CAPITALIZATION POLICY

Items of PPE are Capitalized based on the entity’s adopted policy.

Example: An entity may adopt a policy to capitalize all acquisition amounting to 5,000 or more and
charge as expenses those below this amount.

Note: Capitalization Policy is disclosed in the notes

CESSATION OF CAPITALIZATION

-When the PPE is in the location and condition necessary for it to be capable of operating in the manner
intended by management.

TREATMENT OF SUBSEQUENT EXPENDITURE

1. REVENUE EXPENDITURES - A subsequent cost that does not qualify under the recognition
criteria is expensed immediately
2. CAPITAL EXPENDITURES- A subsequent cost that qualify under the recognition criteria
which is Capitalized as part of the cost of the PPE

a. Meets the definition of PPE

b. It is probable that future economic benefits will flow to the entity
 Extension in the asset’s useful life
 Increase in the asset’s capacity or efficiency beyond its original capacity or
efficiency
o Capacity- asset’s ability to function intended by management
o Efficiency- ability of PPE to produce economic benefit at the least cost and
least time
c. The cost can be measure reliably

REVENUE EXPENDITURE CAPITAL EXPENDITURE

Costs incurred while an item capable of
operating in the manner intended by
management has yet to be bought into use or is
operated at less than full capacity
Additions- modifications to an asset that increase its
physical capacity. Such cost is capitalized because a
new asset is actually created
Improvements/ Betterment- the substitution of a better
asset for the one currently used ( e.g. ,wooden floor to
concrete floor)

If it extends the asset’s useful life – cost is capitalized

by debiting accumulated depreciation
 If it increases the asset’s capacity or efficiency – cost is
capitalized by debiting the asset account.
Initial Operating Loss Replacement- Substitution of similar asset ( e.g. old
wooden floor for a new wooden floor)

Capitalized if the recognition criteria are met

The cost of the replacement part is recognized while

the carrying amount of the replaced part is
derecognized.

If the cost is indeterminable, the cost of the new

Cost of relocating or reorganizing part or all of
the entity’s operations
(replaced) part is used as an indication of what the cost
of the replaced part was at the time it was acquired or
constructed
Major inspections – similar to replacement costs

The cost of the latest major inspection is capitalized

Cost incurred to maintain or to bring back an
asset to its original capacity or efficiency
Rearrangement and reinstallation- normally
charge as expense
Costs of day to day servicing of a PPE ( repairs
and maintenance expense)
(e.g., regular replacement of minor parts,
lubrication, calibration, repainting and cleaning)
while the carrying amount of the previous one is
derecognized
Rearrangement and reinstallation -capitalized only
when the management can clearly demonstrate that
the rearrangement and reinstallation costs constitute
an asset
Repairs and Maintenance -may be capitalized when it
meets the recognition
criteria (e.g., major repair or overhaul that extends the
useful life of an asset)

SAMPLE PROBLEMS:

On December 31, 2022, BTS Inc. Incurred P10, 000 improvement costs on factory equipment.

CASE 1: The improvement extended the asset’s useful life

Date Particulars Amounts

DEC 31, 2020 Accumulated depreciation 10,000
Cash 10,000
CASE 2: The improvement significantly reduced the equipment’s operating costs such that the
equipment is now operating more efficiently than what was originally expected.

Date Particulars Amounts

Dec 31, 2022 Factory Equipment 10,000
Cash 10,000

On January, 2021, BTS purchased an aircraft for P6, 000,000. The aircraft was depreciated over a useful
life of 10 years using the straight line method. On January 1, 2025 a major part of aircraft was replaced
for a total cost of P800, 000.

CASE 1: The cost of the old part is 500,000

Date Particulars Amounts

Loss on replacement 300,000
Accumulated depreciation 200,000
Air Craft 500,000
Air Craft 800,000
Cash 800,000

CASE2: The cost of the old part is indeterminable

Date Particulars Amounts

Loss on replacement 480,000
Accumulated depreciation 320,000
Air Craft 800,000
Air Craft 800,000
Cash 800,000

REVALUATION MODEL After recognition as an asset, an item of PPE 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.

Fair Value- The price that would be received to sell an asset or paid to transfer a liability in an orderly
transaction between market participants at the measurement date (PFRS 13. Fair Value Measurement)
BASIS FOR REVALUATION

A. Highest and best use determine from the perspective of market participants
B. Fair Value Hierarchy
1. Quoted Price for identical asset/liability in active market
2. Inputs other than quoted prices included in Level 1 that are observable
3. Unobservable Input
C. Valuation Technique
 Market Approach – Uses prices and other relevant information generated by market
transactions involving similar assets/liabilities
 Cost Approach – Reflects the amount that is currently needed to replace the service
capacity of an asset ( Current Replacement Cost)
 Income Approach- Converts future amounts ( Cash flows) to a single amount
( Discounted) reflecting current market expectations about those future amounts

FREQUENCY OF REVALUATION

For items with significant and volatile changes in fair value, annual revaluation is necessary. For items
with insignificant changes in fair value, revaluation may be made every 3 or 5 years.

ACCOUNTING FOR REVALUATION OF PPE

An increase or decrease in the CA of a PPE resulting from revaluation is recognized in Other

Comprehensive Income and accumulated in equity under the revaluation surplus account except

1. Increase that represents reversal of previous impairment loss is recognized in profit or loss as
impairment gain.
2. A decrease in excess of the credit balance in the revaluation Surplus of the asset is recognized in
profit or loss as impairment loss.

FORMULA:

FAIR VALUE XX
CARRYING AMOUNT (XX)
REVALUATION SURPLUS XX
On December 31, 2021 BTS Company’s building with historical cost of P20,000,000 and accumulated
depreciation of P5,000,000 is determined to have a Fair Value of P25,000,000. The building has a
remaining useful life of 20 years.

1. Compute for revaluation surplus

FV 25,000,000
Less: CA 15,000,000 ( 20,000,000- 5,000,000)
Revaluation Surplus 10,000,000

2. Compute for the annual depreciation after revaluation. (Use straight line method)

CA,2021 25,000,000/20 years = 1,250,000 Depreciation Expense

On December 31, 2021 BTS Company’s building with historical cost of P20,000,000 and accumulated
depreciation of P5,000,000 is determined to have a Replacement Cost of P25,000,000.
Additional Information:
Actual life 5 years ( ignored)
Effective Life 10 years ( lumipas na taon)
Remaining Life 30 years
Original Life 40 years
What is the Revaluation Surplus? 10/40 x 25,000,000 =

Historical Replacement Cost Increase

Building 20,000,000 25,000,000 5,000,000
Accumulated 5,000,000 6,250,000 1,250,000
Depreciation
CA/DRC/RS 15,000,000 18,750,000 3,750,000

On December 31, 2021 BTS Company’s building with historical cost of P20,000,000 and accumulated
depreciation of P5,000,000 is determined to have a Replacement Cost of P25,000,000.

What is the Revaluation Surplus? Proportionate = 5,000,000/20,000,000 =25%

Historical Replacement Cost Increase

Building 20,000,000 25,000,000 5,000,000
Accumulated 5,000,000 6,250,000 1,250,000
Depreciation
CA/DRC/RS 15,000,000 18,750,000 3,750,000
On January 1, 2021 BTS Company’s building with historical cost of P20,000,000 has a useful life of 20
years. On January 1, 2026 the building is determined to have a Replacement Cost of P25,000,000.

5/20 =25%

Historical Replacement Cost Increase

Building 20,000,000 25,000,000 5,000,000
Accumulated 5,000,000 6,250,000 1,250,000
Depreciation
CA/DRC/RS 15,000,000 18,750,000 3,750,000

Methods of recording revaluation

1. Proportional method - The gross carrying amount is adjusted proportionately to the change in
the carrying amount.

2. Elimination method - The accumulated depreciation is eliminated against the gross carrying
amount of the asset. Under elimination method the revaluation surplus and the related tax liability are
recorded by eliminating the balance of the accumulated depreciation (historical cost). The balancing
figure is recorded to the asset account

On December 31, 2021 BTS Company’s building with historical cost of P20,000,000 and accumulated
depreciation of P5,000,000 is determined to have a Replacement Cost of P25,000,000.
Additional Information:
Actual life 5 years
Effective Life 10 years
Remaining Life 30 years
Income tax rate 30% ( Consider tax rate)

What is the Revaluation Surplus? 10/40 = 25% x 25,000,000 = 6,250,000

Historical Replacement Cost Increase

Building 20,000,000 25,000,000 5,000,000
Accumulated 5,000,000 6,250,000 1,250,000
Depreciation
CA/DRC/RS 15,000,000 18,750,000 3,750,000

Provide the Journal Entry under Proportional Method.

Building 5,000,000
Accumulated depreciation 1,250,000
Deferred tax liability ( 30% x 3750000) 1,125,000
Revaluation Surplus ( Net of tax) 2,625,000
Provide the Journal Entry under Elimination Method.

Accumulated Depreciation 5,000,000

Building 1,250,000 ( Balancing figure)
Deferred tax liability ( 30% x 3750000) 1,125,000
Revaluation Surplus ( Net of tax) 2,625,000

On December 31, 2021 BTS Company’s building with historical cost of P20,000,000 and accumulated
depreciation of P5,000,000 is determined to have a fair value of P24,000,000. Income tax rate is 30%

What is the Revaluation Surplus? 5,000,000/ 20,00,000 = 25%

Historical Replacement Cost Increase

Building 20,000,000 32,000,000 (100%) 12,000,000
Accumulated 5,000,000 8,000,000 3,000,000
Depreciation (25%)
CA/DRC/RS 15,000,000 24,000,000 (75%) 9,000,000

Provide the Journal Entry under Proportional Method.

Building 12,000,000
Accu dep 3,000,000
Deferred tax liab 2,700,00
Revaluation Surplus 6,300,000

Provide the Journal Entry under Elimination Method.

Accumulated dep 5,000,000

Building 4,000,000
Deferred tax liab 2,700,00
Revaluation Surplus 6,300,000

BTS’s land with historical cost of P8, 000, 000 has fair values of P12, 000,000 on December 31,
2011 ,P7,000,000 on December 31, 2014 and P9,000,000 on December31, 2015

Provide Entries on December 31, 2011, December 31, 2014, and December 31, 2015
Date Particulars Amounts
Dec 31,2011 Land 4,000,000
 Revaluation Surplus 4,000,000
Dec 31,2014 Revaluation Surplus 4,000,000
Impairment Loss 1,000,000
Land 5,000,000
Dec 31, 2015 Land 2,000,000
Gain on reversal of 1,000,000
impariment
Revaluation Surplus 1,000,000

ACCOUNT FOR DERECOGNITION OF PPE

Derecognition is opposite of recognition. It is the removal of a previously recognized asset or liability

from the entity’s financial statement.
The carrying amount of an item or PPE shall be derecognized:
a. on disposal; or
b. when no future economic benefits are expected from its use or disposal

DISCLOSURE

General disclosure for each class of PPE

a. The measurement bases used
b. The depreciation methods used
c. The useful lives or depreciation rates used
d. The gross carrying amount and the accumulated depreciation at the beginning and end
of the period
e. A reconciliation of the carrying amount at the beginning and end of the period showing:
additions, disposals and other changes

Reference: Intermediate Accounting 1b, Zeus Vernon B. Millan