Asset Valuation

Property, Plant and Equipment

1
Introduction
• Property, plant and equipment are defined
as fixed tangible assets which are held by a
company for use in the production or
supply of goods and services, for rental to
others, or for administrative purpose

2
The notion of cost
• Historical Cost
• Replacement Cost
• Fair value

3
Historical cost

4
Historical Cost
• Historical cost is the amount paid to
acquire goods or services.
• It includes all expenditures which prepare
the asset for intended use
• Apart from the invoice price of the asset, it
also includes the freight charges, import
duties and installation costs of the asset

5
Replacement cost

6
Replacement Cost
• Replacement cost is the current cost to
replace or to purchase an item similar to
the existing item
• It abandons the realization concept
• Under replacement cost accounting, the net
profit obtained from the profit and loss
account includes both the operating
income and holding gain

7
Fair value

8
Fair value
• It is the amount for which as asset could be
exchanged for in a fair transaction

9
Example 1

10
 Example 1
Chan started a business with a capital of 1000 units of
stock at $1 per unit. On 1 October, he sold 700 units at
$2 per unit. The price level indicates for the year are:
Replacement Cost
1 Jan 2007 $1.0
1 October 2007 $1.3
31 December 2007 $1.5
Profit and loss account for the year ended 31 December 2007
Historical cost Replacement cost
Sales (700*$2) 1400 1400
Less: Cost of sales 700 700*1.3 910
Gross profit 700 490
Realized holding gain 700*0.3 210
Unrealized holding gain 150
Net profit 700 300*0.5 850 11
 Balance Sheet as at 31 December 2007
Historical cost Replacement cost
Stock 300 450
Cash 1400 1400
1700 1850
Capital 1000 1000
Add Profit – realized 700 700
- unrealized 150
1700 1700

12
Valuation of Property, plant and
equipment
• Property, plant and equipment are fixed tangible
assets that
– Are held by an enterprise for use in the production or
supply of goods or services, for rental to others, or for
administrative purpose; and
– Are expected to be used during more than one period
• Property, plant and equipment should be carried
at its cost less any accumulated depreciation and
any accumulated impairment losses

13
Land and buildings

14
Land and buildings
• Freehold land
• Leasehold land
• Buildings

15
Freehold Land
• It has an unlimited useful life, and its value
does not decline over time, so it should be
treated as non-depreciable assets

16
Leasehold land
• Leasehold land should be regarded as
depreciable assets whether the lease is
more than 50 years or not

17
Buildings
• Buildings have limited useful lives. The
cost should be allocated over their useful
economic lives, so they should be regarded
as depreciable assets

18
Exception to the treatment of
land and buildings
• Land and buildings held for resale
• Investment properties

19
Land and building held for
resale
• They should be treated as trading stock.
These assets are stated at the lower of cost
and net realizable value
• No depreciation should be provide for

20
Investment properties
• They are land and buildings held as
investments, and not for the consumption
in the operation of business
• They should not be subject to depreciation,
except when the lease of a property is for
less than 20 years
• They should be valued at open market
value

21
• An increase in value should be credited to
the investment property revaluation reserve
• A decrease in value should be debited to
the investment property revaluation
reserve. If the reserve is insufficient, the
decrease can also be debited to the profit
and loss account

22
Initial measurement of property,
plant and equipment
• Cost of property, plant and equipment
• Expenditures not included in the cost of
property, plant and equipment

23
Cost of property, plant and
equipment
• An item of property, plant and equipment
should be recognized as an asset and
recorded at its cost
• Cost= Purchase Price + Other acquisition
costs – Trade discounts -
rebates

24
Example 2
• Cost of property
$
Construction cost 2000000
Stamp duty 140000
Legal cost 50000
Land premium 5000000
Cost of site preparation 400000
Cost of dismantling the old property 100000
7690000

25
Example 3
• Cost of equipment
$
Purchase price 200000
Less: Trade discounts 20000
180000
Import duty 10000
Delivery cost 4000
Installation cost 3000
197000

26
Expenditures not included in the cost
of property, plant and equipment

• Assets are recorded at their cash prices.

Interest expenses should not be included in
the purchase price unless they are
capitalized in accordance with the SSAP
19 ‘ Borrowing cost’

27
• If the asset is produced by the firm itself, the
following costs should not be included in the cost
of property, plant and equipment:
– Administrative cost
– General overhead cost
– Start-up and similar pre-production costs
– Internal manufacturing profit
– Abnormal amounts of wasted material, labour, or
other resources incurred in the production of a self-
constructed asset

28
Subsequent expenditure
• Improvement on property, plant and equipment can
be recognized as assets only when the expenditure
can improve the condition of assets beyond their
originally assessed standard of performance
• Examples of improvements, can be capitalized,
include:
– Modifying an asset to extend its useful life and to
increase its productive capacity;
– Upgrading an asset to achieve a substantial
improvement in the quality of output

29
 – Adopting new production processes to assure
a substantial reduction in previously assessed
operating costs
• It the subsequent expenditure only restores
or maintains the future economic benefits
to the originally assessed standard, it
should be written off as an expense when it
is incurred. Examples include repairing
and maintenance
30
Revaluation

31
Revaluation
• Two different bases for the determination
of the carrying amount (NBV) of property,
plant and equipment
• As asset may be stated either:
– At cost less accumulated depreciation and any
accumulated impairment losses
– At a revaluated amount, being the fair value
(fair market value), less any subsequent
accumulated depreciation
32
• Owning to the substantial difference
between the cost and market value of land
and buildings, revaluation of land and
buildings is a common practice in Hong
Kong
• The fair value is determined by appraisal
normally undertaken by professional
qualified valuers
33
• Although revaluation of plant and
equipment is permitted by the SSAP,
enterprises seldom recognize the market
value of plant and equipment in their
balance sheets

34
Several points should be noted
upon revaluation of asset:
• An increase in the value of property, plant and
equipment should be credited directly to equity
under the heading of “ revaluation reserve”
• Accumulated depreciation prior to the revaluation
should be credited to the revaluation reserve
• After revaluation, depreciation should be charged
against the revalued amount
• When the revalued asset is disposed of, the
revaluation reserve should be transferred directly
to the retained profits but not to the profit and loss
account
35
Example 4
• The purchase price of land and buildings
was $100 million at 1 January 2000. 10%
depreciation on cost was charged
Revalued on 1 January 2002 $120m
Sold on 1 January 2003 $140m

36
 The Journal
Dr. Cr.
$m $m
2002
Jan 1 Land and Buildings 20
Provision for deprecation
($100*10%*2) 20
Revaluation reserve 40
Being surplus on revaluation transferred to the
revaluation reserve
Dec 31 Profit and loss (120/8) 15
Provision for depreciation 15
Being provision for deprecation on the
revalued amount over the remaining
useful economic life
37
 The Journal
Dr. Cr.
$m $m
2003
Jan 1 Bank 140
Provision for deprecation 15
Land and buildings 120
Profit and loss – gain 35
Being disposal of land and buildings

Jan 1 Revaluation reserve 40

Retained profit 40
Being transfer of the realized revaluation
reserve to the retained profits

38
Treatment of revaluation surplus
and deficit
• An increase in value should be credited
directly to equity under the heading of
‘revaluation reserve’
• A decrease should be charged directly
against the revaluation reserve
• If the amount of the revaluation reserve is
insufficient to write off the decrease in
value, the decrease can be recognized as an
expense in the profit and loss account 39
• If the fair value rises again, the revaluation
deficit recognized as expenses previously
should be reversed and credited to the
profit and loss account as income

40
Example 5
• On 1 Jan 2000, A Ltd. purchased a freehold land at a
cost of $100 million. No depreciation would be
provided on the freehold land
• On 31 Dec 2002, owing to the property market boom,
the freehold land was revalued to $140 million
• On 31 Dec 2003, the property market crashed. The
freehold land was revalued to $90 million
• On 31 Dec 2004, the housing policy changed and the
property market boomed again. The freehold land was
revalued to $160 million.

41
 The Journal
Dr. Cr.
$m $m
2000
Jan 1 Freehold land 100
Bank 100
Being purchase of Freehold land

2002
Dec 31 Freehold land 40
Revaluation reserve 40
Being surplus on revaluation transferred
to the revaluation reserve

42
 The Journal
Dr. Cr.
2003 $m $m
Dec 31 Revaluation reserve 40
Profit and loss 10
Freehold land 50
The revaluation deficit should be directly charged
against the revaluation reserve. The excess amount of
revaluation deficit over the related revaluation reserve
should be charged as an expense to the profit and loss
account
2004
Dec 31 Freehold land 70
Profit and loss 10
Revaluation reserve 60
Being reversal of the write down of $10 million and
revaluation of the asset to its fair value 43
Impairment loss

44
Impairment loss
• Property, plant and equipment should be
stated at cost less accumulated depreciation
and any accumulated impairment losses
• An asset is impaired when its carrying
amount exceeds its recoverable amount
• If there is no indication of impairment loss,
it is not required to make a formal estimate
of recoverable amount

45
Definition
• Carrying amount
• Recoverable amount
• Net realizable value
• Value in use

46
Carrying amount
• Carrying amount is the net book value at
which an asset is recognized in the balance
sheet
Carrying amount
= Historical cost – Accumulated depreciation –
Accumulated impairment losses

47
Recoverable amount
• Recoverable amount is the higher of an
asset’s net realizable value and value in
use

48
Net realizable value
• Net realizable value is the amount at which
an asset could disposed of, less any direct
selling costs

49
Value in use
• Value in use is the present value of
estimated future cash flows expected to
arise from the continuing use of an asset
and from its disposal at the end of its
useful life

50
• When an impairment loss occurs, the
revised carrying amount shown in the
balance sheet is calculated as follows:
Revised carrying amount

Lower of

Carrying amount OR Recoverable amount

Higher of

Net realizable value Value in use

51
Indications of impairment
• The enterprise should estimate the
recoverable amount of assets if the
following indications of impairment
appear:
– External indicators
– Internal indicators

52
External indicators
• A significant decline in the market value of
asset
• Material adverse changes in the
technological, economic or regulatory
environment
• Long-term increase in market interest rates
which results in a material decrease in the
asset’s recoverable amount

53
Internal indicators
• Obsolescence or physical damage of an
asset
• Discontinued operation or major
reorganization
• Evidence indicating that the economic
performance of an asset is worse than
expected

54
Treatment of impairment loss
• If the carrying amount (cost less
accumulated depreciation) exceeds the
recoverable amount (the higher of net
realizable value and value in use), there
will be impairment loss

55
Accounting entries
Dr. Profit and loss Assets previously stated at
Dr. Accumulated cost
depreciation
Cr. Asset
Dr. Revaluation reserve Assets previously revalued
Cr. Asset and the revaluation reserve
is greater than the
impairment loss
Dr. Revaluation reserve Assets previously revalued
(first) and the revaluation reserve
Dr. Profit and loss is less than the impairment
loss
Cr. Asset 56
Example 6

57
• On 1 January 1991, Fortune Ltd. bought a building
at a cost of $2000000. The building had a useful
life of 20 years and depreciation was charged on a
straight line basis
• Owing to the changes in market condition, Fortune
Ltd. considered that the building might be impaired.
On 31 December 2002, the directors estimated that
the net selling price was $480000 (estimated selling
cost of $50000 less selling cost of $20000) and the
value in use of the asset was $300000

58
 $
Historical cost 2000000
Accumulated depreciation as
at December 2002 (2000000*5%*12) 120000
800000
Less: Recoverable amount
(the higher pf the net selling price
of $480000 and the value in use of
$30000) 480000
Impairment loss 320000

59
 The Journal
Dr. Cr.
$m $m
Profit and loss 320000
Provision for depreciation 1200000
Buildings (2000000 – 480000) 1520000

60
Example 7

61
• On 1 January 1991, Fortune Ltd. bought a building at a cost
of $2000000. The building had a useful life of 20 years and
depreciation was charged on a straight line basis
• On 1 January 2001, caused by the property market boom,
the building was revalued to $2500000 with a remaining
useful life of 10 years
• Owing to the changes in market conditions, Fortune Ltd
considered that the building might be impaired . On 31
December 2002, the directors estimated that the net selling
price was $480000 (estimated selling cost of $500000 less
selling cost of $20000) and the value in use of the asset was
$300000

62
 $
Revalued amount 2500000
Accumulated depreciation as
at December 2002 (2500000*2/10) 500000
2000000
Less: Recoverable amount
(the higher pf the net selling price
of $480000 and the value in use of
$30000) 480000
Impairment loss 1520000

63
 The Journal
Dr. Cr.
$ $
2001
Jan 1 Building 500000
Provision for depreciation
($2000000*5%*10) 1000000
Revaluation reserve 1500000
Being surplus on revaluation transferred
to the revaluation reserve
2001
Dec 31 Profit and loss 250000
Provision for depreciation
($2500000*10%) 250000
Being provision for depreciation
on the revalued amount 64
 The Journal
Dr. Cr.
2002 $ $
Dec 31 Profit and loss 250000
Provision for depreciation
($2500000*10%) 250000
Being provision for depreciation
on the revalued amount
2002
Dec 31 Revaluation reserve (1st ) 1500000
Profit and loss (then) 20000
Provision for depreciation 500000
Buildings
(2500000-480000) 2020000
Being carrying amount written down
to the recoverable amount 65
Subsequent reversal of an
impairment loss Recoverable amount

• After the recognition of an impairment loss, the

depreciation should be provided on the revised
carrying amount, less any residual value, over its
remaining useful life
• If the impairment loss recognized in previously years
decreases or on longer exists, the carrying amount of
the asset should be increased to its recoverable amount.
That increase is a reversal of an impairment loss
• The reversal of impairment loss is restricted to the
amount that will restore the carrying amount as if no
impairment loss has been recognized

66
Example 8

67
• On 1 January 1991, Fortune Ltd. bought a
building at a cost of $2000000. The building had
a useful life of 20 years and depreciation was
charged on a straight line basis
• Owing to the changes in market conditions,
Fortune Ltd. considered that the building might
be impaired. On 31 December 2002, the directors
estimated that the recoverable amount was
$480000.

68
Ans.
• An impairment loss of $320000 was recognized
(I.e. 2000000*8/20 - $480000)
• After recognition of impairment loss, the
depreciation 60000 (I.e. 480000*1/8) should be
provided on the revised carrying amount of
$480000 over its remaining useful life of 8 years
• The carrying amount at 31 December 2003 was
$420000(I.e. $480000*7/8)

69
Ans
• After the recognition of impairment loss,
the depreciation $60000 should be
provided on the revised carrying amount of
$480000 over its remaining useful life of 8
years

70
• Owning to the change of the housing
policy, the directors determined the
recoverable amount at 31 December 2004
has increased to $1700000

71
Ans
• The recovery of carrying amount is shown
as follows: $
Carrying amount as at 31 Dec 2003 as if no
impairment loss has been recognized
($800000*7/8) 700000
Less: Carrying amount as at 31 Dec 2003
after recognizing the impairment loss 420000
Reversal of impairment loss 280000
200000*8/20

72
Ans.
The Journal
Dr. Cr.
Buildings 280000
Profit and loss 280000
*The carrying amount of buildings will be shown as $700000

73
• If the enterprise wants to recognize the
market value of the property (I.e.
$1700000) in its balance sheet, the
remainder of the uplift (I.e. $1000000)
would be treated as a revaluation
movement

74
Ans.
The Journal
Dr. Cr.
Buildings 1220000
Provision for depreciation (480000*1/8) 60000
Profit and loss (first) 280000

*The carrying amount of buildings will be shown as $700000

75
Investments
• Both long-term investments and current
investments should be valued at the lower
of cost and market value
• Investment are recorded at their cost of
acquisition, while permanent decreases in
value may be written off against current
profits. Increases in value are not
recognized until realized
76
Example
• Cost of quoted securities in 1995
$100,000
• Market value of investment in 1996
$95,000
• Market value of investment in 1997
$110,000

77
 Ans:
1996 Dr. Profit and loss $5000
Cr. Provision for Diminution in
value of investment $5000

1997 Dr.Provision for Diminution in

value of investment $5000
Cr. Profit and loss $5000

Balance Sheet as at 31 Dec (extract)

1996 Investments $
Quoted securities ,at market value (cost$100000) 95000
1997 Investments
Quoted securities ,at cost (mkt. value$110000) 100000
78