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CPA FAR – STUDY UNIT 8


Property, Plant, Equipment, and Depletable Resources
Core Concepts

1. Initial Measurement of Property, Plant, and Equipment (PPE)


a. These long-term tangible items may be either personal property or real property. PPE
are used in ordinary operations. Types of PPE include (1) land and buildings, (2) land
improvements, (3) machinery and equipment, and (4) leaseholds and leasehold
improvements.
b. PPE are reported at historical cost adjusted for changes in utility, e.g., depreciation and
impairment losses. The initial measurement includes the purchase price as well as all other
costs necessary to acquire these assets, transport them to the sites of their intended use,
and prepare them for operations.
2. Internally Constructed Assets (ICAs) -- Capitalization of Interest
a. The cost of ICAs may include interest costs incurred during construction. Assets qualifying
for interest capitalization are assets produced by the entity (1) for its own use, (2) for the
entity by others for which deposits or progress payments have been made, and (3) for sale
or lease as discrete projects.
b. Capitalized interest is limited to the amount theoretically avoidable if expenditures for
the assets had not been made and may not exceed the total incurred during the period.
Capitalized interest equals weighted-average accumulated expenditures during the
capitalization period times the interest rate(s).
3. Subsequent Expenditures for PPE
a. The accounting issue is whether they should be capitalized or expensed.
b. Substantial expenditures for additions (extensions or expansions) of existing assets are
capitalized. An example is an additional story for a building.
c. A replacement substitutes a new component of an asset for a similar one, for example, a
tile roof for a tile roof. An improvement substitutes a better component, such as a more
efficient heating system.
d. Rearrangements of the configuration of plant assets, reinstallations of such assets, or
relocations of operations may involve material outlays that are separable from recurring
expenses and provide probable future benefits.
e. Repairs and maintenance, i.e., routine, minor expenditures made to maintain the operating
efficiency of PPE, are ordinarily expensed as incurred.
4. Depreciation Methods -- Calculations
a. Depreciation is systematic and rational allocation of the historical cost of an item of PPE to
the periods benefited. It is not a process of valuation.
1) The depreciable base is the total to be allocated. It equals historical cost minus
salvage value minus recognized impairment loss.
b. The straight-line method charges an equal amount of depreciation to each period of the
asset’s useful life (depreciable base ÷ estimated useful life).
c. The declining balance method multiplies the carrying amount at the beginning of each
period by some percentage (e.g., 200% or 150%) of the straight-line rate.
1) The carrying amount decreases as depreciation is recognized. The asset is not
depreciated below salvage value.

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2 CPA FAR – Study Unit 8

d. The sum-of-the-years’-digits method multiplies the constant depreciable base (cost –


salvage value) by a declining fraction.
1) The fraction is the number of years remaining in the asset’s life over the sum of the
digits of all the years in the asset’s life [e.g., for a 5-year asset, the denominator is
15 (1 + 2 + 3 + 4 + 5)].
e. Usage-centered methods calculate depreciation as a function of an asset’s use. For
example, the units-of-output method allocates cost based on production.
1) Periodic depreciation expense equals the depreciable base times the ratio of the units
produced during the current period to the asset’s estimated total lifetime units.
f. Group and composite depreciation methods are efficient ways to account for large
numbers of depreciable assets. The group method applies straight-line depreciation to
groups of similar assets, and the composite method applies it to dissimilar assets with
varying useful lives.
5. Depreciation Methods -- Changes and Comparison
a. Accelerated methods result in lower net income in the earlier years of an asset’s economic
life because depreciation expense is larger in those years.
b. A change in the estimate for depreciation is accounted for prospectively (from the year of
change going forward).
6. Exchanges of Nonmonetary Assets
a. Most nonmonetary exchanges are measured at fair value. However, the accounting should
be based on the carrying amount of the assets given up when
1) Neither the fair value of the assets given up nor the fair value of the assets received is
reasonably determinable,
2) The exchange involves inventory sold in the same line of business that facilitates sales
to customers who are not parties to the exchange, or
3) The exchange lacks commercial substance.
b. In a nonmonetary exchange that is accounted for at carrying amount, if partial monetary
consideration (boot) is received, the recipient must recognize a gain to the extent that
boot exceeds a proportionate share of the carrying amount of the assets surrendered.
7. Disposals Other than by Exchange
a. Disposal can be by sale, abandonment, contribution, nonreciprocal transfers to owners, or
involuntary conversion. Whatever the means,
1) Depreciation is recorded up to the time of disposal,
2) The asset’s carrying amount is removed from the accounts,
3) Any consideration (proceeds) received is debited appropriately, and
4) Gain or loss is usually included in the results of continuing operations.
8. Impairment of Long-Lived Assets
a. A long-lived asset to be held and used is impaired if its carrying amount is greater than its
fair value. However, a loss equal to this excess is recognized for the impairment only when
the carrying amount is not recoverable, that is, when the sum of the asset’s expected
undiscounted cash flows is less than the carrying amount.
b. Under IFRS, an asset is impaired when its carrying amount exceeds its recoverable amount.
The recognized loss equals the excess. The recoverable amount of an asset is the greater
of its fair value minus cost(s) to sell or value in use. An impairment loss on an asset
(besides goodwill) may be reversed in a subsequent period if a change in an estimate used
to measure the recoverable amount has occurred.

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CPA FAR – Study Unit 8 3

9. Assets Classified as Held for Sale


a. An asset is classified as held for sale when (1) a committed plan to sell the asset is in place,
(2) the asset is available for immediate sale, (3) actions have been taken to complete the
plan, (4) it is probable that the sale will be completed within 1 year, (5) the asset is actively
marketed, and (6) the likelihood of withdrawing the plan is low.
b. An asset classified as held for sale is not depreciated. It is measured at the lower of
carrying amount or fair value minus cost to sell. A loss is recognized for a write-down.
10. Depletion
a. Depletion allocates the historical cost of natural resources to the periods benefited.
b. The depletion base equals acquisition costs, plus development costs to prepare the site for
extraction, plus estimated restoration costs, minus estimated residual value.
c. The depletion rate equals the depletion base divided by the units estimated to be
economically recoverable.

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