Property, Plant and Equipment (PPE)

Technical Knowledge
- To understand the nature and characteristics of property, plant and equipment
- To identify specific items of property, plant and equipment
- To know the recognition of property, plant and equipment
- To understand the initial and subsequent measurement of property, plant and equipment

Definition
- 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

Major Characteristics of PPE

1. Tangible asset with physical substance
2. Used in business
a. Used in production or supply of goods or services
b. For rental purposes
c. For administrative purposes
(Assets held for sale or held for investment are not included in PPE.)
3. Expected to be used over a period of more than one year - PPE is a noncurrent asset

Examples of PPE
1. Land 7. Motor vehicle
2. Land improvements 8. Furniture and fixtures
3. Building 9. Office Equipment
4. Machinery 10. Pattern, molds and dies
5. Ship 11. Tools
6. Aircraft 12. Bearer plants

Recognition of PPE
- An item of PPE shall be recognized as an asset when:
1. Probable - It is probable that future economic benefits associated with the asset will flow to the entity
2. Measurable - The cost of the asset can be measured reliably

Spare Parts and Servicing Equipment

- Most spare parts and servicing equipment are usually carried as inventory and recognized as an expense when consumed
- Major spare parts and stand-by equipment qualify as PPE when the entity expects to use them during more than one
period
- If the spare parts and servicing equipment can be used only in connection with an item of PPE, they are accounted for as
PPE and are depreciated over a time period of not exceeding the useful life of the related asset

Measurement at Recognition
- An item of PPE 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 Costs of an item of PPE

1. Purchase price, including import duties and nonrefundable purchase taxes, after deducting trade discounts and rebates
2. 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
3. Initial estimate of the cost of dismantling and removing the item and restoring the site on which it is located, the
obligation for which an entity incurs

Directly Attributable Costs

- Costs that qualify for recognition
1. Costs of employee benefits arising directly from the construction or acquisition of the item of PPE
2. Cost of site preparation
3. Initial delivery and handling cost
4. Installation and assembly cost
5. Professional fees
6. 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
Costs Not Qualifying for Recognition (Expensed Outright)
1. Costs of opening a new facility
2. Costs of introducing a new product or service, including costs of advertising and promotion
3. Cost of conducting business in a new location or with a new class of customer, including costs of staff training
4. Administration and other general overhead costs
5. 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
6. Initial operating expenses
7. Costs of relocating or reorganizing part of all of an entity’s operations

Measurement after Recognition

- After initial recognition, an entity shall choose either one of the following as the accounting policy for PPE:
- The entity shall apply such accounting policy to an entire class of PPE
1. Cost Model
- The PPE are carried at cost less any accumulated depreciation and any accumulated impairment loss
2. Revaluation Model
- The PPE are carried at revalued 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 of PPE (Ways of Acquiring PPE)

1. Cash basis
2. On account subject to cash discount
3. Installment basis
4. Issuance of share capital
5. Issuance of bonds payable
6. Exchange
7. Donation
8. Government grant
9. Construction

Acquisition on a Cash Basis

- The cost of PPE is the cash price equivalent at the recognition date
- The cost of asset acquired on a cash basis includes cash paid plus directly attributable costs such as freight, installation
cost and other cost necessary in bringing the asset to the location and condition for the intended use
- When several assets are acquired at a “basket price” or “lump sum price”, the price or cost is allocated to the assets on
the basis of relative fair value

Illustrative Problem
Land and building are acquired at a single cost of 4,500,000. At the time of acquisition,
the land has a fair value of 2,000,000 and the building 3,000,000.
Fair Value Fraction Allocated Cost
Land 2,000,000 2/5 1,800,000 (4,500,000 x 2/5)
Building 3,000,000 3/5 2,700,000 (4,500,000 x 3/5)

Acquisition on Account subject to 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
- The reason is that a reasonably wise management would take advantage of all discounts
- Cash discounts are generally considered as reduction of cost and not as income
Transaction Gross Method Net Method
1. Acquisition of PPE Equipment - Gross xx Equipment - Net xx
(Example is Equipment) A/P - Gross xx A/P - Net xx

2. Payment within A/P - Gross xx A/P - Net xx

the discount period Cash xx Cash xx
Equipment (Discount) xx

3. Payment beyond A/P - Gross xx A/P - Net xx

The discount period Purchase discount lost xx Purchase discount lost xx
Cash xx Cash xx
Equipment (Discount) xx
Illustrative Problem
An equipment is purchased for 200,000, 2/10, n/30. The purchase may be recorded using either
the gross method or net method.
Transaction Gross Method Net Method
1. Acquisition of PPE Equipment 200,000 Equipment 196,000
A/P 200,000 A/P 196,000

2. Payment within A/P 200,000 A/P 196,000

the discount period Cash 196,000 Cash 196,000
Equipment (Discount) 4,000

3. Payment beyond A/P 200,000 A/P 196,000

the discount period Purchase discount lost 4,000 Purchase discount lost 4,000
Cash 200,000 Cash 200,000
Equipment (Discount) 4,000

Observe that the asset may initially be recorded at gross or at net but ultimately, the recorded cost should be the net
amount.

Acquisition on Installment Basis

- When payment for item of PPE is deferred beyond normal credit terms, the cost is the cash price equivalent
- 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 difference between the installment price and cash price is treated as interest expense to be amortized over the credit
period
- If the PPE is acquired by installment and there is no available cash price, the PPE is recorded at present value using the
effective interest rate

Illustrative Problem
A machinery is purchased at an installment price of 450,000.
The terms are 50,000 down and the balance payable in four equal annual installments.
The cash price of the machinery is 370,000.
A promissory note is issued for the installment balance of 400,000.

Journal Entries
Acquisition of the machinery: First installment payment:
Machinery 370,000 Note payable 100,000
Discount on note payable 80,000 Cash 100,000
Note payable 400,000
Cash 50,000

First amortization of discount on note payable:

Interest expense 32,000
Discount on note payable 32,000

Note Payable Fraction Interest Expense

First year 400,000 4/10 32,000
Second year 300,000 3/10 24,000
Third year 200,000 2/10 16,000
Fourth year 100,000 1/10 8,000
1,000,000 80,000
Illustrative Problem
A machinery is acquired at an installment price of 1,200,000.
The terms are 200,000 down and the balance payable in four equal annual installments.
A note is issued for the balance of 1,000,000. There is no available cash price for the machinery.
However, the implied interest rate for this type of not is 10%.
The present value of an ordinary annuity of 1 for 4 periods at 10% is 3.1699.

Down payment 200,000 Note payable 1,000,000

PV of the note (250,000 x 3.1699) 792,475 Present value of the note (792,475)
Cost of the machinery 992,475 Discount on note payable 207,525
Journal Entries
Acquisition of the machinery: First installment payment:
Machinery 992,475 Note payable 250,000
Discount on note payable 207,525 Cash 250,000
Cash 200,000
Note payable 1,000,000

First amortization of discount on note payable:

Interest expense 79,248
Discount on note payable 79,248

Amortization Table
Year Payment Interest Principal Present Value
January 1 10% 792,475
First year 250,000 79,248 170,752 621,723
Second year 250,000 62,172 187,828 433,895
Third year 250,000 43,390 206,610 227,285
Fourth year 250,000 22,715 227,285 P0

After First Year

Current Liability: Noncurrent Liability:
Note payable 250,000 Note payable 500,000
Discount on note payable (62,172) Discount on note payable (66,105)
Carrying amount 187,828 Carrying amount 433,895

Acquisition by Issuance of Share Capital

- If shares are issued for consideration other than actual cash, the proceeds shall be measured by the fair value of the
consideration received
- 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
- 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:
1. Fair value of the property received
2. Fair value of the share capital
3. Par value or stated value of the share capital
Illustrative Problem
A piece of land is acquired by issuing 25,000 shares with par value of 70. At the time of acquisition,
the fair value of the land 2,200,000 and the share is quoted at 100 per share.
Journal Entry
1. The fair value of the land is used:
Land 2,200,000
Share Capital 1,750,000
Share Premium 450,000

2. The fair value of the share capital is used:

Land 2,500,000
Share Capital 1,750,000
Share Premium 750,000

3. The par value of the share capital is used:

Land 1,750,000
Share Capital 1,750,000
Acquisition by Issuance of Bonds Payable
- When an entity acquires an asset by issuing bonds payable, the entity shall measure the financial liability at its fair value
plus transaction costs that are directly attributable to the issuance of the financial liability
- The asset acquired by issuing bonds payable is measured in the following order:
1. Fair value of bonds payable
2. Fair value of the asset received
3. Face value of bonds payable
Illustrative Problem
A building is acquired by issuing bonds payable with face amount of 2,500,000. At the time of acquisition,
the fair value of the building is 3,000,000 and the quoted price of the bonds is 2,750,000.

Journal Entry
1. The fair value of the bonds payable is used:
Building 2,750,000
Bonds Payable 2,500,000
Premium on Bonds Payable 250,000

2. The fair value of the building is used:

Building 3,000,000
Bonds Payable 2,500,000
Premium on Bonds Payable 500,000

3. The face amount of the bonds payable is used:

Building 2,500,000
Bonds Payable 2,500,000

Acquisition by Exchange
- The cost of an item of PPE acquired in exchange for a nonmonetary asset or a combination of monetary and
nonmonetary asset is measured at fair value
- The exchange is recognized at carrying amount under the following:
1. The exchange transaction lacks commercial substance
2. The fair value of the asset given or the fair value of the asset received is not reliably measurable

Commercial Substance
- The event or transaction causing the cash flows of an entity to change significantly by reason of 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
- The entity-specific value of the portion of the entity’s operations affected by the transaction changes as a result of the
exchange
- Entity-specific value is the present value of the cash flows an entity expects to arise from the continuing use of an asset
and from the disposal at the end of useful life or expects to incur when settling a liability

Exchange with Commercial Substance and No Cash is involved

- The cost of the New PPE is measured in order of priority:
1. Fair value of property given
2. Fair value of property received
3. Carrying amount of property given

Exchange with Commercial Substance and Cash is involved

- Same measurement in order of priority above with additional treatment for cash paid and cash received:
1. Cash paid is added to the cost of New PPE for the Payor
2. Cash received is deducted to the cost of New PPE for the Payee

Exchange without Commercial Substance

- The cost of the New PPE is measured at the Carrying Amount of the Asset Given (3)
- No gain or loss on exchange
- Cash paid and cash received is treated the same with exchange that have commercial substance
Illustrative Problem
A Company and B Company exchanged equipment:
A Company B Company
Equipment 4,000,000 5,000,000
Accumulated depreciation 2,250,000 3,375,000
Carrying amount 1,750,000 1,625,000
Fair value 1,500,000 2,000,000
Cash paid by A to B 500,000 500,000

Books of A Company Books of B Company

Equipment - New 2,000,000 Equipment - New 1,500,000
Accumulated depreciation 2,250,000 Accumulated depreciation 3,375,000
Loss on exchange 250,000 Cash 500,000
Equipment - Old 4,000,000 Equipment - Old 5,000,000
Cash 500,000 Gain on exchange 375,000

Fair value of asset given 1,500,000 Fair value of asset given 2,000,000
Cash payment 500,000 Cash received (500,000)
Cost of new asset 2,000,000 Cost of new asset 1,500,000

Fair value of asset given 1,500,000 Fair value of asset given 2,000,000
Carrying amount 1,750,000 Carrying amount 1,625,000
Loss on exchange 250,000 Gain on exchange 375,000

Illustrative Problem
Y Company Z Company
Equipment 2,000,000 2,500,000
Accumulated depreciation 950,000 1,000,000
Carrying amount 1,050,000 1,500,000
Fair value 1,125,000 1,250,000
Cash paid by Y to Z 125,000 125,000

The cash flows of the asset received do not differ from the cash flows of asset transferred.

Books of Y Company Books of Z Company

Equipment - New 1,175,000 Equipment - New 1,375,000
Accumulated depreciation 950,000 Accumulated depreciation 1,000,000
Equipment - Old 2,000,000 Cash 125,000
Cash 125,000 Equipment - Old 2,500,000

Carrying amount 1,050,000 Carrying amount 1,500,000

Cash payment 125,000 Cash received (125,000)
Cost of new asset 1,175,000 Cost of new asset 1,375,000

Trade In
- A form of exchange
- A property is acquired by exchanging another property as part payment and the balance payable in cash or any other
form of payment in accordance with agreed terms
- Involves a nondealer acquiring the asset from a dealer
- Trade in usually involves a significant amount of cash and therefore, the transaction has commercial substance
- The new asset is recorded at the following in the order of priority:
1. Fair value of the asset given plus cash payment
2. Trade in value of asset given plus cash payment
- If the fair value of the asset given is not clearly determinable
- In effect, this is the fair value of the asset received

- Care should be exercised in determining the fair value of the new asset received.
- The list price is often bloated to permit the seller to increase the trade in value for a used asset. The cash price of the new
asset is believed to be the fair value.
Illustrative Problem
An entity traded an old equipment with a dealer for newer model.
Old Equipment:
Cost 2,800,000
Accumulated depreciation 2,000,000
Carrying amount 800,000
Fair value 700,000
Trade in value 1,000,000

New Equipment:
List price 4,000,000
Trade in value of old equipment (1,000,000)
Cash payment 3,000,000

Fair Value Approach Trade in Value Approach

Equipment - New 3,700,000 Equipment - New 4,000,000
Accumulated depreciation 2,000,000 Accumulated depreciation 2,000,000
Loss on exchange 100,000 Equipment - Old 2,800,000
Equipment - Old 2,800,000 Cash 3,000,000
Cash 3,000,000 Gain on exchange 200,000

Fair value of asset given 700,000 Trade in value of asset given 1,000,000
Cash payment 3,000,000 Cash payment 3,000,000
Cost of new asset 3,700,000 Cost of new asset 4,000,000

Fair value of asset given 700,000 Trade in value of asset given 1,000,000
Carrying amount 800,000 Carrying amount 800,000
Loss on exchange 100,000 Gain on exchange 200,000

Acquisition by Donation
- At present, IFRS does not address donation or contributions
- However, IFRS explicitly addresses government grant
- In this regard, reference is made to local GAAP in relation to accounting for donation
- Philippine GAAP provides “contributions, including stock of an entity, received from shareholders shall be recorded at
the fair value of the items received, 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 (it does not enhance the value of the asset)
- Directly attributable costs incurred subsequently, such as installation and testing cost necessary to bring the donated
asset to the location and condition for the intended use shall be capitalized
- Capital gifts or grants (generally subsidies) shall be recorded at fair value when they are received or receivable
(recognized as income)
- When capital gifts or grants are not subsidies, the offsetting credit is a liability account until the initial restrictions are
met

Construction
- The cost of self-constructed asset is determined using the same principles as of an acquired asset
- The cost of self-constructed PPE shall include:
1. Direct cost of materials
2. Direct cost of labor
3. Indirect cost and incremental overhead specifically identified or traceable to the construction
- If the incremental overhead is not specifically identifiable, allocation of overhead may be done on the basis of direct
labor cost or direct labor hours
Illustrative Problem
An asset is constructed and the following costs are incurred:
Materials (normal, 2,000,000) 2,600,000
Labor (normal, 1,600,000) 2,000,000
Manufacturing Overhead 1,800,000
6,400,000

Constructed Asset Finished Goods Total

Materials 600,000 2,000,000 2,600,000
Labor 400,000 1,600,000 2,000,000
Manufacturing Overhead 360,000 1,440,000 1,800,000
1,360,000 5,040,000 6,400,000
The overhead is allocated to the constructed asset and finished goods on the basis of direct labor cost.

Direct Labor Fraction Overhead

Constructed Asset 400,000 4/20 360,000
Finished Goods 1,600,000 16/20 1,440,000
2,000,000 1,800,000
Saving or Loss on Construction
- Where the actual cost of construction is less than the price at which the constructed asset can be purchased from outside
parties, the difference is not income but saving
- The saving is realized in future periods by reason of lower depreciation charges on the asset
- Any internal profit is eliminated in arriving at the cost of self-constructed asset
- Where the actual cost of construction is more than the price at which the asset can be purchased from outside parties, the
constructed asset shall be recorded at actual cost. The difference is not loss on the construction.
- However, if there is clear evidence that the actual cost is materially excessive and this is due to construction
inefficiencies or failures whether due to temporary, idle capacity or industrial disputes, the excess shall be treated as loss
- The cost of abnormal amount of wasted material, labor or overhead incurred in the production of self-constructed asset is
not included in the cost of the asset

Intervening Operations
- These operations may occur before or during the construction or development activities
- For example, income may be earned through using a building site as a car park until construction starts
- Because incidental operations are not necessary to bring an item to the location and condition for the intended use, the
income and related expenses of incidental operations are recognized in profit and loss

Derecognition of PPE
- The cost of PPE together with the related accumulated depreciation shall be removed from the accounts
- The carrying amount of an item of PPE shall be derecognized on disposal or when no future economic benefits are
expected from its use or disposal
- Gain or loss from derecognition of PPE shall be included in profit or loss
- The gain or loss arising from the derecognition of an item of PPE shall be determined as the difference between the net
disposal proceeds and the carrying amount of the item

Fully Depreciated PPE

- The carrying amount of the PPE is equal zero or the carrying amount is equal to the residual value
- The asset account and the related accumulated depreciation account are closed and the residual value is set up in a
separate account
- 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
- The entities are encouraged but not required to disclose fully depreciated property

Property classified as “Held for Sale”

- An item of PPE is classified as “held for sale” if the asset is available for immediate sale in the present condition within
one year from the date of classification as held for sale
- Such asset shall be excluded from PPE and presented separately as current asset
- An entity shall measure a noncurrent asset held for sale at the lower of carrying amount or fair value less cost of disposal
- The writedown to fair value less cost of disposal is treated as an impairment loss
- Noncurrent asset classified as held for sale shall not be depreciated
Idle or Abandoned Property
- An entity shall not classify as held for sale a noncurrent asset that is to be abandoned
- The carrying amount would be recovered principally through continuing use
- Temporary idle activity or abandonment does not preclude depreciating the asset as future benefits are consumed not
only through usage but also through wear and tear and obsolescence
- Noncurrent asset to be abandoned includes an item of PPE that is to be used until the end of the economic life

Optional Disclosures
- Entities are encouraged to disclose the following information which may prove relevant to the needs of financial
statement users:
1. The carrying amount of temporarily idle PPE
2. The gross carrying amount of any full depreciated PPE still in use
3. The carrying amount of PPE retired from active use and classified as held for sale
4. When the cost model is used, the fair value of PPE when this is materially different from the carrying amount