change in the total
useful life, depreciation in year 2 will be HK$212,500 (HK$850,000 ÷ 4).
3.8. Accounting for Natural Resources and Depletion

Natural resources consist of standing timber and resources extracted from the ground, such as
oil, gas, and minerals.IFRS defines extractive industries as those businesses involved in finding
and removing natural resources located in or near the earth’s crust.
Standing timber is considered a biological asset under IFRS. In the years before they are
harvested, the recorded value of biological assets is adjusted to fair value each period
Acquisition cost of an extractable natural resource is the
 price needed to acquire the resource and
 Prepare it for its intended use.
Depletion is the allocation of the cost to expense in a rational and systematic manner over the
resource’s useful life.
 Depletion is to natural resources as depreciation is to plant assets.
 Companies generally use units-of-activity method.
 Depletion generally is a function of the units extracted.
Illustration: Lane Coal Company invests HK$50 million in a mine estimated to have 10 million
tons of coal and no residual value. In the first year, Lane extracts and sells 250,000 tons of coal.
Lane computes the depletion expense as follows:
Depletion cost per unit = (Total cost – Residual Value)/total estimated units available
$50,000,000/10,000,000= $5 per ton

Annual depletion expense = $5.00 per ton x 250,000 tons = $1,250,000 annual depletion
Inventory (coal) 1,250,000
Accumulated Depletion 1,250,000

3.9. Accounting for Intangible Assets and Amortization

Intangible assets are those assets which don’t have any physical substance. However, for
accounting purposes intangible assets include patents, copy rights, trademarks, trade names, and
goodwill etc. the basic principles of accounting for intangible asset are the determination of the
acquisition costs and the recognition of periodic cost expiration which is called amortization.
1. Patents:Exclusive right to manufacture, sell, or otherwise control an invention for a
specified number of years from the date of the grant
Capitalize costs of purchasing a patent and amortize over its legal life or its useful life,
whichever is shorter. Expense any Research and Development costs in developing a patent.
Legal fees incurred successfully defending a patent are capitalized to Patents account.
Illustration: National Labs purchases a patent at a cost of $720,000. National estimates the
useful life of the patent to be eight years. National records the annual amortization for the ended
December 31 as follows

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Cost $720,000
Useful life ÷ 8 years
Annual expense $ 90,000
Amortization Expense 90,000
Accumulated amortization- Patents 90,000
2. Copy right is an exclusive right granted by the government to protect the production and
sale of literary or artistic materials. It granted for the life of the creator plus a specified
number of years, commonly 70 years.Capitalize costs of acquiring and defending it.
Amortized to expense over useful life.
3. Trademarks and Trade Names
Word, phrase, jingle, or symbol that identifies a particular enterprise or product. It has a Legal
protection for specified number of years, commonly 20 years. Protection may be renewal
indefinitely. Capitalize cost of acquisition andNo amortization.
4. Goodwill- is an intangible asset that is attached to a business as a result of such favorable
factors as location, product superiority, reputation, managerial skill, etc. Goodwill is recorded
normally when it is purchased from others. Here there is no legal life for goodwill, and
purchased goodwill will remain on the balance sheet as an asset and not subjected for
amortization raze than anImpairment Testswill made periodically.Internally created goodwill
should not be capitalized
3.10. Presentation of Plant Assets, Natural Resource and Intangible Assets on the
Financial Statements
Plant assets and natural resources are reported with the related accumulated depreciation and
accumulated depletion on the financial statement. On the other hand intangible assets may be
reported at net of the related accumulated amortization or with accumulated amortization in the
statement of financial position.

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