Ch-2. PPE

PREVIEW OF CHAPTER 1
Topics/Learning Objectives (L.O.)

1. Nature of plant assets
2. Cost of plant assets/Valuation
3. Costs after acquisition
4. Depreciation & depletion of plant assets
5. Disposition of plant assets
6. Nature, cost, & amortization of intangible assets
10-1
10-2
According to IAS 16
are held for use in the
. production or supply of
goods or services, for rental
PPE:- to others, or for
are administrative purposes; and
tangible
items
that: are expected to be used
during more than one period.
Spare parts that will be consumed with in 12 month or

in one operating cycle shall be classified as
inventories.
10-3 If they will be in use for more than 12
2.1. NATURE OF PROPERTY, PLANT, AND EQUIPMENT
Property, plant, and equipment are assets of a durable nature.

Other terms commonly used are plant assets, fixed assets, and
capital assets.
 Major characteristics:  Includes:
Land,
 “Used in operations” and not for resale/investment.
Building
 Include standby assets (in non-continuous use)
structures
 Exclude idle assets (land or building)-investment (offices,
 Revenue producing assets-productive purpose factories,
 Long-term/long-lived in nature and usually depreciated. warehouses),
 Long-term prepayments and
 Bundle of future services Equipment
(machinery,
 Possess physical substance. furniture,
 Tangible in nature-fixed in nature tools).
 Conversion (indirect) cost to a product
10-4
 Not directly incorporated/become part of a product
2.2. ACQUISITION COST OF PP&E [INITIAL VALUATION]
Guideline for Initial Valuation
 Historical cost [Cost principle] measures the cash or cash

equivalent price of obtaining the asset and bringing it to the
location and condition necessary for its intended use.
 Cost consists of all expenditures necessary & reasonable

to acquire an asset and make it ready for its intended use.
 Companies value property, plant, and equipment in

subsequent periods using either the
 Cost Model or
 Revaluation Method.
10-5
2. ACQUISITION COST OF PP&E [INITIAL VALUATION]
 Cost Components/Elements [Subject to Mode of Acquisition]

 Cost of Land
All expenditures made to acquire land and ready it for use.
Costs typically include:
(1) purchase price;
(2) closing costs, such as title (fees) to the land, attorney’s fees,
recording fees, sales taxes, broker’s commission
(3) costs of surveying, grading, filling, leveling, draining, and clearing;
(4) Razing or removing unwanted buildings, less the salvage
(5) assumption of any liens (delinquent real estate taxes),
mortgages, or encumbrances on the property; and
(6) additional land improvements that have an indefinite life ( Paving a
public street bordering the land)
10-6
 Cost of Land
 Improvements with limited lives, such as private
driveways, walks, fences, and parking lots, are recorded
as Land Improvements and depreciated.
 Land acquired and held for speculation is classified as an
investment.
 Land held by a real estate concern for resale should be
classified as inventory.
10-7
Illustration: Sunrise Company acquires real estate at a cash

cost of Br.100,000. The property contains an old warehouse
that is razed at a net cost of Br.6,000 (Br.7,500 in costs less
Br.1,500 proceeds from salvaged materials). Additional
expenditures are the attorney’s fee, Br.1,000, and the real
estate broker’s commission, Br.8,000.
Required: Determine the amount to be reported as the cost of

the land.
10-8
Required: Determine amount to be reported as the cost of the

land.
Land
Cash price of property (Br.100,000) Br.100,000
Net removal cost of warehouse (Br.7,500-Br.1,500) 6,000
Attorney's fees (Br.1,000) 1,000
Real estate broker’s commission (Br.8,000) 8,000
Cost of Land Br.115,000
Illustration 10-2
Computation of cost of land
10-9
 Cost of Land Improvements

Structural additions made to land. Cost includes all
expenditures necessary to make the improvements ready
for their intended use.
 Examples: driveways, parking lots, fences, landscaping,

and underground sprinklers, trees and shrubs, outdoor
lighting, concrete sewers and drainage.
 Limited useful lives.
 Expense (depreciate) the cost of land improvements over
their useful lives.
10-10
COST OF BUILDINGS
Includes all costs related directly to purchase or construction.
Purchase costs:
 Purchase price, closing costs (attorney’s fees, title insurance, etc.)
and real estate broker’s commission.
 Remodeling, and replacing or repairing the roof, floors, electrical
wiring, and plumbing. Reconditioning (purchase of an existing
building)
Construction costs:
 materials, labor, and overhead costs incurred during construction
and professional fees and building permits.

 Contract price plus payments for architects’ fees, Engineers’ fees,
building permits, and excavation costs.
 Companies consider all costs incurred, from excavation to
completion, as part of the building costs.
 Insurance & interest costs incurred during construction
 Walkways to and around the building
10-11
Illustration: The expenditures and receipts below are related to land,

land improvements, and buildings acquired for use in a business
enterprise. Determine how the following should be classified:
a. Money borrowed to pay building contractor a. Notes Payable

(signed a note)
b. Payment for construction from note proceeds b. Buildings
c. Cost of land fill and clearing c. Land
d. Delinquent real estate taxes on property d. Land
assumed by purchaser
e. Premium on 6-month insurance policy during e. Buildings
construction
10-12
Illustration: Determine how the following should be classified:
f. Refund of 1-month insurance premium f. (Buildings)

because construction completed early
g. Architect’s fee on building g. Buildings
h. Cost of real estate purchased as a plant site h. Land
(land Br.200,000 and building Br.50,000)
i. Commission fee paid to real estate agency i. Land
j. Cost of razing and removing building j. Land
k. Installation of fences around property k. Land
Improvements
10-13
Illustration: Determine how the following should be classified:
l. Proceeds from residual value of demolished l. (Land)

building
m. Interest paid during construction on money m. Buildings
borrowed for construction
n. Land
n. Cost of parking lots and driveways
Improvements
o. Cost of trees and shrubbery planted o. Land
(permanent in nature)
p. Excavation costs for new building p. Buildings
10-14
 Cost of Equipment
Include all expenditures incurred in acquiring the equipment
and preparing it for use. Costs include:
 Cash purchase price,
 freight and handling charges,
 insurance on the equipment while in transit,
 cost of special foundations if required,
 assembling and installation costs, and
 costs of conducting trial runs.
 Sales taxes
 Repairs (purchase of used equipment)
 Reconditioning (purchase of used equipment)
 Modifying for use
10-15
 Cost of Acquiring Fixed Assets Excludes:
 Vandalism (deliberate destruction of property)

 Mistakes in installation
 Uninsured theft
 Damage during unpacking and installing
 Fines for not obtaining proper permits from
government agencies
10-16
2. Special Issues
a) Self-Construction
Factory Overhead [FOH]
Interest cost [Debt Financing]
b) Savings or loss on self-construction
c) Cash discounts
c) Deferred payment contracts
d) Issuance of shares
e) Group/Basket/Lump sum purchases (vs.
individual/separate)
f) Donations/Grants/Gifts
g) Exchanges of non-monetary assets
10-17
Valuation of PPE-Interest Capitalization
Self-Constructed assets: These are assets constructed by the
business for use in operations.
Costs include:
 Materials and direct labor
 Direct/Variable manufacturing overhead
 Interest during construction [b/c of HC & Matching principles]
 Pro rata portion of indirect manufacturing overhead, i.e. Full
costing approach.
 Full costing is the most commonly used and is the generally
accepted method used to allocate the indirect MOH between
the normal operation (inventories) and self-construction. That
is all overhead costs are allocated both to production and to
self-constructed assets based on the relative amount of a
chosen cost driver (for example, labor hours) incurred.
10-18
 IFRS requires — capitalizing actual interest incurred during

construction. According to IAS 23 Borrowing Costs or interest
cost that are directly attributable to the acquisition, construction or
production of a qualifying asset form part of the cost of that asset.
Other borrowing costs are recognized as an expense.
 Consistent with historical cost.

 Capitalization considers three items:
1. Qualifying assets.
2. Capitalization period.
3. Amount to capitalize.
10-19
Qualifying Assets
Require a substantial period of time to get them ready for their
intended use or sale.
Two types of assets:
 Assets under construction for a company’s own use.
 Assets intended for sale or lease that are constructed or
produced as discrete projects.
Non-qualifying assets include:
 Inventories that are routinely manufactured.
 Assets that are in use or ready for their intended use.
 Assets that are not being used in the earning activities of the
company and are not undergoing the activities necessary to
get them ready for use.
10-20
Capitalization Period
Begins when:
1. Expenditures for the assets are being incurred.
2. Activities for readying the asset for use or sale are in progress .
3. Interest costs are being incurred.
 Capitalization continues for as long as these three conditions exist or
ceases when any one of the three conditions is not met or when the
asset is substantially completed.
 If the first condition is not met, the conceptual basis for interest
capitalization is absent.
 If the second condition is not met, construction activities are not the
cause of the opportunity cost.
 If the third condition is not met, there is no interest to capitalize.
Ends when:
The asset is substantially complete and ready for use
10-21
Interrupted when:
 Brief & inherent in normal construction work (e.g. labor disputes)-
Capitalization continues
 Intentional delays (e.g. customer choice of fixtures)-Capitalization
discontinued.
 Capitalization period: time between the expenditure date and the

date interest capitalization stops or year-end (whichever comes first)
 If the construction period covers more than one fiscal period,

accumulated expenditures include prior years’ capitalized
interest. (See comprehensive illus #2)
10-22
Amount to Capitalize
Capitalize the lesser of:
1. Actual interest cost incurred [both on the specific & general
or other loans].
2. Avoidable interest (Interest Potentially Capitalizable =IPC):
the amount of interest cost during the period that a
company could theoretically avoid if it had not made
expenditures for the asset. Or Avoidable interest is the
amount that could have been avoided, if expenditures for
the asset had not been made. It is a function of AAE.
 Average Accumulated Expenditures [AAE]-is a measure of
the debt that could have been retired and is the average
cash investment during the construction period.
10-23
Illustration: Assume a company borrowed $200,000 at 12% interest

from State Bank on Jan. 1, 2015, for specific purposes of constructing
special-purpose equipment to be used in its operations. Construction on
the equipment began on Jan. 1, 2015, and the following expenditures
were made prior to the project’s completion on Dec. 31, 2015:
Actual Expenditures during 2015: Other general debt existing on

January 1 $ 100,000 Jan. 1, 2015:
April 30 150,000
$500,000, 14%, 10-year
November 1 300,000 bonds payable
December 31 100,000
Total expenditures $ 650,000 $300,000, 10%, 5-year
note payable
10-24
Step 1 - Determine which assets qualify for capitalization of

interest.
Special purpose equipment qualifies because it requires a period of
time to get ready and it will be used in the company’s operations.
Step 2 - Determine the capitalization period.

The capitalization period is from Jan. 1, 2015 through Dec. 31, 2015,
because expenditures are being made and interest costs are being
incurred during this period while construction is taking place.
10-25
Step 3 - Compute weighted-average accumulated

expenditures (WAAE).
Weighted
Average
Actual Capitalization Accumulated
Date Expenditures Period Expenditures
Jan. 1 $ 100,000 12/12 $ 100,000
Apr. 30 150,000 8/12 100,000
Nov. 1 300,000 2/12 50,000
Dec. 31 100,000 0/12 -
$ 650,000 $ 250,000
A company weights the construction expenditures by the amount of time

(fraction of a year or accounting period) that it can incur interest cost on the
expenditure.
10-26
Step 4 - Compute the Actual and Avoidable Interest.
Selecting Appropriate Interest Rate:

1. For the portion of weighted-average accumulated expenditures
that is less than or equal to any amounts borrowed specifically to
finance construction of the assets, use the interest rate incurred
on the specific borrowings.
2. For the portion of weighted-average accumulated expenditures

that is greater than any debt incurred specifically to finance
construction of the assets, use a weighted average of interest
rates incurred on all other outstanding debt during the
period.
10-27
Step 4 - Compute the Actual and Avoidable Interest.

Actual Interest
Interest Actual
Debt Rate Interest Weighted-average
Specific Debt $ 200,000 12% $ 24,000 interest rate on
general debt
General Debt 500,000 14% 70,000 $100,000 = 12.5%
300,000 10% 30,000 $800,000
$ 1,000,000 $ 124,000
Accumulated Interest Avoidable

Avoidable Interest Expenditures Rate Interest
$ 200,000 12% $ 24,000
50,000 12.5% 6,250
$ 250,000 $ 30,250
10-28
Step 5 – Capitalize the lesser of Avoidable interest or Actual

interest.
Avoidable interest $ 30,250

Actual interest 124,000
Journal entry to Capitalize Interest:
Equipment 30,250
Interest Expense 30,250
10-29
Comprehensive Illustration 1: On November 1, 2014, ABC

Company contracted Pfeifer Construction Co. to construct a building
for $1,400,000 on land costing $100,000 (purchased from the
contractor and included in the first payment). ABC made the
following payments to the construction company during 2015.
10-30
ABC Construction completed the building, ready for occupancy, on

December 31, 2015. ABC had the following debt outstanding at
December 31, 2015.
Specific Construction Debt
1. 15%, 3-year note to finance purchase of land and
construction of the building, dated December 31, 2014, with
interest payable annually on December 31 $750,000
Other Debt
2. 10%, 5-year note payable, dated December 31, 2011, with
interest payable annually on December 31 $550,000
3. 12%, 10-year bonds issued December 31, 2010, with
interest payable annually on December 31
$600,000
Compute weighted-average accumulated expenditures for 2015.
10-31
Compute weighted-average accumulated expenditures for 2015.
ILLUSTRATION 10-4
Computation of Weighted-Average
Accumulated Expenditures
10-32
ILLUSTRATION 10-5
Compute the avoidable interest. Computation of
Avoidable Interest
10-33
Compute the actual interest cost, which represents the maximum

amount of interest that it may capitalize during 2015.
ILLUSTRATION 10-6
Computation of Actual
Interest Cost The interest cost that Shalla capitalizes is the
lesser of $120,228 (avoidable interest) and
$239,500 (actual interest), or $120,228.
10-34
ABC records the following journal entries during 2015:
January 1 Land 100,000

Buildings (or CIP) 110,000
Cash 210,000
March 1 Buildings 300,000
Cash 300,000
May 1 Buildings 540,000
Cash 540,000
December 31 Buildings 450,000
Cash 450,000
Buildings (Capitalized Interest) 120,228
Interest Expense. 119,272
Cash
239,500
10-35
At December 31, 2015, ABC discloses the amount of interest

capitalized either as part of the income statement or in the notes
accompanying the financial statements.
ILLUSTRATION 10-7
Capitalized Interest
Reported in the Income
Statement
ILLUSTRATION 10-8
Capitalized Interest
Disclosed in a Note
10-36
Comprehensive Illustration 2: On January 2, 20X1, A
Company commenced construction of a new building for its own
use at an estimated cost of Br. 2,200,000. The construction is
expected to be completed one month before the end of Year 20X2
(November 30). The following debts were held by the company
throughout the term of construction of the building:
Construction (specific) loan Br. 750,000, 15%, 3 years Notes Payable
General (nonspecific) loans 550,000, 10%, 5 years Notes Payable
600,000, 12%, 10 years, Bonds Payable
Moreover, the company made the following expenditures (payments) on the
construction of the building:
January 1, 20X1 $210,000
March 1, 20X1 300,000
May 1, 20X1 540,000
December 31, 20X1 450,000
August 1, 20X2 400,000
October 30, 20X2 200,000
10-37
A.Capitalized Interest For 20X1

Step 1: Compute actual interest expense for 20X1.
Construction loan (750,000*0.15*12/12) $112,500
Long-term note (550,000*0.10*12/12) 55,000
Long-term bonds (600,000*0.12*12/12) 72,000
Total Actual Interest $239,500
Step 2: Compute Weighted Average Accumulated Expenditures

(WAAE) for 20X1.
Expenditure Capitalization Period WAAE
Date Amount
January 1 $210,000 12/12 $210,000
March 1 300,000 10/12 250,000
May 1 540,000 8/12 360,000
December 31 450,000 0/12 0
Total $1,500,000 $820,000
10-38
Step 3: Compute the Interest Potentially Capitalizable (IPC) for 20X1.

•Case 1 WAAE > Construction (Specific) Loan
IPC = Interest on + Interest on Excess of WAAE
Construction Loan over Construction Loan
Interest on Excess of WAAE

Over Construction Loan = (WAAE- Construction Loan)*WAIR
WAIR = Total Actual Interest on Nonspecific Loans
Total Nonspecific Interest-Bearing Loans
•Case 2 WAAE < Construction (Specific) Loan
IPC = WAAE * Interest Rate on Specific Loan
Thus, IPC for 20X1:
= (750,000*0.15) + (820,000-750,000)*0.1104 = $120,228
10-39
Step 4: Capitalize the Lesser (Lower) of Actual Interest and IPC for
20X1.
Building under construction 120,228
OR
Interest Expense (239,500-120,228) 119,272
Cash (or Interest Payable) 239,500
B. Capitalized Interest For 20X2
Step 1: Compute actual interest expense for 20X2.
Construction loan (750,000*0.15*11/12) $103,125
Long-term note (550,000*0.10*11/12) 50,417
Long-term bonds (600,000*0.12*11/12) 66,000
Total Actual Interest $219,542
10-40
Step 2: Compute Weighted Average Accumulated Expenditures
(WAAE) for 20X2.
 1,620,228 = 1,500,000 (Construction Costs for 20X1) +120,228 (capitalized interest for
20X1)
Step 3: Compute the Interest Potentially Capitalizable (IPC) for 20X2.
= (750,000*0.15*11/12)
Expenditure + (1,783,865-750,000)*0.1104*11/12=
Capitalization WAAE $207,752
Date Amount period
January 1 $1,620,228 11/11 $1,620,228

August 1 400,000 4/11 145,455
October 1 200,000 1/11 18,182
Total $2,220,228 $1,783,865
10-41
Step 4: Capitalize the lesser of Actual Interest and IPC
OR
Interest Expense (219,542-207,752) 11,790
Cash (or Interest Payable) 219,542
10-42
Comprehensive illus #3: Cut Industries, Inc. has decided to

construct a new computerized assembly plant.
 Construction will take about 18 months.
 Construction costs are estimated at $6.4 million (excluding
capitalized interest).
 A 12%, $2 million loan is obtained and will become
effective on January 1, 2013, at the beginning of
construction.
 Cut Industries, Inc.’s other debts are:
5-year notes payable, 11% interest $3,000,000
Mortgage on other plant, 9% interest 4,800,000
10-43
The weighted-average interest rate on the general non construction
debt is computed as follows:
The following expenditures were incurred on the project during

2013.
January 1, 2013 $1,200,000
October 1, 2013 1,800,000
In the previous slide we noted that the weighted-average rate
was 9.8% (rounded).
10-44
Computation of the amount of interest to be capitalized
for 2013 follows:
In previous, the weighted- The firm borrowed

average rate was determined $1,800,000 on October 1
to be 9.8%
10-45
The amount of interest capitalized cannot exceed total interest
incurred during the year. Total interest during 2013 was as follows:
The actual interest was $1,002,000 and the calculated interest

was $192,500. Thus, the entry is as follows:
Construction in Progress 192,500
Cash 1,002,000
$1,002,000  $192,500
10-46
Assume that additional construction expenditures of $3,200,000

were made on February 1, 2014, and the project was completed
on May 31, 2014. The amount of interest to be capitalized for
2014 follows.
10-47
• Avoidable interest in 2014 includes interest on all loans that

could have been repaid with the construction expenditures
made in 2013.
• These expenditures total $3,193,500 ($1,200,000 + $1,800,000
+ $192,500) and include interest capitalized in 2013.
• Interest is capitalized until construction is completed on May
31 and the building is ready for use.
• Because $253,227 is less than the actual annual interest of
$1,002,000, the entire $253,227 is capitalized in 2014.
• The total building cost is $6,645,727, which includes $192,500
of interest capitalized in 2013 and $253,227 in 2014.
10-48
Valuation of PPE- Savings or Loss on Self-Construction
 When the cost of self-construction of an asset is less

than the cost to acquire it through purchase or
construction from outsiders, the difference is not a
profit, but a savings.
• When the cost is greater than the cost to acquire it
through purchase or construction from outsiders, the
asset should be recorded at cost.
10-49
Valuation of PPE- Savings or Loss on Self-Construction
Illustration: Kaplan Limited completed the construction of equipment on
November 10, 20X1. The following itemizes total construction costs:
Material $200,000
Labor 500,000
Incremental overhead 100,000
Capitalized interest 100,000
Total $900,000
Kaplan recorded all construction costs in equipment under
construction.
1. If the asset’s market value at completion equals or exceeds
$900,000, the following entry would be made on November 10,
20X1:
Equipment…………………………..900,000
Equipment under construction…………….900, 000
2. If the asset’s market value is only $880,000, the following entry
would be made on November 10, 20X1:
Equipment……………………………….880, 000
Loss on Construction of Equipment…….20,000
Equipment under construction…………….900, 000
10-50
Valuation of PPE- Cash Discounts
Cash Discounts — whether taken or not — generally considered a
reduction in the cost of the asset. The Net-of-Discount Method is
the preferred method
Example: ABC Co purchased equipment for Br 60,000 on account
under the term 2/10, n/30. Record the purchase:
Equipment ………………………………… 58,800
Accounts Payable…………………………………… 58,800
10-51
Valuation of PPE: Lump-sum (Basket) Purchases
Lump-Sum Purchases — Allocate the total cost among the various
assets on the basis of their relative fair market values.
Example: A company pays $120,000 for equipment and a building.
The land and building are appraised at $50,000 and $75,000,
respectively.
Appraisal Relative Total Allocated
Assets Value Fair Value Cost Cost
Equipment 50,000 50,000/125,000 120,000 48,000
Building 75,000 75,000/125,000 120,000 72,000
Total 125,000 120,000
Equipment 48,000
Building 72,000
Cash 120,000
10-52
Valuation of PPE: Issuance of Shares
Issuance of Shares — The market price of the shares issued is a

fair indication of the cost of the property acquired.
Example: North Co. decides to purchase building located adjacent to
it for expansion of its operation. The building is owned by Sky Co. In
lieu of paying cash for the building, North issues to Sky Co. 5,000
shares of common stock (par value $10) that have a fair value of $12
per share. Make the journal entry
Building (5,000 x $12)…………………….. 60,000

Common Stock………………………………………………….. 50,000
Paid-In Capital in Excess of Par—Common Stock.. 10,000
10-53
Valuation of PPE- Deferred-Payment Contracts
Deferred-Payment Contracts — Assets purchased on long-term credit
contracts are valued at the present value of the consideration exchanged.
Example 1: On January 2, 2013, purchased equipment with a cash price of
$50,000 for $15,000 down plus seven annual payments of $7,189 each.
Equipment 50,000
Discount on Notes Payable 15,323
Notes Payable 50,323
Cash 15,000
Example 2: Greathouse Company purchases equipment today in exchange
for a $10,000 zero-interest-bearing note payable four years from now. The
market interest rate is 9%. Record the purchase
Equipment …………………………… 7,084.30
Discount on Notes Payable………… 2,915.70
Notes Payable ………………..…………………. 10,000
10-54
Valuation of PPE: Exchanges
Exchanges of Non-Monetary Assets

Ordinarily accounted for on the basis of:
 the fair value of the asset given up or
 the fair value of the asset received,
whichever is clearly more evident.
Companies should recognize immediately any gains or losses on
the exchange when the transaction has commercial substance
(future cash flows change as a result of the transaction).
For example, ABC Co. exchanges some of its equipment for Building
held by XYZ Co. It is likely that the timing and amount of the cash
flows arising for the building will differ significantly from the cash
flows arising from the equipment. As a result, both ABC Co. and XYZ
Co. are in different economic positions. Therefore, the exchange has
commercial substance, and the companies recognize a gain or loss on
the exchange.
10-55
• In some cases, an enterprise acquires a new asset

by exchanging or trading existing nonmonetary
assets.
• Monetary assets are those assets whose amounts
are fixed in terms of currency, by contract, or
otherwise (cash, accounts receivable).
• Nonmonetary assets include all the other assets

(inventories, land).
10-56
Accounting for Exchanges
* If cash is 25% or more of the fair value of the exchange,

recognize entire gain because earnings process is complete.
10-57
Summary of Gain and Loss Recognition on Exchanges of

Nonmonetary Assets Lacks Commercial Substance
10-58
Exchanges - Loss Situation
Companies recognize a loss immediately whether the exchange

has commercial substance or not.
Rationale: Companies should not value assets at more than their
cash equivalent price; if the loss were deferred, assets would be
overstated.
10-59
Exchange – Gain Situation Illustration: ABC Company exchanged

equipment used in its manufacturing operations for similar equipment used
in the operations of XYZ Company plus $3,000 in cash . The following
information pertains to the exchange.
ABC XYZ
Equipment (cost) $28,000 $28,000
Accumulated Depreciation 19,000 10,000
Fair value of equipment 15,500 12,500

Cash given up 3,000
Instructions: Prepare the journal entries to record the exchange on the books
of both companies.
10-60
Calculation of Gain or Loss

ABC XYZ
Fair value of equipment received $12,500 $15,500
Cash received / paid 3,000 (3,000)
Less: Bookvalue of equipment
($28,000-19,000) (9,000)
($28,000-10,000) (18,000)
Gain or (Loss) on Exchange $6,500 ($5,500)
When a company receives cash (sometimes referred to as “boot”)

in an exchange that lacks commercial substance, it may
immediately recognize a portion of the gain.
10-61
Has Commercial Substance
ABC:
Equipment 12,500
Cash 3,000
Accumulated depreciation 19,000
Equipment 28,000
Gain on exchange 6,500
XYZ:
Equipment 15,500
Loss on exchange 5,500
Equipment 28,000
Cash 3,000
10-62
Lacks Commercial Substance
ABC:
Equipment (12,500 – 5,242) 7,258
Cash 3,000
Equipment 28,000
Gain on exchange 1,258
Cash Received Total Recognized

x =
Cash Received + FMV of Assets Received Gain Gain
$3,000
x $6,500 = $1,258
$3,000 + $12,500
Deferred gain = $6,500 – 1,258 = $5,242
10-63
Lacks Commercial Substance
XYZ (no change):

Equipment 15,500
Loss on exchange 5,500
Equipment 28,000
Cash 3,000
Companies recognize a loss immediately whether the

exchange has commercial substance or not.
10-64
Valuation of PPE: Contributions
Contributions: Nonreciprocal transfers: transfer of assets where
nothing is given up in exchange (e.g. donations, gift, grants)
Companies should use:
 the fair value of the asset to establish its value on the books and
 should recognize contributions received as revenues in the period
received.
 When a company contributes a non-monetary asset, it should
record the amount of the donation as an expense at the fair value
of the donated asset.
 Two approaches to valuing and recording such transfer:
1. Capital Approach: credit contributed surplus account (donated
capital)
2. Income Approach: credit represents income and the gain is
deferred over the life of the asset (exception being land)
a) Cost Reduction Method: credit the respective asset account
b) Deferral Method: credit Deferred Revenue
10-65
Valuation of PPE: Contributions/Grants
Illustration: Kline Industries donates land to the city of Los Angeles

for a city park. The land cost $80,000 and has a fair value of $110,000.
Kline Industries records this donation as follows.
Donor’s Book:
Contribution Expense 110,000
Land 80,000
Gain on Disposal of Land 30,000
Donee’s Book:
Land 110,000
Contribution Revenue 110,000
10-66
Government Grants are assistance received from a government

in the form of transfers of resources to a company in return for
past or future compliance with certain conditions relating to the
operating activities of the company.
IFRS requires grants to be recognized in income (income

approach) on a systematic basis that matches them with the
related costs that they are intended to compensate.
10-67
Example 1: Grant for Lab Equipment. AG Company received a

€500,000 subsidy from the government to purchase lab
equipment on January 2, 2015. The lab equipment cost is
€2,000,000, has a useful life of five years, and is depreciated on
the straight-line basis.
IFRS allows AG to record this grant in one of two ways:
1. Credit Deferred Grant Revenue for the subsidy and amortize

the deferred grant revenue over the five-year period.
2. Credit the lab equipment for the subsidy and depreciate this
amount over the five-year period.
10-68
Example 1: Grant for Lab Equipment. If AG chooses to record

deferred revenue of €500,000, it amortizes this amount over the
five-year period to income (€100,000 per year). The effects on the
financial statements at December 31, 2015, are:
ILLUSTRATION 10-17
Government Grant
Recorded as Deferred
Revenue
10-69
Example 1: Grant for Lab Equipment. If AG chooses to reduce

the cost of the lab equipment, AG reports the equipment at
€1,500,000 (€2,000,000 - €500,000) and depreciates this amount
over the five-year period. The effects on the financial statements
at December 31, 2015, are: ILLUSTRATION 10-18
Government Grant Adjusted to Asset
10-70
Post Acquisition Costs
• In general:
1. If costs incurred increase future benefits, capitalize
costs (Capital Expenditure)
2. If costs maintain a given level of services, expense
costs (Revenue Expenditure)
• Evidence of future economic benefit would include
increases in
1. useful life,
2. quantity of product produced, and
3. quality of product produced.
10-71
Post Acquisition Costs
• Costs incurred after acquisition can be:
1. Additions: increase or extension of existing assets &
capitalize the cost of addition to asset account.
2. Improvements and replacements: substitution of an
existing asset for an improved or equivalent one
3. Rearrangement and reinstallation[ Relocation/
Reorganization]: moving asset from one location to
another
4. Repairs: costs that maintain assets in operating
condition
10-72
Post acquisition Costs
Improvements and Replacements

Capitalize costs, if
They increase future service potential
Improvements or Replacements
Substitution of Substitution of
a better asset a similar asset
for present for present
asset asset
10-73
 Capitalization Approaches
a. Carrying value of asset is known
Substitution approach: Remove cost of and accumulated
depreciation on old asset, recognizing any gain or loss. Capitalize
cost of improvement/ replacement.
b. Carrying value of the asset is unknown
 Capitalize the new asset (without removing the old asset from
the pool), [If the quantity or quality of the asset’s productivity is
increased capitalize cost of improvement/replacement to asset
account] OR
 Debit accumulated depreciation (when expenditures extend
useful life of asset)
10-74
 Rearrangement and reinstallation
a) If original installation cost is known, account for cost of

rearrangement/ reinstallation as a replacement (carrying value
known).
b) If original installation cost is unknown and rearrangement/
reinstallation cost is material in amount and benefits future
periods, capitalize as an asset.
c) If original installation cost is unknown and rearrangement/
reinstallation cost is not material or future benefit is
questionable, expense the cost when incurred.
10-75
 Repairs
a. Ordinary: Expense cost of repairs when incurred.
b. Major/Extraordinary: As appropriate, treat as an
addition, improvement, or replacement.
Example: Improvements
Instinct Enterprises decides to replace the pipes in its
plumbing system. A plumber suggests that the company
use plastic tubing in place of the cast iron pipes and
copper tubing. The old pipe and tubing have a book value
of $15,000 (cost of $150,000 less accumulated
depreciation of $135,000), and a scrap value of $1,000.
The plastic tubing costs $125,000.
10-76
If Instinct pays $124,000 for the new tubing after

exchanging the old tubing, it makes the following entry:
Plant Assets (plumbing system)….. 125,000
Acc. Dep.—Plant Assets……………… 135,000
Loss on Disposal of Plant Assets…… 14,000
Plant Assets………………………….………… 150,000
Cash ($125,000 - $1,000)………………… 124,000
10-77
Depreciation—Method of Cost Allocation
Depreciation is the accounting process of allocating the cost

of tangible assets to expense in a systematic and rational
manner to those periods expected to benefit from the use of
the asset.
Allocating costs of long-lived assets:

 Fixed assets = Depreciation expense
 Intangibles = Amortization expense
 Mineral resources = Depletion expense
10-78
Depreciation—Cost Allocation
Factors Involved in the Depreciation Process

Three basic questions:
1. What depreciable base is to be used?
 Depreciable Base=Cost-Residual Value
1. What is the asset’s useful life?
2. What method of cost apportionment is best?
10-79
Factors Involved in Depreciation Process
Estimation of Service Lives

 Service life often differs from physical life.
 Companies retire assets for two reasons:
1. Physical factors (casualty or expiration of physical life).
2. Economic factors
 inadequacy: results when an asset ceases to be useful
to a company because the demands of the firm have
changed,
 Supersession: is the replacement of one asset with
another more efficient and economical asset, and
 Obsolescence: is the catchall for situations not involving
10-80
inadequacy and supersession.
Methods of Depreciation
The profession requires the method employed be “systematic
and rational.” Methods used include:
1. Activity method (units of use or production).

2. Straight-line method.
3. Diminishing (accelerated)-charge methods:
a) Sum-of-the-years’-digits.
b) Declining-balance method.
10-81
Activity Method ILLUSTRATION 11-2

Data Used to Illustrate
Depreciation Methods
Data for
Stanley Coal
Mines
Illustration: If Stanley uses the crane for 4,000 hours the first
year, the depreciation charge is:
ILLUSTRATION 11-3
Depreciation Calculation,
Activity Method—Crane
Example
10-82
Straight-Line Method ILLUSTRATION 11-2

Data for
Stanley Coal
Mines
Illustration: Stanley computes depreciation as follows:
ILLUSTRATION 11-4
Depreciation Calculation,
Straight-Line Method—
Crane Example
10-83
Diminishing-Charge Methods ILLUSTRATION 11-2

Data for
Stanley Coal
Mines
Sum-of-the-Years’-Digits. Each fraction uses the sum of the

years as a denominator (5 + 4 + 3 + 2 + 1 = 15). The numerator
is the number of years of estimated life remaining as of the
beginning of the year.
Alternate sum-of-the- n(n+1) 5(5+1)

= = 15
years’ calculation 2 2
10-84
Sum-of-the-Years’-Digits
ILLUSTRATION 11-6
Sum-of-the-Years’-Digits
Depreciation Schedule—
Crane Example
10-85
Diminishing-Charge Methods ILLUSTRATION 11-2

Data for
Stanley Coal
Mines
Declining-Balance Method.
 Utilizes a depreciation rate (percentage) that is some multiple
of the straight-line method.
 Does not deduct the salvage value in computing the
depreciation base.
10-86
Declining-Balance Method
ILLUSTRATION 11-7
Double-Declining
Depreciation Schedule—
Crane Example
10-87
Component Depreciation
IFRS requires that each part of an item of property, plant,

and equipment that is significant to the total cost of the
asset must be depreciated separately.
Illustration: EuroAsia Airlines purchases an airplane for
€100,000,000 on January 1, 2016. The airplane has a useful life
of 20 years and a residual value of €0. EuroAsia uses the straight-
line method of depreciation for all its airplanes. EuroAsia identifies
the following components, amounts, and useful lives.
ILLUSTRATION 11-8
Airplane Components
10-88
Computation of depreciation expense for

ILLUSTRATION 11-9
EuroAsia for 2016. Computation of
Depreciation journal entry for 2016.

Depreciation Expense 8,600,000
Accumulated Depreciation—Airplane 8,600,000
10-89
On the statement of financial position at the end of 2016,

EuroAsia reports the airplane as a single amount.
ILLUSTRATION 11-10
Presentation of Carrying
Amount of Airplane
10-90
Special Depreciation Methods

Companies often depreciate multiple-asset accounts using one
rate. For example, A Company might depreciate telephone poles,
microwave systems, or switchboards by groups.
The choice of method depends on the nature of the assets
involved:
Group method used when the assets are similar in nature and
have approximately the same useful lives.
Composite approach used when the assets are dissimilar and
have different lives.
Companies are also free to develop tailor-made depreciation
methods, provided the method results in the allocation of an
asset’s cost in a systematic and rational manner (Hybrid or
Combination Methods).
10-91
Group and Composite Depreciation
The computation for group or composite methods is essentially
the same: find an average and depreciate on that basis. Companies
determine the composite depreciation rate by dividing the
depreciation per year by the total cost of the assets.
Illustration: Money Motors establishes the composite depreciation
rate for its fleet of cars, trucks, and campers as shown in the
following illustration:
10-92
If there are no changes in the asset account, Money will depreciate

the group of assets to the residual or salvage value at the rate of
$56,000 ($224,000 x 25%) a year. As a result, it will take Mooney 3.39
years to depreciate these assets.
The length of time it takes a company to depreciate it assets on a
composite basis is called the composite life.
If Money retires an asset before, or after, the average service life of
the group is reached, it buries the resulting gain or loss in the
Accumulated Depreciation account. This practice is justified because
Money will retire some assets before the average service life and
others after the average life. For this reason, the debit to
Accumulated Depreciation is the difference between original cost and
cash received. Mooney does not record a gain or loss on disposition.
10-93
To illustrate, suppose that Mooney Motors sold one of the campers

with a cost of $5,000 for $2,600 at the end of the third year. The
entry is:
Accumulated Depreciation 2,400
Cash 2,600
Cars, Trucks, and Campers 5,000
If Money purchases a new type of asset (mopeds, for example),
it must compute a new depreciation rate and apply this rate in
subsequent periods.
10-94
Special Depreciation Issues

1. How should companies compute depreciation for
partial periods?
 Companies determine the depreciation expense for
the full year and then
 prorate this depreciation expense between the two
periods involved.
This process should continue throughout the useful life of

the asset.
10-95
Depreciation and Partial Periods
Illustration—(Four Methods): Maserati Corporation purchased a

new machine for its assembly process on August 1, 2015. The cost
of this machine was €150,000. The company estimated that the
machine would have a salvage value of €24,000 at the end of its
service life. Its life is estimated at 5 years and its working hours are
estimated at 21,000 hours. Year-end is December 31.
Instructions: Compute the depreciation expense under the

following methods.
(a) Straight-line depreciation. (c) Sum-of-the-years’-digits.
(b) Activity method (d) Double-declining balance.
10-96
Straight-line Method
Current
Depreciable Annual Partial Year Accum.
Year Base Years Expense Year Expense Deprec.
2015 € 126,000 / 5 = $ 25,200 x 5/12 = € 10,500 $ 10,500
2016 126,000 / 5 = 25,200 25,200 35,700
2017 126,000 / 5 = 25,200 25,200 60,900
2018 126,000 / 5 = 25,200 25,200 86,100
2019 126,000 / 5 = 25,200 25,200 111,300
2020 126,000 / 5 = 25,200 x 7/12 = 14,700 126,000
€ 126,000
Journal entry:
2015 Depreciation expense 10,500

Accumultated depreciation 10,500
10-97
Activity Method (Assume 800 hours used in 2015)

(€126,000 / 21,000 hours = €6 per hour)
(Given) Current
Hours Rate per Annual Partial Year Accum.
Year Used Hours Expense Year Expense Deprec.
2015 800 x $6 = € 4,800 € 4,800 € 4,800
2016 x =
2017 x =
2018 x =
2019 x =
800 € 4,800
Journal entry:
10-98 Advance slide in presentation mode to reveal answer.

5/12 = .416667
Sum-of-the-Years’-Digits Method 7/12 = .583333
Current
Depreciable Annual Partial Year Accum.
Year Base Years Expense Year Expense Deprec.
2015 € 126,000 x 5/15 = 42,000 x 5/12 € 17,500 € 17,500
2016 126,000 x 4.58/15 = 38,500 38,500 56,000
2017 126,000 x 3.58/15 = 30,100 30,100 86,100
2018 126,000 x 2.58/15 = 21,700 21,700 107,800
2019 126,000 x 1.58/15 = 13,300 13,300 121,100
2020 126,000 x .58/15 = 4,900 4,900 126,000

€ 126,000
Journal entry:
Double-Declining Balance Method

Current
Depreciable Rate Annual Partial Year
Year Base per Year Expense Year Expense
2015 € 150,000 x 40% = € 60,000 x 5/12 = € 25,000
2016 125,000 x 40% = 50,000 50,000
2017 75,000 x 40% = 30,000 30,000
2018 45,000 x 40% = 18,000 18,000
2019 27,000 x 40% = 10,800 Plug 3,000

€ 126,000
Journal entry:
Special Depreciation Issues

2. Does depreciation provide for the replacement of assets?
 Does not involve a current cash outflow.
 Funds for the replacement of the assets come from the
revenues.
3. How should companies handle revisions in
depreciation rates?
 Accounted for in the current and prospective periods
 Not handled retrospectively
10-101
Revision of Depreciation Rates
Arcadia HS, purchased equipment for $510,000 which was estimated to

have a useful life of 10 years with a residual value of $10,000 at the end
of that time. Depreciation has been recorded for 7 years on a straight-
line basis. In 2015 (year 8), it is determined that the total estimated life
should be 15 years with a residual value of $5,000 at the end of that
time.
Questions:
 What is the journal entry to correct No Entry
the prior years’ depreciation? Required
 Calculate the depreciation expense

for 2015.
10-102
After
After77
Revision of Depreciation Rates years
years
Equipment cost $510,000 First,

First,establish
establishNBV
NBV
Salvage value - 10,000 at
atdate
dateof ofchange
changein
in
Depreciable base 500,000 estimate.
estimate.
Useful life (original) 10 years
Annual depreciation $ 50,000 x 7 years = $350,000
Balance Sheet (Dec. 31, 2014)

Equipment $510,000
Net book value (NBV) $160,000
10-103
After
After77
Revision of Depreciation Rates years
years
Net book value $160,000 Depreciation

Depreciation
Salvage value (new) 5,000 Expense
Expensecalculation
calculation
Depreciable base 155,000 for
for2015.
2015.
Useful life remaining 8 years
Annual depreciation $ 19,375
Journal entry for 2015
Depreciation Expense 19,375

Accumulated Depreciation 19,375
10-104
Depletion-Natural Resources
Natural resources, often called wasting assets can be

divided into two categories:
1. Biological assets (timberlands)

2. Mineral resources (oil, gas, and mineral mining).
They have two main features:
1. complete removal (consumption) of the asset, and
2. replacement of the asset only by an act of nature.
Depletion - process of allocating the cost of natural
resources.
10-105
Depletion-Natural Resources
Establishing a Depletion Base

Computation of the depletion base involves four factors:
1. Acquisition cost (The amount paid to obtain the property
right to search and find an undiscovered natural resource. It
also includes the price paid for an already discovered
resource.)
2. Exploration costs (the cost incurred to find the resource)

3. Development costs
• Tangible Costs: Include all of the transportation and other
heavy equipment needed to extract the resource and get it
ready for market (depreciation expense).
10-106
Depletion
Write-off of Resource Cost

Normally, companies compute depletion on a units-of-
production method (activity approach). Depletion is a function
of the number of units extracted during the period.
Calculation:
Total Cost – Residual value

= Depletion Cost Per Unit
Total Estimated Units Available
Units Extracted x Cost Per Unit = Depletion
10-107
Depletion
Illustration: MaClede Co. acquired the right to use 1,000 acres of

land in South Africa to mine for silver. The lease cost is €50,000,
and the related exploration costs on the property are €100,000.
Intangible development costs incurred in opening the mine are
€850,000. MaClede estimates that the mine will provide
approximately 100,000 ounces of gold. ILLUSTRATION 11-19
Computation of Depletion Rate
10-108
Depletion
If MaClede extracts 25,000 ounces in the first year, then the

depletion for the year is €250,000 (25,000 ounces x €10).
Inventory 250,000
Accumulated Depletion 250,000
ILLUSTRATION 11-20
Statement of Financial Position
MaClede’s statement of financial position: Presentation of Mineral Resource
Depletion cost related to inventory sold is part of cost of goods sold.

10-109
Presentation of PPE & Natural Resources
Presentation of Property, Plant, Equipment, and

Mineral Resources
Depreciating assets, use Accumulated Depreciation.

Depleting assets may include use of Accumulated Depletion
account, or the direct reduction of asset.
Disclosures Basis of valuation (usually cost)

Pledges, liens, and other commitments
10-110
IMPAIRMENTS
Recognizing Impairments
According to IAS 36: A long-lived tangible asset is impaired
when a company is not able to recover the asset’s carrying
amount either through using it or by selling it or impairment
loss is the amount by which the carrying amount of an asset or a cash-
generating unit exceeds its recoverable amount.
On an annual basis, companies review the asset for

indicators of impairments—that is, a decline in the asset’s
cash-generating ability through use or sale.
10-111 LO 5
If impairment indicators are present, then an impairment test

must be conducted.
ILLUSTRATION 11-15
Impairment Test
10-112 LO 5
Example: Assume that Cruz Company performs an impairment
test for its equipment. The carrying amount of Cruz’s equipment is
€200,000, its fair value less costs to sell is €180,000, and its
value-in-use is €205,000.
ILLUSTRATION 11-15
€200,000 €205,000
No
Impairment
€180,000 €205,000
10-113 LO 5
Example: Assume the same information for Cruz Company
except that the value-in-use of Cruz’s equipment is €175,000
rather than €205,000.
€20,000 Impairment Loss
ILLUSTRATION 11-15
€200,000 €180,000
€180,000 €175,000
10-114 LO 5
Example: Assume the same information for Cruz Company
except that the value-in-use of Cruz’s equipment is €175,000
rather than €205,000.
€20,000 Impairment Loss
ILLUSTRATION 11-15
€200,000 €180,000
Cruz makes the following entry to record the impairment loss.

Loss on Impairment 20,000
Accumulated Depreciation—Equipment 20,000
10-115 LO 5
Impairment Illustrations
Case 1
At December 31, 2016, Hanoi Company has equipment with a cost of
VND26,000,000, and accumulated depreciation of VND12,000,000. The
equipment has a total useful life of four years with a residual value of
VND2,000,000. The following information relates to this equipment.
1. The equipment’s carrying amount at December 31, 2016, is
VND14,000,000 (VND26,000,000 - VND12,000,000).
2. Hanoi uses straight-line depreciation. Hanoi’s depreciation was
VND6,000,000 [(VND26,000,000 - VND2,000,000) ÷ 4] for 2016
and is recorded.
3. Hanoi has determined that the recoverable amount for this asset at
December 31, 2016, is VND11,000,000.
4. The remaining useful life of the equipment after December 31,
2016, is two years.
10-116 LO 5
Case 1: Hanoi records the impairment on its equipment at

December 31, 2016, as follows.
VND3,000,000 Impairment Loss

ILLUSTRATION 11-15
VND14,000,000 VND11,000,000
Loss on Impairment 3,000,000

Accumulated Depreciation—Equipment 3,000,000
10-117 LO 5
Equipment VND 26,000,000

Less: Accumulated Depreciation-Equipment 15,000,000
Carrying value (Dec. 31, 2016) VND 11,000,000
Hanoi Company determines that the equipment’s total useful life

has not changed (remaining useful life is still two years). However,
the estimated residual value of the equipment is now zero. Hanoi
continues to use straight-line depreciation and makes the
following journal entry to record depreciation for 2017.
Depreciation Expense 5,500,000

Accumulated Depreciation—Equipment 5,500,000
10-118 LO 5
Case 2
At the end of 2015, Verma Company tests a machine for impairment. The
machine has a carrying amount of $200,000. It has an estimated
remaining useful life of five years. Because there is little market-related
information on which to base a recoverable amount based on fair value,
Verma determines the machine’s recoverable amount should be based on
value-in-use. Verma uses a discount rate of 8 percent. Verma’s analysis
indicates that its future cash flows will be $40,000 each year for five
years, and it will receive a residual value of $10,000 at the end of the five
years. It is assumed that all cash flows occur at the end of the year.
ILLUSTRATION 11-16
Value-in-Use Computation
10-119 LO 5
Case 2: Computation of the impairment loss on the machine at
the end of 2015.
$33,486 Impairment Loss
ILLUSTRATION 11-15
$200,000 $166,514
Unknown $166,514
10-120 LO 5
Case 2: Computation of the impairment loss on the machine at
the end of 2015.
$33,486 Impairment Loss
$200,000 $166,514

Accumulated Depreciation—Machinery 33,486
Unknown $166,514
10-121 LO 5
Reversal of Impairment Loss
Illustration: Tan Company purchases equipment on January 1,

2015, for HK$300,000, useful life of three years, and no residual
value.
At December 31, 2015, Tan records an impairment loss of

HK$20,000.
10-122 LO 5
Reversal of Impairment Loss
Depreciation expense and related carrying amount after the

impairment.
At the end of 2016, Tan determines that the recoverable amount of

the equipment is HK$96,000. Tan reverses the impairment loss.

Recovery of Impairment Loss 6,000
10-123 LO 5
IMPAIRMENTS
Cash-Generating Units
When it is not possible to assess a single asset for impairment
because the single asset generates cash flows only in
combination with other assets, companies identify the
smallest group of assets that can be identified that generate
cash flows independently of the cash flows from other assets.
10-124 LO 5
IMPAIRMENTS
Impairment of Assets to Be Disposed Of (IFRS 5: Non-current

Assets Held for Sale and Discontinued Operations)
 Report the impaired asset at the lower-of-cost-or-net

realizable value (fair value less costs to sell).
 No depreciation or amortization is taken on assets held
for disposal during the period they are held.
 Can write up or down an asset held for disposal in future
periods, as long as the carrying amount after the write up
never exceeds the carrying amount of the asset before
the impairment.
10-125 LO 5
IMPAIRMENTS
ILLUSTRATION 11-18
Graphic of Accounting for
Impairments
10-126 LO 5
REVALUATIONS
Recognizing Revaluations
Companies may value long-lived tangible asset subsequent
to acquisition at cost or fair value.
► Change in the fair value accounted for by adjusting the asset
account and establishing an unrealized gain.
► Unrealized gain is often referred to as revaluation surplus.
10-127 LO 7
REVALUATIONS
► The general rules for revaluation accounting are as

follows.
1. When a company revalues its long-lived tangible

assets above historical cost, it reports an unrealized
gain that increases other comprehensive income.
Thus, the unrealized gain bypasses net income,
increases other comprehensive income, and
increases accumulated other comprehensive
income.
10-128 LO 7
REVALUATIONS

follows.
2. If a company experiences a loss on impairment

(decrease of value below historical cost), the loss
reduces income and retained earnings. Thus, gains
on revaluation increase equity but not net income,
whereas losses decrease income and retained
earnings (and therefore equity).
10-129 LO 7
REVALUATIONS

follows.
3. If a revaluation increase reverses a decrease that

was previously reported as an impairment loss, a
company credits the revaluation increase to income
using the account Recovery of Impairment Loss up
to the amount of the prior loss. Any additional
valuation increase above historical cost increases
other comprehensive income and is credited to
Unrealized Gain on Revaluation.
10-130 LO 7
REVALUATIONS

follows.
4. If a revaluation decrease reverses an increase that

was reported as an unrealized gain, a company first
reduces other comprehensive income by eliminating
the unrealized gain. Any additional valuation
decrease reduces net income and is reported as a
loss on impairment.
10-131 LO 7
Recognizing Revaluation
Revaluations Issues
Company can select to value only one class of assets, say
buildings, and not revalue other assets such as land or equipment.
If a company selects only buildings,
► revaluation applies to all assets in that class of assets.
► A class of assets is a grouping of items that have a similar
nature and use in a company’s operations.
► Companies must also make every effort to keep the assets’
values up to date.
10-132 LO 7
REVALUATION OF DEPRECIABLE ASSETS
► To illustrate the accounting for revaluations using
depreciable assets, assume that Nokia (FIN) purchases
equipment for €1,000,000 on January 2, 2015. The
equipment has a useful life of five years, is depreciated
using the straight-line method of depreciation, and its
residual value is zero.
► Revaluation–2015: Valuation Increase
 Nokia chooses to revalue its equipment to fair value
over the life of equipment. Nokia records depreciation
expense of €200,000 (€1,000,000 ÷ 5) as follows.
10-133 LO 7
► After this entry, Nokia's equipment has a carrying

amount of €800,000 (€1,000,000 − €200,000). Nokia
employs an independent appraiser, who determines that
the fair value of equipment at December 31, 2015, is
€950,000.
10-134 LO 7
► To report the equipment at fair value, Nokia does the following.
1. Reduces the Accumulated Depreciation—Equipment account to zero.
2. Reduces the Equipment account by €50,000—it then is reported at its
fair value of €950,000.
3. Records an Unrealized Gain on Revaluation—Equipment for the
difference between the fair value and carrying amount of the
equipment, or €150,000 (€950,000 − €800,000). The entry to record
this revaluation at December 31, 2015, is as follows.
10-135 LO 7
► Illustration 1A-4 provides a summary of the revaluation adjustments

for Nokia in 2015.
10-136 LO 7
► Following these revaluation adjustments, the carrying

amount of the asset is now €950,000. Nokia reports
depreciation expense of €200,000 in the income
statement and Unrealized Gain on Revaluation—
Equipment of €150,000 in other comprehensive income.
This unrealized gain increases accumulated other
comprehensive income (reported on the statement of
financial position in the equity section).
10-137 LO 7
► Revaluation–2016: Decrease below Historical Cost

 Assuming no change in the useful life of the equipment,
depreciation expense for Nokia in 2016 is €237,500
(€950,000 ÷ 4), and the entry to record depreciation
expense is as follows.
10-138 LO 7
► Under IFRS, Nokia may transfer from AOCI the difference between
depreciation based on the revalued carrying amount of the
equipment and depreciation based on the asset's original cost to
retained earnings. Depreciation based on the original cost was
€200,000 (€1,000,000 ÷ 5) and on fair value is €237,500, or a
difference of €37,500 (€237,500 − €200,000). The entry to record
this transfer is as follows.
10-139 LO 7
► At this point, before revaluation in 2016, Nokia has the following

amounts related to its equipment.
10-140 LO 7
► Nokia determines through appraisal that the equipment now has a

fair value of €570,000. To report the equipment at fair value, Nokia
does the following.
1. Reduces the Accumulated Depreciation—Equipment account of
€237,500 to zero.
2. Reduces the Equipment account by €380,000 (€950,000 −
€570,000)—it then is reported at its fair value of €570,000.
3. Reduces Unrealized Gain on Revaluation—Equipment by
€112,500, to offset the balance in the unrealized gain account
(related to the revaluation in 2015).
4. Records a loss on impairment of €30,000.
10-141 LO 7
► The entry to record this transaction is as follows.
10-142 LO 7
► Following the revaluation entry, the carrying amount of

the equipment is now €570,000. Nokia reports
depreciation expense of €237,500 and an impairment
loss of €30,000 in the income statement (which reduces
retained earnings). Nokia reports the reversal of the
previously recorded unrealized gain by recording the
transfer to retained earnings of €37,500 and the entry to
Unrealized Gain on Revaluation—Equipment of
€112,500. These two entries reduce the balance in
AOCI to zero.
10-143 LO 7
► Revaluation–2017: Recovery of Impairment Loss

 Assuming no change in the useful life of the equipment,
depreciation expense for Nokia in 2017 is €190,000
(€570,000 ÷ 3), and the entry to record depreciation
expense is as follows.
10-144 LO 7
► Nokia transfers the difference between depreciation
based on the revalued carrying amount of the
equipment and depreciation based on the asset's
original cost from AOCI to retained earnings.
Depreciation based on the original cost was €200,000
(€1,000,000 ÷ 5) and on fair value is €190,000, or a
difference of €10,000 (€200,000 − €190,000). The entry
to record this transfer is as follows.
10-145 LO 7
► Nokia determines through appraisal that the equipment
now has a fair value of €450,000. To report the
equipment at fair value, Nokia does the following.
1. Reduces the Accumulated Depreciation—Equipment
account of €190,000 to zero.
2. Reduces the Equipment account by €120,000
(€570,000 − €450,000)—it then is reported at its fair
value of €450,000.
3. Records an Unrealized Gain on Revaluation—
Equipment for €40,000.
4.
10-146
Records a Recovery of Loss on Impairment for €30,000.
LO 7
► The entry to record this transaction is as follows.
10-147 LO 7
► Following the revaluation entry, the carrying amount of
the equipment is now €450,000. Nokia reports
depreciation expense of €190,000 and an impairment
loss recovery of €30,000 in the income statement. Nokia
records €40,000 to Unrealized Gain on Revaluation—
Equipment, which increases AOCI to €50,000.
10-148 LO 7
► On January 2, 2018, Nokia sells the equipment for
€450,000. Nokia makes the following entry to record this
transaction.
10-149 LO 7
► Nokia does not record a gain or loss because the
carrying amount of the equipment is the same as its fair
value. Nokia transfers the remaining balance in
Accumulated Other Comprehensive Income to Retained
Earnings because the equipment has been sold. The
entry to record this transaction is as follows.
10-150 LO 7
► The transfer from Accumulated Other
Comprehensive Income does not increase net
income. Even though the equipment has
appreciated in value by €50,000, the company
does not recognize this gain in net income over
the periods that Nokia held the equipment.
10-151 LO 7
► At this point, before revaluation in 2017, Nokia has the following

amounts related to its equipment.
10-152 LO 7
Disposition of PPE
A company may retire plant assets voluntarily or dispose of

them by
 Sale,
 Exchange,
 Involuntary conversion, or
 Abandonment.
Depreciation must be taken up to the date of disposition.
10-153
Disposition of PPE: Sale
When fixed assets are sold, the owner may break
even, sustain a loss, or realize a gain.
1. If the sale price is equal to book value, there will
be no gain or loss.
2. If the sale price is less than book value, there will
be a loss equal to the difference.
3. If the sale price is more than book value, there will
be a gain equal to the difference.
Gain or loss will be reported in the income statement

as Other Income or Other Loss.
10-154
Disposition of PPE: Sale
Illustration: City Company owns machinery that cost $20,000 when
purchased on January 1, 2004. Depreciation has been recorded at a
rate of $3,000 per year, resulting in a balance in accumulated
depreciation of $9,000 at December 31, 2006. The machinery is sold
on September 1, 2007, for $10,500. Prepare journal entries to (a)
update depreciation for 2007 and (b) record the sale.
(a) update depreciation for 2007
Depreciation expense ($3,000 x 8/12) 2,000
(b) record the sale
Cash 10,500
Machinery 20,000
Gain on sale 1,500
10-155
Disposition of PPE: Discarding/ Abandonment
Illustration 1: A piece of equipment acquired at a cost of $25,000 is
fully depreciated. On February 14, the equipment is discarded.
Accumulated Depr.—Equipment 25,000
Equipment 25,000
Illustration 2: costing $6,000 is depreciated at an annual straight-line
rate of 10%. After the adjusting entry, Accumulated Depreciation—
Equipment had a $4,750 balance. The equipment was discarded on
March 24.
a. Update the Depreciation
Depreciation Expense.—Equipment 150
Accum. Depreciation—Equipment[=600 × 3/12] 150
b. Write-off Equipment Discarded
Accumulated Depr.—Equipment 4900
Loss on Disposal of Fixed Asset 1100
Equipment 6000
10-156
Disposition of PPE: Involuntary Conversion
Involuntary Conversion: Sometimes an asset’s service is

terminated through some type of involuntary conversion such as
fire, flood, theft, or condemnation.
Companies report the difference between the amount recovered

(e.g., from a condemnation award or insurance recovery), if any,
and the asset’s book value as a gain or loss.
They treat these gains or losses like any other type of disposition
or often reported as extraordinary items.
10-157
Illustration 1: Camel Transport Corp. had to sell a plant located on

company property that stood directly in the path of an interstate
highway. Camel received $500,000, which substantially exceeded
the book value of the land of $150,000 and the book value of the
building of $100,000 (cost of $300,000 less accumulated
depreciation of $200,000). Camel made the following entry.
Cash 500,000
Accumulated Depreciation—Buildings 200,000
Buildings 300,000
Land 150,000
Gain on Disposal of Plant Assets 250,000
10-158
Illustration 2: A company’s building with cost Br900,000 and

accumulated depreciation of br580,000, is condemned by the
government for the construction of a highway. The government sets a
price of br200,000 as the condemnation award.
Cash 200,000
Accumulated Depreciation—Buildings 580,000
Loss on condemnation of property 120,000
Buildings 900,000
10-159

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PREVIEW OF CHAPTER 1

Topics/Learning Objectives (L.O.)

Spare parts that will be consumed with in 12 month or

Property, plant, and equipment are assets of a durable nature.

Guideline for Initial Valuation

 Historical cost [Cost principle] measures the cash or cash

 Cost consists of all expenditures necessary & reasonable

 Companies value property, plant, and equipment in

 Cost Components/Elements [Subject to Mode of Acquisition]

Illustration: Sunrise Company acquires real estate at a cash

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

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

 Cost of Land Improvements

 Examples: driveways, parking lots, fences, landscaping,

and professional fees and building permits.

Illustration: The expenditures and receipts below are related to land,

a. Money borrowed to pay building contractor a. Notes Payable

Illustration: Determine how the following should be classified:

f. Refund of 1-month insurance premium f. (Buildings)

Illustration: Determine how the following should be classified:

l. Proceeds from residual value of demolished l. (Land)

 Cost of Acquiring Fixed Assets Excludes:

 Vandalism (deliberate destruction of property)

 IFRS requires — capitalizing actual interest incurred during

 Consistent with historical cost.

 Capitalization period: time between the expenditure date and the

 If the construction period covers more than one fiscal period,

Illustration: Assume a company borrowed $200,000 at 12% interest

Actual Expenditures during 2015: Other general debt existing on

Step 1 - Determine which assets qualify for capitalization of

Step 2 - Determine the capitalization period.

Step 3 - Compute weighted-average accumulated

A company weights the construction expenditures by the amount of time

Step 4 - Compute the Actual and Avoidable Interest.

Selecting Appropriate Interest Rate:

2. For the portion of weighted-average accumulated expenditures

Step 4 - Compute the Actual and Avoidable Interest.

Accumulated Interest Avoidable

Step 5 – Capitalize the lesser of Avoidable interest or Actual

Avoidable interest $ 30,250

Journal entry to Capitalize Interest:

Comprehensive Illustration 1: On November 1, 2014, ABC

ABC Construction completed the building, ready for occupancy, on

Compute weighted-average accumulated expenditures for 2015.

Compute weighted-average accumulated expenditures for 2015.

Compute the actual interest cost, which represents the maximum

ABC records the following journal entries during 2015:

January 1 Land 100,000

At December 31, 2015, ABC discloses the amount of interest

A.Capitalized Interest For 20X1

Step 2: Compute Weighted Average Accumulated Expenditures

Step 3: Compute the Interest Potentially Capitalizable (IPC) for 20X1.

Interest on Excess of WAAE

Step 3: Compute the Interest Potentially Capitalizable (IPC) for 20X2.

January 1 $1,620,228 11/11 $1,620,228

Comprehensive illus #3: Cut Industries, Inc. has decided to

The following expenditures were incurred on the project during

In previous, the weighted- The firm borrowed

The actual interest was $1,002,000 and the calculated interest

Assume that additional construction expenditures of $3,200,000

• Avoidable interest in 2014 includes interest on all loans that

 When the cost of self-construction of an asset is less

Issuance of Shares — The market price of the shares issued is a