CHAPTER 1

PROPERTY, PLANT, AND EQUIPMENT

Learning Objectives
After studying this chapter, the student should be able to:

1. Define what are property, plant, and equipment.

2. Explain the major characteristics in the definition of property, plant, and

equipment.

3. Identify costs to be included in the different types of acquisition of property, plant,

and equipment.

4. Properly account for the acquisition of property, plant, and equipment using

various special arrangements, including deferred payment and self-construction.

5. Separate costs into those that should be expensed immediately and those that should

be capitalized, and understand the accounting standards for research and

development.

6. Account for the cost after acquisition.

7. Account those costs chargeable to land, building, machinery, and equipment.

8. Record the disposal of property, plant, and equipment.

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 CHAPTER 1

PROPERTY, PLANT, AND EQUIPMENT

Many billions of pesos are invested each year in new property, plant and equipment and
increasingly in intangible assets as well. A time-line of the business and accounting issues
associated with property, plant, and equipment are shown below:

Exhibit 1-1

One of the keys to a successful business is correctly choosing which long-term assets to buy.
Capital budgeting and discounted cash flow analysis are essential elements in making the best
choices. In addition to the difficult financial decisions surrounding long-term assets, many
accounting questions are introduced when long-term items are acquired. These accounting issues
include the following:
Ø Which costs should be capitalized as assets and which ones should be expensed?
Ø What costs should be included in the acquisition cost of a long-term asset?
Ø How should intangible assets be recorded?
Ø At what amounts should long-term assets be recorded when the financing of the purchase
is more complex than a simple cash payment?
Ø How should expenditures make subsequent to acquisition be recorded?
Ø What recognition should be given to changes in the market value of long-term assets?

Definition

Philippine Accounting Standard (PAS) No. 16 defines the following terms.

The 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”.

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Accordingly, the major characteristics in the definition are:

∗ Tangible assets meaning with physical substance.

∗ Used in business meaning used in production or supply of goods or services, for rental
purposes and administrative purposes.
∗ The Useful life of more than one period meaning such property, plant, and equipment are
expected to be used over a period of more than one year.

Examples of property, plant and equipment include land, building, machinery, ship, aircraft,
motor vehicle, furniture and fixtures, office equipment, patterns, molds and dies, tools, leasehold
improvement, and book plates.

Carrying amount is the amount at which an asset is recognized after deducting any accumulated
depreciation and accumulated impairment losses.

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

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

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

Entity-specific value is the present value of the cash flows an entity expects to arise from the
continuing use of an asset from its disposal at the end of its useful life or expects to incur when
settling a liability.

Fair value is the amount for which an asset could be exchanged between knowledgeable, willing
parties in an arm’s length transaction.

An impairment loss is an amount by which the carrying amount of an asset exceeds its
recoverable amount.

Recoverable amount is the higher of an asset’s fair value minus costs to sell and its value in use.

The residual value of an asset is the estimated amount that an entity would currently obtain from
disposal of the asset, after deducting the estimated costs of disposal, if the asset were already of
the age and in the condition expected at the end of its useful life.

Useful life is:

(a) The period over which an asset is expected to be available for use by an entity; or
(b) The number of production or similar units expected to be obtained from the asset by an
entity.

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Recognition of property, plant, and equipment

PAS 16 provides that, “The cost of an item of property, plant and equipment shall be recognized
as an asset if, and only if:”

(a) it is probable that future economic benefits associated with the item will flow to the
entity; and
(b) the cost of the item can be measured reliably

An entity shall evaluate all its property, plant and equipment costs at the time they are incurred.
These costs include costs incurred initially to acquire or construct an item of property, plant and
equipment and costs incurred subsequently to add to, replace part of, or service it.

Spare parts and servicing equipment are usually carried as inventory and recognized in profit or
loss (expense) when consumed.

However, major spare parts and stand-by equipment qualify as property, plant and equipment
when an entity expects to use them during more than one period.

Similarly, if the spare parts and servicing equipment can be used only in connection with an item
of property, plant, and equipment, they are accounted for as property, plant and equipment.

Measurement at recognition

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

PAS 16 paragraphs 23, further provides that, “The cost of an item of property, plant and
equipment is the cash price equivalent at the recognition date. If payment is deferred beyond
normal credit terms, the difference between the cash price equivalent and the total payment is
recognized as interest over the period of credit.”

The cost of property includes not only the original purchase price or equivalent value but also
any other expenditure required in obtaining and preparing the asset for its intended use. Any
taxes, freight, installation and other expenditures related to the acquisition should be included in
the asset’s cost. Post-acquisition cost – costs incurred after the asset is placed into service – are
usually expensed rather than added to the acquisition cost. Exceptions to this general rule apply
to some major replacements or improvements and will be discussed later in the chapter.

Elements of cost

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

(a) Its purchase price, including import duties and non-refundable purchase taxes, after
deducting trade discounts and rebates.

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 (b) Any costs 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) The initial estimate of the costs of dismantling and removing the item and restoring the
site on which it is located, the obligation for which an entity incurs either when the item
is acquired or as a consequence of having used the item during a particular period for
purposes other than to produce inventories during that period.

Examples of directly attributable costs are:

(a) costs of employee benefits (as defined in PAS 19 Employee Benefits) arising directly
from the construction or acquisition of the item of property, plant, and equipment;
(b) costs of site preparation;
(c) initial delivery and handling costs;
(d) installation and assembly costs;
(e) costs of testing whether the asset is functioning properly, after deducting the net proceeds
from selling any items produced while bringing the asset to that location and condition
(such as samples produced when testing equipment); and
(f) Professional fees.

Examples of costs that are not costs of an item of property, plant and equipment are:

(a) costs of opening a new facility;

(b) costs of introducing a new product or service (including costs of advertising and
promotional activities);
(c) Costs of conducting business in a new location or with a new class of customer
(including costs of staff training); and (d) administration and other general overhead
costs.

Recognition of costs in the carrying amount of an item of property, plant, and equipment ceases
when the item is in the location and condition necessary for it to be capable of operating in the
manner intended by management. Therefore, costs incurred in using or redeploying an item is
not included in the carrying amount of that item. For example, the following costs are not
included in the carrying amount of an item of property, plant, and equipment:

(a) costs 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;
(b) initial operating losses, such as those incurred while demand for the item’s output builds
up; and
(c) Costs of relocating or reorganizing part or all of an entity’s operations.

Measurement after recognition

An entity shall choose either the cost model or the revaluation model as its accounting policy and
shall apply that policy to an entire class of property, plant, and equipment.

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 ∗ Cost model - After recognition as an asset, an item of property, plant and equipment
shall be carried at its cost less any accumulated depreciation and any accumulated
impairment losses.

∗ Revaluation model - After recognition as an asset, an item of property, plant and

equipment whose fair value can be measured reliably shall be carried at a revalued
amount, being its fair value at the date of the revaluation less any subsequent
accumulated depreciation and subsequent accumulated impairment losses. Revaluation
shall be made with sufficient regularity to ensure that the carrying amount does not differ
materially from that which would be determined using fair value at the end of the
reporting period.

Acquisition of Property, Plant, and Equipment

The Property, plant, and equipment can be acquired in various arrangements. The amount to be
recognized as the cost of property, plant, and equipment will differ in each manner of
acquisition.

The manner of acquiring property, plant, and equipment includes:

1. Cash basis
2. Acquisition on account
3. Acquisition on installment basis
4. Acquisition by issuance of securities (share capital or bonds)
5. Acquisition by Exchange
6. Acquisition by Donation
7. Acquisition by Construction

Acquisition on cash basis

When an asset is acquired for cash, the acquisition is recorded at the amount of cash paid plus
any expenditure for freight, insurance while in transit, installation, trial runs, and any other costs
necessary to prepare the asset for its intended use.

In some purchases, some assets may be acquired at a basket price for one lump sum. For
example, Jerry Jones acquired football equipment, cable TV rights, player contracts, and the
Cowboys’ NFL franchise rights when he purchased the Dallas Cowboys. To account for the
assets on an individual basis, the total purchase price must be allocated among the individual
assets. When part of a purchase price can be clearly identified with specific assets, such a cost
assignment should be made and the balance of the purchase price allocated to the remaining
assets. When no part of the purchase price can be related to specific assets, the entire amount
must be allocated among the different assets acquired by relative fair value or appraised value
of the assets on the date of acquisition.

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Illustration

1. At the beginning of the year, Margarita Corporation purchased equipment for P2,500,000
cash, and incurred the following necessary costs to prepare the equipment for its intended
use: transportation cost to bring the asset into position P6,800, insurance while in transit
P5,500 and cost of installation P8,000.

Journal entry to record the acquisition.

Equipment 2,520,300
Cash 2,520,300

2. At the beginning of the current year, Albino Corporation purchased for P8, 100,000,
including appraiser’s fee of P75,000, a warehouse building and the land on which it is
located. The following data were available concerning the property:

Current Seller
Appraised value original cost
Land 3,000,000 2,100,000
Warehouse building 4,500,000 4,200,000
7,500,000 6,300,000

Journal entry to record the acquisition.

Land 3,240,000
Building 4,860,000
Cash 8,100,000

Cost of land (30/75 x P8, 100,000) 3,240,000

Cost of Building (45/75 x P8, 100,000) 4,860,000

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.

If the discount is not taken, the same is charged to purchase discount lost account which is
shown as other expense. Most companies in a wise management would take advantage of all
discounts.

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

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Illustration

A machinery is purchased for 1,500,000, 2/10, n/30. The purchase may be recorded using either
the gross method or net method.

Gross method Net method

1. To record the acquisition:

Machinery 1,500,000 Machinery 1,470,000

Accounts payable 1,500,000 Accounts payable 1,470,000

2. To record the payment within the discount

period:

Accounts payable 1,500,000 Accounts payable 1,470,000

Cash 1,470,000 Cash 1,470,000
Machinery 30,000

3. To record the payment beyond the discount

period:

Accounts payable 1,500,000 Accounts payable 1,470,000

Purchase discount lost 30,000 Purchase discount lost 30,000
Cash 1,500,000 Cash 1,500,000
Equipment 30,000

Acquisition on installment basis

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

In other words, if an asset is acquired on installment basis, and there is a cash price available,
sound accounting practice dictates that 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.

However, if an asset is acquired by installment and there is no available cash price, the asset is
recorded at an amount equal to present value of all payments using an implied interest rate.

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Illustrations

1. RAIRAI Corporation purchased equipment from KHYLE Company at an installment

price of P875, 000. The terms are P125, 000 down and the balance payable in three equal
annual installments. The cash price of the equipment is P725, 000. A promissory note is
issued for the installment balance of P750, 000.
Journal entries are as follows:

To record the acquisition.

Equipment 725,000
Discount on note payable 150,000
Note payable 750,000
Cash 125,000

To record the first installment payment.

Note payable 250,000

Cash 250,000

To amortize the discount on note payable.

Interest expense 75,000

Discount on note payable 75,000

Note payable Fraction Interest expense

First year 750,000 75 / 150 75,000

Second year 500,000 50 /150 50,000
Third year 250,000 25 / 150 25,000
1,500,000 150,000

Note: The fractions are developed from the note payable outstanding each year. The
fractions are then multiplied by the discount of P150, 000 to arrive at the annual
interest expense.

2. At the beginning of the current year, KHYLE Corporation purchased equipment from
KHALYL Company at an installment price of P1, 750,000. The terms are P250, 000
down and the balance payable in three equal annual installments. A promissory note is
issued for the balance of P1, 500,000. The present value of an ordinary annuity of 1 is
2.487 for three periods using an implied interest rate of 10%.

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 Journal entries are as follows:

To record the acquisition.

Equipment 1,493,500
Discount on note payable 256,500
Cash 250,000
Note payable 1,500,000
Downpayment 250,000
Present value of note payable (500,000 x 2.487) 1,243,500
Total Cost 1,493,500

Note payable 1,500,000

Present value of note payable 1,243,500
Implied interest 256,500

To record the first installment payment.

Note payable 500,000

Cash 500,000

To amortize the discount on note payable.

Interest expense 124,350

Discount on note payable 124,350

Schedule of amortization of discount on notes payable.

Year Payment Interest Principal Present value

January 1 1,243,500
First year 500,000 124,350 375,650 867,850
Second year 500,000 86,785 413,215 454,635
Third year 500,000 45,365 454,635 -

Notes:

∗ “Effective interest” method is used in amortizing the discount on note payable as

interest expense.
∗ The annual payment is equal to P500,000 computed by dividing the note of
P1,500,000 by 3 years.
∗ The annual interest expense is equal to the present value of the note multiplied by
10%. Thus, for the first year, P1,243,500 time 10% equals P124,350, and so on.
∗ The principal payment is equal to the annual payment minus the applicable
interest expense. Thus, for the first year, P500,000 minus P124,350 equals
P375,650, and so on.

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 ∗ The present value is equal to the preceding present value minus the principal
payment. Thus, for the first year, P1,243,500 minus P375,650 equals P867,850,
and so on.

At the end of the first year, the note payable is classified and presented in the statement of
financial position as follows:

Current liability:
Note payable 500,000
Discount on note payable 86,785
Carrying amount 413,215

Noncurrent liability:
Note payable 500,000
Discount on note payable 45,365
Carrying amount 454,635

Acquisition by issuance of securities (share capital or bonds)

A company may acquire certain property by issuing its bonds or stocks. When an entity acquires
an asset by issuance of securities, the property shall be measured at an amount equal to the
following in the order of priority:

Issuance of share capital Issuance of bond

1. Fair value of the property received 1. Fair value of bonds payable

2. Fair value of the share capital 2. Fair value of asset received
3. Par value or stated value of the share 3. Face value of bonds payable
capital

If the securities are selling at more or less than par value, the securities are credited at par or face
value and the difference recorded as share premium or, in the case of bonds, as premium on
bonds payable or discount on bonds payable. Selling share capital less than par value is not
allowed.

Fair value is determined by making reference to the cash transactions of the same or similar
assets, quoted market prices and independent appraisals.
If the entity cannot estimate reliably the fair value of the goods or services received, the entity
shall measure their value by reference to the fair value of the equity instruments issued.

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Illustrations

1. Assume that at the beginning of the year; IRENE Corporation acquired a piece of land by
issuing 15,000 shares with par value of P125. At the time of acquisition, the fair value of
the land is P2, 000,000, and the share is quoted at P150 per share.

Journal entry to record the acquisition:

a. Fair value of the land is used.

Land 2,000,000
Share capital 1,875,000
Share premium 125,000

b. Fair value of the share capital is used.

Land (15,000 x 150) 2,250,000

Share capital 1,875,000
Share premium 375,000

c. Par value of the share capital is used.

Land 1,875,000
Share capital 1,875,000

Letter “a “is preferable.

2. Assume that on the beginning of the year, IRENE Corporation acquired a piece of land by
issuing P2, 500,000 face value bonds, the bonds are quoted at 97. At the time of
acquisition, the fair value of the land is P2, 700,000.

Journal entry to record the acquisition.

a. Fair value of bonds payable.

Land 2,425,000
Discount on bonds payable 75,000
Bonds payable 2,500,000

b. Fair value of asset received.

Land 2,700,000
Bonds payable 2,500,000
Premium on bonds payable 200,000

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 c. Face value of bonds payable.

Land 2,500,000
Bonds payable 2,500,000

Letter “a “is preferable.

Acquisition by Exchange

PAS 16 provides that “the cost of an item of property, plant, and equipment acquired in exchange
for a non-monetary asset or a combination of monetary and nonmonetary asset is measured at
fair value, unless the exchange transaction lacks commercial substance or the fair value of
neither the asset received nor the asset given up is reliably measurable.

If the exchange transaction lacks commercial substance, the cost of the acquired item of
property, plant and equipment are measured at the carrying amount of the asset given up.

An entity determines whether an exchange transaction has commercial substance by considering

the extent to which its future cash flows are expected to change as a result of the transaction. An
exchange transaction has commercial substance if:

(a) the configuration (risk, timing, and amount) of the cash flows of the asset received differs
from the configuration of the cash flows of the asset transferred; or
(b) the entity-specific value of the portion of the entity’s operations affected by the
transaction changes as a result of the exchange; and
(c) the difference in (a) or (b) is significant about the fair value of the assets exchanged.

Exchange – no cash involved

If a property is acquired in an exchange with commercial substance and there is no cash

involved, its cost is measured at the following in order of priority:

a. Fair value of property given

b. Fair value of property received
c. Carrying amount of property given

Illustration

At the beginning of the year MHE Corporation exchanged equipment with a carrying amount of
P1, 250,000 for machinery with a fair value of P1, 375,000. At the time of exchange, the
equipment has a fair value of P1, 325,000.

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Journal entries are as follows:

a. Fair value of property given is used.

Machinery 1,325,000
Equipment 1,250,000
Gain on exchange 75,000

b. Fair value of property received is used.

Machinery 1,375,000
Equipment 1,250,000
Gain on exchange 125,000

c. Carrying amount of property given is used.

Machinery 1,250,000
Equipment 1,250,000
Letter “a” is preferable.

Exchange – cash is involved

If a property is acquired in an exchange and there is cash involved or monetary consideration, the
cost of the property is measured at the fair value of the asset received which is equivalent to the
fair value of the asset given up adjusted by the amount of any cash transferred.

a. Payor - Fair value of the asset given plus cash payment.

b. Recipient – Fair value of the asset given minus the cash received.

Illustration

On January 5, 2015, Lei and Loi exchanged machinery as follows:

LEI LOI

Machinery 2,400,000 3,000,000

Accumulated depreciation 1,350,000 2,025,000
Carrying amount 1,050,000 975,000
Fair value 900,000 1,200,000
Cash paid by Lei 300,000

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Journal entries are as follows:

Books of LEI (Payor)

Machinery - New 1,200,000

Accumulated depreciation 1,350,000
Loss on exchange 150,000
Machinery – old 2,400,000
Cash 300,000

Fair value of asset given 900,000

Add: Cash payment 300,000
Cost of new asset 1,200,000
Fair value of asset given 900,000
Less: Carrying amount 1,050,000
Loss on exchange (150,000)

Books of LOI (Recipient)

Machinery – new 900,000

Cash 300,000
Accumulated depreciation 2,025,000
Machinery – old 3,000,000
Gain on exchange 225,000

Fair value of asset given 1,200,000

Less: Cash received 300,000
Cost of new asset 900,000

Fair value of asset given 1,200,000

Less: Carrying amount 975,000
Gain on exchange 225,000

Illustration – Exchange no commercial substance

On January 5, 2015, LEI and LOI exchanged a machinery as follows:

LEI LOI

Machinery 2,400,000 3,000,000

Accumulated depreciation 1,350,000 2,025,000
Carrying amount 1,050,000 975,000
Fair value 900,000 1,200,000
Cash paid by Lei 300,000

Assume that the exchange transaction lacks commercial substance.

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Journal entries are as follows:

Books of LEI (Payor)

Machinery – new 1,350,000

Accumulated depreciation 1,350,000
Machinery – old 2,400,000
Cash 300,000

Carrying amount 1,050,000

Cash payment 300,000
Cost of new asset 1,350,000

Books of LOI (Recipient)

Machinery 675,000
Accumulated depreciation 2,025,000
Cash 300,000
Machinery – old 3,000,000

Carrying amount 975,000

Less: Cash received 300,000
Cost of new asset 675,000

Trade in

Another form of exchange is trade in. A new property is acquired (from a dealer) by exchanging
another property as part payment and the balance payable in cash or any other form of payment
by agreed terms. It usually involves a significant amount of cash.

In this type of acquisition, the acquired asset is recorded at the following in order of priority.

1. Fair value of the asset given plus the cash payment.

2. Trade in value of the asset given plus the cash payment.

Illustration

On July 6, 2015, KALAI Corporation traded an old machinery with KALOI Corporation a dealer
for a newer model. The pertinent data are:

Old machinery:
Cost 2,100,000
Accumulated depreciation 1,500,000
Carrying amount 600,000
Fair value 525,000
Trade in value 750,000

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 New machinery:

List price 3,000,000

Trade in value of old equipment (750,000)
Cash payment 2,250,000

Journal entries are as follows:

1. Fair value of asset given plus cash payment.

Machinery – new 2,775,000

Accumulated depreciation 1,500,000
Loss on exchange 75,000
Machinery – old 2,100,000
Cash 2,250,000

Fair value of asset given 525,000

Cash payment 2,250,000
Cost of new asset 2,775,000

Fair value of asset given 525,000

Less: Carrying amount 600,000
Loss on exchange (75,000)

2. Trade in value of asset given plus cash payment.

Machinery – new 3,000,000

Accumulated depreciation 1,500,000
Machinery – old 2,100,000
Cash 2,250,000
Gain on exchange 150,000

Trade in value of asset given 750,000

Cash payment 2,250,000
Cost of new asset 3,000,000

Trade in value of asset given 750,000

Less: Carrying amount 600,000
Gain on exchange 150,000

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Donation

When property is received through donation, there is no cost that can be used as a basis for its
valuation. Even though certain expenditures may have to be made incidental to the gift, these
expenditures are generally considerably less than the value of the property. Here cost obviously
fails to provide a satisfactory basis for asset valuation.

Property acquired through a donation should be appraised and recorded at its fair value, with the
credit going to donated capital, if significant.
Expenses incurred in connection with the donation, like payment of registration fees and legal
fees shall be charged to the donated capital account.

Illustration

On April 18, 2015, IRENE MOSQUEDA a shareholder of BHUDDY Corporation donated an

Isuzu Elf to the company to be used as delivery equipment. The vehicle had an original cost of
P1, 800,000 and a fair value of P1, 200,000. BHUDDY Corporation paid registration fees and
cost of ownership transfer of P10, 000 in connection with the donation.

Journal entry to record the donation.

Delivery equipment 1,200,000

Donated capital 1,200,000

Donated capital 10,000

Cash 10,000

Construction

Sometimes buildings or equipment are constructed by a company for its own use. This may be
done to save on construction costs, to utilize idle facilities, or to achieve a higher quality of
construction.

Like purchased assets, these are recorded at cost, including all expenditures incurred to build the
asset and make it ready for its intended use.
All costs that can be related to construction should be charged to the assets under construction.

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

∗ Direct cost of materials

∗ Direct cost of labor
∗ Indirect cost and incremental overhead specifically identifiable or traceable to the
construction

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There is no question about the inclusion of charges for material and labor directly attributable to
the new construction. However, there is a difference of opinion regarding the amount of
overhead properly assignable to the construction activity.

If the incremental overhead is not specifically identifiable, allocation of overhead may be done
by direct labor cost or direct labor hours.

Saving 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 by outsiders, the difference for accounting purposes is not a profit but a savings.
The construction is properly reported at its actual cost. The savings will emerge as an increase in
net income over the life of the asset as lower depreciation is charged against periodic revenue.
Assume, on the other hand, the cost of self-construction is greater than bids originally received
for the construction. There is generally no assurance that the asset under alternative arrangements
might have been equal in quality to that which was self-constructed. In recording this transaction,
just as in recording others, accounts should reflect those courses of action taken, not the
alternatives that might have been selected. However, if there is evidence indicating cost has been
materially excessive because of construction inefficiencies or failures, the asset should be
evaluated for possible recording or an impairment loss.

De-recognition

De-recognition means that the cost of the property, plant, and equipment together with the
related accumulated depreciation shall be removed from the accounts.

PAS 16 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 its use or
disposal.

Assets may be retired by sale, exchange, or abandonment. Generally, when an asset is disposed
of, any unrecorded depreciation or amortization for the period is recorded at the date of
disposition. A book value as of the date of disposition can then be computed as the difference
between the cost of the asset and its accumulated depreciation. If the disposition price exceeds
the book value, a gain is recognized. If the disposition price is less than the book value, a loss is
recorded. As part of the disposition entry, the balances in the asset and accumulated depreciation
accounts for the asset are cancelled.

Land, Building, and Machinery

Land Account

The classification of land in the statement of financial position depends on the nature and
purpose of the land.

Land used as a plant site shall be treated as property, plant, and equipment.

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Land held for a currently undetermined use is treated as an investment property.

However, if the land is held definitely as a future plant site, it is classified as owner-occupied
property and not an investment property and therefore shall be included in property, plant, and
equipment.

Land held for long-term capital appreciation is treated as an investment property.

Land held for current sale by a real estate developer as in the case of subdivided lots is treated as
a current asset as part of the inventory.

PIC Interpretation on land and building

1. Land and an old building are purchased at a single cost:

a. If the old building is usable, the single cost is allocated to land and building based on
relative fair value.
b. If the old building is unusable, the single cost is allocated to land only.

2. The old building is demolished immediately to make room for construction of a new building:
a. Any allocated carrying amount of the usable old building is recognized as a loss if the
new building is accounted for as property, plant, and equipment or investment
property.
b. Any allocated carrying amount of the usable old building is capitalized as a cost of the
new building if the new building is accounted for as inventory.
c. The demolition cost minus salvage value is capitalized as a cost of the new building
whether the new building is accounted for as property, plant, and equipment, investment
property or inventory.
d. Needless to say, the net demolition cost is capitalized as a cost of the land if the old
building is demolished to prepare the land for the intended use by not to make room for
the construction of new building.

3. A building is acquired and used in a prior period but demolished in the current period to
make room for construction of a new building:
a. The carrying amount of the old building is recognized as a loss, whether the new building
is property, plant, and equipment, investment property or inventory.
b. The net demolition cost is capitalized as a cost of the new building whether the new
building is accounted for as property, plant, and equipment, investment property or
inventory.
c. If the old building is subject to a contract of lease, any payments to tenants to induce
them to vacate the old building shall be charged to the cost of the new building.

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MACHINERY – Capital and revenue expenditure

When machinery is purchased, the cost normally includes the following:

a. Purchase price
b. Freight, handling, storage and other cost related to the acquisition
c. Insurance while in transit
d. Installation cost, including site preparation and assembling
e. The cost of testing and trial run, and another cost necessary in preparing the machinery
for its intended use.
f. The initial estimate of the cost of dismantling and removing the machinery and restoring
the site on which it is located, and for which the entity has a present obligation.
g. Fee paid to consultants for advice on the acquisition of the machinery.
h. The cost of safety rail and platform surrounding machine
i. The cost of water device to keep the machine cool.

If machinery is removed to a new location, the undepreciated cost of the machinery and the old
installation cost are expensed, and the new installation cost is charged to the new asset.

If machinery is removed and retired to make room for the installation of a new one, the removal
cost not previously recognized as a provision is charged to expense.

Tools

Tools are classified as machine tools and hand tools. Machine tools include drills and punches.
Hand tools include hammer and saws. Tools should be segregated from the machinery account.

Patterns and dies

Patterns and dies are used in designing or forging out a particular product. Patterns and dies used
for the regular product are recorded as assets. Patterns and dies are depreciated over the useful
life.

However, patterns and dies used for specially ordered product form part of the cost of the special
product.

Equipment

The term “equipment” includes delivery equipment, store equipment, office equipment and
furniture and fixtures.

The cost of such equipment includes the purchase price, freight and other handling charges,
insurance while in transit, installation costs and other costs necessary in preparing them for the
intended use.

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Returnable containers

Returnable containers include bottles, boxes, tanks, drums and barrels which are returned to the
seller by the buyer when the contents are consumed or used.
Containers in big units or of great bulk as in the case of tanks, drums and barrels are classified as
property, plant and equipment. On the other hand, containers that are small and individually
involve small amount as in the case of bottles and boxes are classified as other noncurrent assets.

Capital expenditure and revenue expenditure

The decision as to whether a given expenditure is an asset or expense is one of the many areas in
which an accountant must exercise judgment. Conceptually, the issue is straightforward: If
expenditure is expected to benefit future periods, it is an asset; otherwise, it is an expense.

Exhibit 1-2

Few people would disagree with the claim that the cost of office supplies used is an expense.
Once the supplies are used, they offer no more future benefit. Similarly, the cost of a building
clearly should be capitalized because the building will provide economic benefit in future
periods. The endpoints of the continuum are easy, but it is the vast middle ground where
accountants must exercise their judgment.

Post-acquisition Expenditures

Over the useful lives of plant assets, regular as well as special expenditures are incurred. Certain
expenditures are required to maintain and repair assets; others are incurred to increase their
capacity or efficiency or to extend their useful lives. Each expenditure requires careful analysis
to determine whether it should be expensed or capitalized.

The words maintenance, repairs, renewals, replacements, additions, betterments, improvements,

and rearrangements are often used in describing expenditures made in the course of asset use.

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Maintenance and Repairs

Expenditures to maintain plant assets in goods operating conditions are referred to as

maintenance. Among these are expenditures for painting, lubricating, and adjusting equipment.
Maintenance expenditures are ordinary, recurring, and do not improve the asset or add its life;
therefore, they are recorded as expenses when they are incurred.

Expenditures to restore assets in good operating condition upon their breakdown or to restore and
replace broken parts are referred to as repairs. These are ordinary and recurring expenditures
that benefit only current operations; thus, they also are charged to expense immediately.

Renewals and Replacements

Expenditures for overhauling plant assets are frequently referred to as renewals. These amounts
should be expensed as incurred. Substitutions of parts or entire units are referred to as
replacements.

Additions and Betterments

Enlargements and extensions of existing facilities are referred to as additions. Changes in assets
designed to provide increased or improved services are referred to as betterments. If the
addition or betterment does not involve a replacement of parts of an existing asset, the
expenditure should be capitalized by adding it to the cost of the asset, or, if the new component
has a useful life different from the larger asset of which it is a component, establishing a separate
asset account for the component.

Table 1-3 : Summary of Expenditures Subsequent to Acquisition

Type of Expenditure Definition Accounting Treatment

Maintenance and Repairs
Renewals and replacements:
Normal cost of keeping property Expensed as incurred because the
in operating condition. cost is intended to keep an
existing component in working
order.

1. No extension of useful life Unplanned replacement. Expense as incurred; no new

or increase in future cash
flows.
2. Extends useful life or
increases future cash flows.
Additions and betterments
Expenditure needed to fulfill
original plans.
Improvement resulting from
replacement with better
component.
Expenditures that add to asset
usefulness by either extending
life or increasing future cash
flows.
component acquired.
Replacement of a component.
Capitalize the cost of the new
component. The remaining book
value of the replaced component
is added to depreciation expense
for the period.
Account for as a separate
component of the asset with a
separate estimated useful life.

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Accounting for major replacement

An important consideration in determining the appropriate accounting treatment for a

replacement is whether the original part of an existing asset is separately identifiable.

If separate identification is practicable, the major replacement is debited to the asset account.

The cost of the part eliminated and the related accumulated depreciation is removed from the
accounts and the remaining carrying amount of the old part is treated as a loss.

If it is not practicable for an entity to determine the carrying amount of the replaced part, it may
use the cost of the replacement as an indication of the “likely original cost” of the replaced part
at the time it was acquired or constructed.

However, the current replacement cost shall be discounted.

Illustration – Separate identification is practicable

A building having a useful life of 20 years is constructed at a total cost of P15, 000,000.

After ten years, the old roof is replaced with a new roof costing P1, 500,000.

A study of the original construction records reveals that P1, 200,000 is an accurate estimate of
the original cost of the old roof.
Journal entries

1. To eliminate the original cost of the old roof:

Loss on retirement of building 600,000

Accumulate depreciation 600,000
Building 1,200,000

2. To record the replacement:

Building 1,500,000
Cash 1,500,000

3. To record subsequent annual depreciation:

Depreciation 840,000
Accumulated depreciation 840,000

Building (15,000,000 – 1,200,000 + 1,500,000) 15,300,000

Accumulated depreciation (7,500,000 – 600,000) 6,900,000
Carrying amount 8,400,000
Annual depreciation (8,400,000 / 10 years) 840,000

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Separate identification is not practicable

Assume the same data in the preceding illustration and it is not practicable to identify the cost of
the specific part replaced.

1. To eliminate the cost of the old roof replaced:

Loss on retirement of building 418,500

Accumulated depreciation 418,500
Building 837,000

If it is not practicable to identify the original cost of the replaced part, the entity may use
the replacement cost as an indication of the “likely original cost”.

However, this requires discounting of the replacement cost. If the appropriate discount
rate is 6%, the replacement cost of P1, 500,000 is discounted at 6% for 10 years.

The present value of 1 at 6% for 10 periods is .558. Thus, the likely original cost is equal
to P1, 500,000 multiplied by .558 or P837, 000.

2. To record the replacement:

Building 1,500,000
Cash 1,500,000

3. To record the subsequent annual depreciation:

Depreciation 858,150
Accumulated Depreciation 858,150

Building (15,000,000 – 837,000 + 1,500,000) 15,663,000

Accumulated depreciation (7,500,000 – 418,500) 7,081,500
Carrying amount 8,582,500

Annual depreciation (8,582,500 / 10 years) 858,250

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Review Questions
1. Explain the recognition of property, plant, and equipment.

2. What are the elements of cost of property, plant, and equipment?

3. Explain derecognition of property, plant, and equipment.

4. What is capital expenditures?

5. What is revenue expenditures?

6. Explain Repairs and maintenance.

7. Explain the recognition of subsequent cost.

8. Mention five items which are capitalized as a cost of building acquired by purchase.

9. Explain accounting treatment for real property taxes.

10. Explain accounting for the purchase of land and an old building at a single cost.

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