FINANCIAL ACCOUNTING & REPORTING 1

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Property, Plant and Equipment (Part 3)

Module 024 Property, Plant and Equipment

(Part 3)

IAS 16 Property, Plant, and Equipment outline the accounting treatment for
most types of property, plant, and equipment.
Property, plant, and equipment are initially measured at their cost,
subsequently measured either using a cost or revaluation model, and
depreciated so that their depreciable amount is allocated on a systematic
basis over its useful life.
At the end of this module, you are expected to:
1. Know the different depreciation methods, i.e., Straight-line method,
Declining balance method, Sum-of-the-years’ digits method, Group, and
composite depreciation;
2. Understand the accounting principles and treatment on the depletion of
wasting assets; and
3. Be able to recognize any accounting changes affecting depreciation.

Depreciation methods
The standard is not prescriptive about methods of depreciation. It simply says that the
depreciation method shall reflect the pattern in which the asset's future economic benefits
are expected to be consumed by the entity, mentioning straight line, diminishing balance,
and units of production as possibilities.

The overriding requirement is that the depreciation charge reflects the pattern
of consumption of the benefits the asset brings over its useful life and is applied
consistently from period to period.

Course Module
IAS 16 contains an explicit requirement that the depreciation method is reviewed at least at
each period end to determine if there has been a significant change in the pattern of
consumption of an asset's benefits. This could mean, for example, concluding that the
straight-line method was no longer appropriate and changing to a diminishing balance
method. If there has been such a change, the depreciation method should be changed to
reflect it. However, this change is a change in accounting estimate and not a change in
accounting policy. This means that the consequent depreciation adjustment should be
made prospectively, i.e., the asset's depreciable amount should be written off over current
and future periods.

A variety of depreciation methods can be used to allocate the depreciable amount of an

asset on a systematic basis over its useful life.

Straight line method

This method is widely used in practice because of its simplicity. It assumes that the
asset provides equal economic benefits in each period of its estimated useful life.
The annual depreciation charge is computed as

Cost (or revalued amounts) less residual value

Estimated useful life in a number of years

Oftentimes, depreciation is calculated using a rate applied to the depreciable

amount (cost or revalued amount, less residual value) of the asset. This rate is
obtained as 100% divided by the life in years. Thus, 10-year life would use 10%, 5-
year life would use 20%, and 4-year life would use 25%.

Decreasing Charge Methods

These methods assume that the assets provide higher economic benefits during the
early years of their useful life, thus providing higher depreciation expenses in the
earlier years. This is based on the theory that assets generally are capable of
generating more revenue in their early years of use.
Sum-of-the-year digits method
The depreciation charge for each year is computed as:

Depreciable amount x Estimated useful life, beginning of the year

Sum of the digits in the life of the asset

Double declining balance method

This is also known as a 200% declining balance, where depreciation is computed by
multiplying a fixed rate by the declining carrying value of the asset at the beginning
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Property, Plant and Equipment (Part 3)

of the period. The fixed-rate under this method is computed as twice the straight-
line rate.
Rate = 2/n
where n is useful life in years
Thus, if the life of the asset is ten years, the double rate is 20%; if five years, the
double rate is 40%; if four years, the double rate is 50%. It will be noted that this
method ignores the asset's residual value, and depreciation in the final year of the
asset is usually taken as the difference between the beginning year carrying value
and residual value.

150% declining balance method

Computation of depreciation under this method is practically the same as in the
double declining balance method, except that the fixed rate applied to the beginning
carrying amount is 150% of the straight rate.
Rate = 1.5/n
where n is useful life in years
Thus, if the life of the asset is ten years, the fixed rate is 15%; if five years, the fixed
rate is 30%; if four years, the fixed rate is 37.5%.

Group and Component depreciation

Under the group depreciation method, all similar assets are grouped and treated as
a single unit for depreciation purposes, while under the composite depreciation
method, several assets that are dissimilar in nature are grouped and treated as a
single unit for depreciation purposes.
The computation of depreciation for both methods is the same and essentially uses
the straight-line method.
Under the group or composite depreciation method, when any one of the assets in
the group is sold, the asset account is credited for the cost of the asset retired, cash
is debited for its sales price, and the difference is debited to accumulated
depreciation. No gain or loss is recognized on the sale or retirement of the asset
since the recorded depreciation is not related to any specific asset in the group.
The entry for the disposal is:
Cash (Proceeds from sale) xxx
Accumulated Depreciation (Cost minus proceeds) xxx
Equipment (or any appropriate PPE account, at cost) xxx

Course Module
In contrast with the concept of group or composite depreciation is the concept of
component depreciation that is required by IAS 16. Under this concept, 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.
An entity allocates the amount initially recognized in respect of an item of property
plant and equipment to its significant parts and depreciates separately the
remainder of the item over the useful life of the asset.

To illustrate, assume an aircraft costs P50,000,000. Included in the purchase price of

the aircraft are the passenger seats costing P2,000,000, and the engine costing
P10,000,000. Both seats and engine are expected to be replaced after five years of
continuous use, while the remainder of the aircraft is expected to have a useful life
of 15 years. The aircraft, other than the engine and the passenger seats, has a
residual value of P3,500,000. The engine has an estimated residual value of the sets
P200,000 at the end of five years. The residual value of the seats is considered not
material.
The cost of the airplane is therefore composed of the following:
Passenger seats P2,000,000
Engine 10,000,000
Other parts 38,000,000
The total annual depreciation for the aircraft is computed as follows, using the
straight-line depreciation:
Passenger seats (P10,000,000 –P200,000) / 5 P1,960,000
Engine P2,000,000 / 5 400,000
Other parts (P38,000,000-3,500,000) / 15 2,300,000
Total depreciation P4,660,000
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Property, Plant and Equipment (Part 3)

Unit-of-production method

Under this method, the asset is written off in line with its estimated total output. By
relating depreciation to the proportion of productive capacity utilized to date, it
reflects the fact that the useful economic life of certain assets, principally machinery,
is more closely linked to their usage and output than to time. This method is
normally used in extractive industries, for example, to amortize the costs of the
development of productive oil and gas facilities.

The essence of choosing a fair depreciation method is to reflect the consumption of

economic benefits provided by the asset concerned. In most cases, the straight-line basis
will give perfectly acceptable results, and the vast majority of entities use this method.
Where there are instances, such as the extraction of a known proportion of a mineral
resource, or the use of a certain amount of the total available number of working hours of a
machine, it may be that a unit of production method will give fairer results.

Depletion of wasting assets

The standard on property, plant, and equipment does not apply to natural resources and
mineral rights (wasting assets) but does apply to property, plant, and equipment items
used to develop or maintain the activities or assets pertaining to natural resources and
mineral rights.

Similar to property, plant, and equipment, wasting assets are subject to depletion, which
requires a systematic allocation of its cost over the period the natural resource is extracted
or produced.

The method used for the depletion takes the form of the productive output method, where
the depletion rate is
Depletion cost (cost less estimated residual value)
Total estimated units that can be recovered from the asset

When an additional cost is incurred and/or when a change is estimated occurs, a revised
depletion rate is computed as
Remaining depletable cost + Additional cost
Revised estimated units at the beginning of the year

Course Module
Accounting changes affecting depreciation
IAS 16 contains an explicit requirement that the depreciation method applied to property,
plant, and equipment should be reviewed periodically, and, if there has been a significant
change in the expected pattern of economic benefits from those assets, the method should
be changed to reflect the changed pattern. When such a change in the depreciation method
is necessary, the change should be accounted for as a change in estimate, and the
depreciation charge for the current and future period should be adjusted. For example,
concluding that the diminishing balance method was no longer appropriate and changing
to a straight line method. If there has been such a change, the depreciation method should
be changed to reflect it.

Likewise, the useful life of an item of property, plant, and equipment should be reviewed
periodically, and if expectations are significantly different from previous estimates, the
depreciation charge for the current and future periods should be adjusted. No retrospective
adjustment is required in the accounts.
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Property, Plant and Equipment (Part 3)

Glossary
Carrying amount: Amount at which an asset is recognized after deducting any
accumulated depreciation and accumulated impairment losses.
Cost: Amount of cash or cash equivalents paid or the fair value of other consideration
given to acquire an asset at the time of its acquisition or construction or, where
applicable, the amount attributed to that asset when initially recognized in accordance
with the specific requirements of other IFRSs, e.g., IFRS 2 – Share-based Payment.
Depreciable amount: Cost of an asset, or other amount substituted for cost, less its
residual value.
Depreciation: The systematic allocation of the depreciable amount of an asset over its
useful life.
Entity-specific value: The present value of the cash flows an entity expects to arise from
the continuing use of an asset and from its disposal at the end of its useful life or expects
to incur when settling a liability.
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.
Impairment loss: The amount by which the carrying amount of an asset exceeds its
recoverable amount.
Recoverable amount: The higher an asset's fair value, the fewer costs to sell and its
value in use.
Residual value: The estimated amount that an entity would currently obtain from the
disposal of the asset, after deducting the estimated costs of disposal, if the asset were
already of age and in the condition expected at the end of its useful life.
Useful life:
(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.

Course Module
References and Supplementary Materials
Books and Journals
IAS 16, Property, Plant and Equipment
Cabrera, M. B., & Ocampo, R. R. (n.d.). Financial Accounting & Reporting - Standards &
Application (2014-2015 ed., Vol. 2). Manila, Philippines.
Robles, N. S., & Empleo, P. M. (2014). Intermediate Accounting (2014 ed., Vol. 1). Manila,
Philippines.
Valix, C. T., Peralta, J. F., & Valix, C. M. (2017). Financial Accounting (2017 ed., Vol. 2).Manila,
Philippines.

Online Supplementary Reading Materials

1. IAS 16 — Property, Plant, and Equipment
http://www.ifrs.org/issued-standards/list-of-standards/ias-16-property-plant-and-
equipment/; October 10, 2017

2. The Reporting of Property and Equipment;

http://open.lib.umn.edu/financialaccounting/chapter/10-1-the-reporting-of-property-
and-equipment/; October 23, 2017

3. Reporting Land Improvements and Impairments in the Value of Property and

Equipment; http://open.lib.umn.edu/financialaccounting/chapter/10-6-reporting-
land-improvements-and-impairments-in-the-value-of-property-and-equipment/;
October 23, 2017

4. Depreciation, impairments, and depletion;

https://www.accountingformanagement.org/explanation/depreciation-impairments-
and-depletion/; October 23, 2017

Online Instructional Videos

1. Introduction to PPE: http://www.investopedia.com/video/play/property-plant-and-
equipment-ppe/; October 10, 2017
2. Depreciation: http://www.investopedia.com/video/play/depreciation/; October 10,
2017
3. Declining balance Method: http://www.investopedia.com/video/play/declining-
balance-method/; October 10, 2017