CHAPTER 14: PAS 16 - PROPERTY, PLANT AND EQUIPMENT

Property, Plant and Equipment

Property, plant and equipment are tangible assets that are held for use in production or supply of goods or services, for
rental to others, or for administrative purposes, and are expected to be used during more than one period.

Accordingly, the major characteristic in the definition of property, plant and equipment are:

a. The property, plant and equipment are tangible assets, meaning with physical substance.

b. The property, plant and equipment are used in business, meaning used in production or supply of goods or services,
for rental purposes and for administrative purposes.

c. The property, plant and equipment are expected to be used over a period of more than one year.

Examples of property, plant and equipment

1. Land 7. Motor vehicle

2. Land improvements 8. Furniture and fixtures
3. Building 9. Office equipment
4. Machinery 10. Patterns, molds and dies
5. Ship 11. Tools
6. Aircraft 12. Bearer plants

Recognition of property, plant and equipment

a) It is probable that future economic benefits associated with the asset will flow to the entity.
b) The cost of the asset can be measured reliably.

Measurement at recognition

An item of property, plant and equipment that qualifies for recognition as an asset shall be measured at cost.

Cost is the amount of cash or cash equivalent paid and the fair value of the other consideration given to acquire an asset
at the time of acquisition or construction.

Elements of cost

The cost of an item of property, plant and equipment comprises:

a) Purchase price, including import duties and nonrefundable purchase taxes, after deducting trade discounts and
rebates.
b) Cost directly attributable to bringing the asset to the location and condition necessary for it to be capable of
operating in the manner intended by management.
c) Initial estimate of the cost of dismantling and removing the item and restoring the site on which it is located for
which an entity has a present obligation.

Directly attributable costs

Examples of attributable costs that qualify for recognition include:

a) Cost of employee benefit arising directly from the construction or acquisition of the item of property, plant and
equipment.
b) Cost of site preparation
c) Initial delivery and handling cost
d) Installation and assembly cost
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e) Professional fee
f) Costs of testing whether the asset is functioning properly.

Costs not qualifying for recognition

Examples of costs that are expensed rather than recognized as cost are:

a) Cost of opening a new facility

b) Cost of introducing a new product or service, including cost of advertising and promotion
c) Cost of conducting business in a new location or with a new class of customer, including cost of staff training
d) Administration and other general overhead cost
e) Cost incurred while an item capable of operating in the manner intended by management has yet to be brought
into use or is operated at less than full capacity
f) Initial operating loss
g) Cost of relocating or reorganizing part or all of an entity’s operations

Measurement after recognition

After initial recognition, an entity shall choose either the cost

model or the revaluation models the accounting policy for property, plant and equipment.

The entity shall apply such accounting policy to an entire class of property, plant and equipment.

The cost model means that property, plant and equipment are carried at cost less any accumulated depreciation and any
accumulated impairment loss.

The revaluation model means that property, plant and equipment are carried at revalued carrying amount. The revalued
carrying amount is the fair value at the date of revaluation less any subsequent accumulated depreciation and
subsequent accumulated impairment loss.

Acquisition on a cash basis

The cost of an item of property, plant and equipment is the cash price equivalent at the recognition date.

The cost of asset acquired on a cash basis simply includes the cash paid plus directly attributable costs such a freight,
installation cost and other cost necessary in bringing the asset to the location and condition for the intended use.

Acquisition on account

When an asset is acquired on account subject to a cash discount, the cost of the asset is equal to the invoice price minus
the discount, regardless of whether the discount is taken or not.

Cash discounts are generally considered as reduction of cost and not as income.

Acquisition on installment basis

When payment for item of property, plant and equipment is deferred beyond normal credit terms, the cost is the cash
price equivalent.

In other words, if an asset is offered at a cash price and at an installment price and is purchased at the installment price,
the asset shall be recorded at the cash price.

The excess of the installment price over the cash price is treated as an interest to be amortized over the credit period.
CHAPTER 14: PAS 16 - PROPERTY, PLANT AND EQUIPMENT
Issuance of share capital

Philippine GAAP provides that if shares are issued for consideration other than actual cash, the proceeds shall be
measured by the fair value of the consideration received.

Accordingly, where a property is acquired through the issuance of share capital, the property shall be measured at an
amount equal to the following in the order of priority.

a. Fair value of the property received

b. Fair value of the share capital

c. Par value or stated value of the share capital

Issuance of bonds payable

PFRS 9, paragraph 5,1,1, provides the asset acquired by issuing bonds payable is measured in the following order.

a. Fair value of bonds payable

b. Fair value of asset received

c. Face amount of bonds payable

Exchange

PAS 16, paragraph 24, provides that the cost of an item of property, plant and equipment acquired in exchange for a
nonmonetary asset or a combination of monetary and nonmonetary asset is measured at fair value plus any cash
payment.

However, the exchange is recognized at carrying amount if the exchange transaction lacks commercial substance.

Definition of commercial substance

Commercial substance is a new notion and is defined as the even or transaction causing the cash flows of the entity to
change significantly by reason of the exchange.

An exchange transaction has commercial substance when the cash flows of the asset received differ significantly from
the cash flows of the asset transferred.

Construction

The cost of self -constructed asset is determined using the same principles as for an acquired asset.

The cost of self-constructed property, plant and equipment includes:

1.Direct cost of materials

2.Direct cost of labor

3.Indirect cost and incremental overhead specifically identifiable or traceable to the construction.

PAS 16, paragraph 22, provides that the cost of abnormal amount of wasted material, labor or overheard incurred in the
production of self-constructed asset is not included in the cost of the asset.

Derecognition
CHAPTER 14: PAS 16 - PROPERTY, PLANT AND EQUIPMENT
Derecognition means that the cost of the property, plant and equipment together with the related accumulated
depreciation shall be removed from the statement of financial position.

PAS 16, paragraph 67, provides that the carrying amount of an item of property, plant and equipment shall be
derecognized on disposal or when no future economic benefits are expected from the use or disposal.

The gain or loss is the difference between the net disposal proceeds and the carrying amount of the item and reported
in the profit and loss.

Gains shall not be included in revenue but treated as other income.

Fully depreciated property

A property is said to be fully depreciated when the carrying amount is equal to zero, or the carrying amount is equal to
the residual value.

In such a case, the asset account and the related accumulated depreciation account are closed and the residual value is
set up in a separate account.

However, it is not uncommon for an entity to continue to use an asset after it has been fully depreciated.

The cost of fully depreciated asset remaining in service and the related accumulated depreciation ordinarily shall not be
removed from the accounts.

However, entities are encouraged but not required to disclose fully depreciated property.

Concept of depreciation

Depreciation is defined as the systematic allocation of the depreciable amount of an asset over the useful life.

Depreciation is not so much a matter of valuation. Depreciation is a matter of cost allocation in recognition of the
exhaustion of the useful life of an item of property, plant and equipment.

The objective of depreciation is to have each period benefiting from the use of the asset bear in equitable share of the
asset cost.

Depreciation in the financial statements

Depreciation is an expense.

Depreciation may be part of the cost of goods manufactured or an operating expense.

The depreciation charge for each period shall be recognized as expense unless it is included in the carrying amount of
another asset.

Depreciation period

Depreciation of an asset begins when it is available for use, meaning, when the asset is in the location and condition
necessary for it to be capable of operating in the manner intended by management.

Depreciation ceases when the asset is derecognized.

Therefore, depreciation does not cease when the asset becomes idle temporarily.
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Temporary idle activity does not preclude depreciating the asset as future economic benefits are consumed not only
through usage but also through wear and tear and obsolescence.

Factors of depreciation

In order to properly compute the amount of depreciation, three factors are necessary, namely depreciable amount,
residual value and useful life.

Depreciable amount

Depreciable amount is the cost of an asset or other amount substituted for cost, less the residual value.

Each part of an item of property, plant and equipment with a cost that is significant in relation to the total cost of the
item shall be depreciated separately.

For example, it may be appropriate to depreciate separately the airframe, engines, fittings (seat and floor coverings) and
tires of an aircraft.

The entity also depreciates separately the remainder of the item and the remainder consists of the parts of the item that
are individually not significant.

Residual value

Residual value is the estimated net amount currently obtainable if the asset is at the end of the useful life.

The residual value of an asset shall be reviewed at least at each financial year-end and if expectation differs from
previous estimate, the change shall be accounted for as a change in an accounting estimate.

The residual value of an asset may increase to an amount equal to or greater than the carrying amount.

If it does, the depreciation charge is zero unless and until the residual value subsequently decreases to an amount below
the carrying amount.

Depreciation is recognized even if the fair value of the asset exceeds the carrying amount as long as the residual value
does not exceed the carrying amount.

Useful life

Useful life is either the period over which an asset is expected to be available for use by the entity, or the number of
production or similar units to be obtained from the asset by the entity.

Factors in determining useful life

a. Expected usage of the asset- Usage is assessed by reference to the asset’s expected capacity or physical output.
b. Expected physical wear and tear- This depends on the operational factors such as the number of shifts the asset
is used, the repair and maintenance program, and the care and maintenance of the asset while idle.
c. Technical or commercial obsolescence- The arises from changes or improvements in production, or change in
the market demand for the product output of the asset.
d. Legal limits for the use of the asset, such as the expiry date of the related lease.

Depreciation method

The depreciation method shall reflect the pattern in which the future economic benefits from the asset are expected to
be consumed by the entity.
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The depreciation method shall be reviewed at least at every year -end.

If there has been a significant change in the expected pattern of economic benefits, the method shall be changed to
reflect the changed pattern.

Such change shall be accounted for as a change in accounting estimate.

A variety of depreciation methods can be used.

Depreciation methods include straight line, production method and diminishing balance method.

Straight line method

Under the straight-line method, the annual depreciation charge is calculated by allocating the depreciable amount
equally over the number of years of useful life.

In other words, straight line depreciation is a constant charge over the useful life of the asset.

The straight-line method is adopted when the principal cause of depreciation is passage of time.

The straight-line approach considers depreciation as a function of time rather than as a function of usage.

Production method

The production method or output method assumes that depreciation is more a function of use rather than passage of
time.

The useful life of the asset is considered in terms of the output it produces or the number of hours it works.

Thus, depreciation is related to the estimated production capability of the asset and is expressed in a rate per unit of
output or per hour of use.

The production method is adopted if the principal cause of depreciation is usage.

Diminishing balance or accelerated methods

The diminishing balance or accelerated methods provide higher depreciation in the earlier years and lower depreciation
in the later years of the useful life of the asset.

Thus, these methods result in a decreasing depreciation charge over the useful life.

The accelerated depreciation is on the philosophy that new assets are generally capable of producing more revenue in
the earlier years than in the later years.

The accelerated methods include sum of years ‘digits method and double declining method balance.