Issues in Financial Accounting 15th Edition Henderson Solutions Manual

Issues in Financial Accounting 15th
Edition Henderson Solutions Manual

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Chapter 8
ACCOUNTING FOR PROPERTY, PLANT AND
EQUIPMENT
LEARNING OBJECTIVES
After studying this chapter you should be able to:
1 distinguish between current and non-current assets;
2 understand the requirements in AASB 116 ‘Property, Plant and Equipment’ for the initial
recognition and measurement of property, plant and equipment;
3 understand the requirements in AASB 123 ‘Borrowing Costs’ for the recognition of
borrowing costs;
4 calculate borrowing costs expense;
5 understand the requirements in AASB 116 ‘Property, Plant and Equipment’ for the
revaluation of property, plant and equipment;
6 understand the requirements of AASB 136 ‘Impairment of Assets’ in relation to asset
impairment;
7 understand the impairment test in AASB 136 ‘Impairment of Assets’;
8 understand the nature of depreciation;
9 identify some practical problems in accounting for depreciation expense; and
10 understand the requirements of AASB 116 ‘Property, Plant and Equipment’ for
depreciating property, plant and equipment.
Copyright © 2014 Pearson Australia (a division of Pearson Australia Group Pty Ltd) –
9781442561175/Henderson/Issues in Financial Accounting/15e
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QUESTIONS
1 Non-current assets, such as property, plant and equipment, are traditionally measured and
reported as if they are prepayments. The acquisition of a non-current asset is recorded in
the same way as any prepayment, such as rent, advertising or insurance. The expenditure
is a payment that will provide economic benefits beyond the current reporting period. As
the prepayment is consumed, it is recognised as an expense in the form of depreciation.
Interpreting non-current assets as prepayments means that they are recognised initially at
their cost of acquisition. The prepayment interpretation of accounting for non-current
assets is inconsistent with upwards revaluations of those assets.
2 (a) AASB 116 ‘Property, Plant and Equipment’ requires that where there is an
acquisition, the acquired assets must be measured at the acquisition date at cost.
Cost is the amount of cash or cash equivalents paid or the fair value of the other
consideration given to acquire the asset. The components of the cost of an item of
property, plant and equipment are discussed in paragraphs 16–22 of AASB 116.
(b) The principal requirements of AASB 116 are as follows:

• Property, plant and equipment must be accounted for using either the cost model
or the revaluation model.
• All assets in the same class must be accounted for on the same basis but different
bases may be used for different classes.
• If the revaluation model is chosen for a class of assets, the assets must be
revalued with sufficient frequency to keep fair values ‘up to date’.
• A revaluation increment for an asset must be credited to the revaluation surplus
unless it reverses a revaluation decrement that was recognised as an expense in an
earlier period, in which case, the revaluation increment should be recognised as
revenue.
• A revaluation decrement for an asset must be recognised as an expense unless it
reverses a revaluation increment that was credited to the revaluation surplus, in
which case, the revaluation decrement must be debited to the revaluation surplus.
• AASB 116 does not comment on the ability of an entity to change the
measurement model of a class of assets (e.g. change from cost model to
revaluation model). Instead, any change in accounting policy is governed by
AASB 108 ‘Accounting Policies, Changes in Accounting Estimates and Errors’.
3 (a) Where an asset is revalued and there is a revaluation increment, then that increment
shall be credited to a revaluation surplus unless it reverses a previously recorded
decrement, in which case, it is credited as revenue to the income statement.
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(b) Where an asset is revalued and there is a revaluation decrement, then that decrement
shall be debited as an expense to the income statement unless it reverses a previously
recorded increment, in which case, it is debited to the revaluation surplus.
4 The standard is silent on the reasons for the different treatments of upwards and
downwards revaluations. The difference is probably a residual of the doctrine of
conservatism which did not allow the recognition of revenue until it was virtually certain.
An increase in the value of an asset did not guarantee that revenue would eventually be
realised. The value may fall and the revenue may never be realised. The doctrine of
conservatism would not allow the recognition of revenue in these circumstances.
On the other hand, the doctrine of conservatism required that expenses should be
recognised as soon as there was a chance that they would be incurred. A fall in the value
of an asset would be interpreted as a clear indication that an expense could be incurred
and conservatism would require that it should be recognised.
5 (a) Fair value is defined in paragraph 6 of AASB 116 and paragraph 9 of AASB 13 as:
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.
(b) Yes. AASB 116 does not specifically state that fair value is the ceiling for the
carrying amount of property, plant and equipment when the revaluation model is
chosen, but that is the effect of applying the standard.
6 Paragraph 37 of AASB 116 describes an asset class as ‘a grouping of assets of a similar

nature and use in an entity’s operations’.
7 There is the potential for managers to selectively revalue items of property, plant and
equipment to achieve desired financial outcomes. To limit opportunistic revaluations,
paragraph 36 requires that ‘if an item of property, plant and equipment is revalued, the
entire class of property, plant and equipment to which that asset belongs shall be
revalued’. Thus, the increments and decrements of all items within a class of assets will
likely balance each other out, making it more difficult for managers to manage the
balance sheet and/or income statement to achieve a desired result.
AASB 116 requires property, plant and equipment to be recognised initially at cost.
Subsequent to initial recognition, management may choose either the cost model or the
revaluation model to measure property, plant and equipment. The revaluation model is to
be applied to an item of property, plant and equipment only if its fair value can be
measured reliably. This implies that management may revert to the cost method in the
event that the item’s fair value in some future period cannot be measured reliably. In any
event, there is no prohibition in AASB 116 on changing the measurement model.
In fact, AASB 116 provides no comment on the ability of an entity to change the
measurement model of a class of assets (e.g. change from cost model to revaluation
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model). Instead, any change in accounting policy is governed by AASB 108 ‘Accounting
Policies, Changes in Accounting Estimates and Errors’. Specifically, paragraph 14 of
AASB 108 allows a change in measurement model only if it results in financial statements
that provide ‘reliable and more relevant’ financial information.
8 The statement is not correct. Once the revaluation model is chosen, the entity has no
choice but to revalue assets upwards and downwards. AASB 116 requires that once the
revaluation model is chosen, assets must be carried at fair value. It is true, however, that
revaluation increments mean that depreciation expense is increased and that gains on sale
are reduced. This is illustrated in Example 8.11. It could, perhaps, be argued that the
initial choice of the revaluation model means a choice to forego gains on sale.
9 The statement is correct where the asset has been revalued upwards and it is sold for its
carrying amount. In this case, the increase in the asset’s value above cost is not included
in income. This is illustrated in Example 8.11.
10 The statement is incorrect. Paragraph 35 of AASB 116 allows either the net or the gross
method to be used. It is suggested in the standard that the net method is ‘often used’ for
buildings and the gross method is ‘often used’ when an asset is revalued by applying an
index to its depreciated replacement cost. Examples 8.12 and 8.13 illustrate that although
the net and the gross methods give the same carrying amounts and subsequent
depreciation expenses, the details shown in the balance sheet are different.
11 (a) AASB 136 defines the recoverable amount of an asset or cash-generating unit as ‘the
higher of its fair value less costs of disposal and its value-in-use’ (para. 6). Fair
value less costs of disposal to sell is determined as:
‘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’ (para. 6).
The determination of fair value less costs of disposal is elaborated in AASB 13 ‘Fair
Value Measurement’.
Value-in-use is defined as ‘the present value of the future cash flows expected to
be derived from an asset or cash-generating unit’ (para. 6). Estimating an asset’s
value-in-use is a two-step process requiring first, the estimation of net future cash
flows from the continued use and disposal of an asset, and second, application of an
appropriate discount rate. The elements to be included in the calculation of an asset’s
value-in-use are listed in paragraph 30 as follows:
• the expected future cash flows derived from the asset;
• the expected variations in the amount and timing of future cash flows;
• the time value of money (represented by current market risk-free rate of
interest);
• the price for bearing the uncertainty inherent in the asset; and
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• other relevant factors for pricing the future cash flows such as illiquidity.
(b) No. If either of these amounts (i.e. fair value less costs of disposal or value-in-use)
exceeds the asset’s carrying amount, the asset is not impaired and it is not necessary
to estimate the other amount (para. 19, AASB 136).
(c) This will often be the case for an asset that is held for disposal (para. 21, AASB 136).
This is because the value-in-use of an asset held for disposal will consist mainly of
the net disposal proceeds, as the future cash flows from continuing use of the asset
until its disposal are likely to be negligible.
12 (a) AASB 116 describes a reduction in the carrying amount of a non-current asset to its
fair value as a ‘revaluation decrement’. AASB 116 refers to a reduction in the
carrying amount of an asset to its recoverable amount as ‘an impairment loss’.
Paragraph 5 of AASB 136 requires that the revaluation requirements of AASB 116 are
first applied before an entity applies AASB 136 to determine whether the asset may
be impaired.
(b) AASB 116 requires that assets are carried at revalued amount (i.e. fair value). Fair
value does not take account of the costs of disposal which are defined in paragraph
28 of AASB 136 to include ‘legal costs, stamp duty and similar transaction costs,
costs of removing the asset, and direct incremental costs to bring the asset into
condition for its sale’. Thus, if an asset’s fair value is its market value, disposal costs
are the only difference between fair value (required by AASB 116) and fair value less
costs of disposal (required by AASB 136).
(i) If disposal costs are immaterial, it is unlikely that a revalued asset will be
impaired since the recoverable amount of the revalued asset will be close to its
revalued amount (para. 5, AASB 136).
(ii) If disposal costs are material, the fair value less costs of disposal of the revalued
asset is necessarily smaller than its fair value (para. 5, AASB 136). Therefore,
the revalued asset will only be impaired if its value-in-use is less than its
revalued amount (i.e. fair value).
13 (a) The basic requirements of AASB 136 are set down in paragraphs 9 and 59. Paragraph
9 stipulates that, at each reporting date, an entity is to assess whether there is any
indication that an asset may be impaired (i.e. if an asset’s carrying amount may
exceed its recoverable amount).
Paragraph 12 of AASB 136 lists the external and internal factors whose existence
may be regarded as evidence of asset impairment. The list is not intended to be
exhaustive and an entity may refer to other indications that an asset is impaired
(para. 13). The external factors include:
• declines in market value greater than would be expected as a result of normal
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wear and tear;
• adverse changes in the technological, market, economic or legal environment in
which the entity or the asset operates;
• increases in interest rates that would reduce fair value calculations involving
future cash flows; and
• the carrying amount of net assets exceeding the entity’s market capitalisation.
Internal factors include:
• evidence of obsolescence or physical damage to an asset;
• changes, such as restructuring, that could affect the value-in-use of an asset; and
• evidence that an asset’s economic performance will be worse than expected.
Where any of these external or internal factors suggest there is an impairment, the
recoverable amount of the asset must be calculated (para. 9). Where there is no
indication of an impairment loss, the entity is not required to make a formal estimate
of recoverable amount (para. 8).
If, and only if, the recoverable amount of an asset is less than its carrying amount,
the carrying amount of the asset shall be reduced to its recoverable amount. That
reduction is an impairment loss (para. 59).
(b) It is possible that an asset previously considered impaired may be favourably

affected by a change in circumstances that results in an increase in its estimated
service potential either from use or sale. To take account of this eventuality, AASB
136 requires that an assessment is made at each reporting period of whether there is
any indication that the impairment of an asset recognised in a prior period may no
longer exist or may have decreased (para. 110). Paragraph 111 suggests external and
internal sources of information that should be considered, as a minimum, in seeking
an indication of a reversal of a prior impairment loss.
External indicators of a potential reversal of an impairment loss include:
• increases in the market value of the asset;
• favourable changes in the technological, market, economic or legal environment
in which the entity or the asset operates; and
• decreases in interest rates that would increase fair value calculations involving
future cash flows (para. 111).
Internal factors include:
• changes, such as restructuring, that could favourably affect the value-in-use of an
asset; and
• evidence that an asset’s economic performance will be better than expected (para
111).
If there are indications of a reversal of an impairment loss, then a recoverable
amount for the asset must be determined (para. 110). If the recoverable amount now
exceeds the asset’s carrying amount, the carrying amount of the asset is increased to
its recoverable amount (para. 114). The increase in the asset’s value is recognised as
an income item ‘reversal of impairment loss’ (paras 114, 119).
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For assets measured using the revaluation model, any reversal of an impairment
loss is to be treated as a revaluation increase in accordance with AASB 116
‘Property, Plant and Equipment’ (para. 119). That is, the reversal of an impairment
loss is credited directly to the revaluation surplus. However, ‘to the extent that an
impairment loss on the same revalued asset was previously recognised in profit or
loss, a reversal of that impairment loss is also recognised in profit and loss’ (para.
120).
AASB 116 places a ceiling on the carrying amount of an asset for which a reversal
of a previous impairment loss is to be recognised:
The increased carrying amount of an asset other than goodwill attributable
to a reversal of an impairment loss shall not exceed the carrying amount
that would have been determined (net of amortisation or depreciation) had
no impairment loss been recognised for the asset in prior years. (para.117)
14 (a) In many cases it is not possible to calculate the recoverable amount of an individual
asset because it belongs to a larger unit. The asset, by itself, may not produce cash
flows but does so in combination with other assets. In this situation, AASB 136
requires that the standard be applied to a cash-generating unit (para. 66).
It is acknowledged in paragraph 68 that identification of an asset’s cash-
generating unit involves judgement, and paragraphs 67 to 73 as well as illustrative
example 1 from AASB 136 provide further guidelines. For example, since a cash-
generating unit is the smallest identifiable group of assets that generates cash inflows
that are largely independent of the cash inflows from other assets or groups of assets
(para. 6), it is important to identify cash flows that are independent to an asset or
group of assets.
Factors to consider include: how management monitors the entity’s operations,
including by product lines, business, individual locations, districts or regional areas;
and how management decisions are made regarding continuing with or disposing of
its assets and operations (para. 69). In addition, an asset or group of assets is
considered to be a cash-generating unit if an active market exists for the output
produced by the asset or group of assets (para. 70).
A main requirement of AASB 136 is that cash-generating units are identified
consistently over time, unless a change is justified, in which case, full disclosure of
the reasons for the change must be made (paras 72, 130).
(b) Case 1 (example, para. 67, AASB 136) – The private road is not capable of generating
cash inflows that are largely independent of the cash inflows from the other assets of
the factory. Therefore, the cash-generating unit for the private road is the factory as a
whole.
Case 2 (Example 1A, Illustrative Examples, AASB 136) – In identifying A’s cash-
generating unit, an entity would consider whether:
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(a) internal management reporting is organised to measure performance on a store-
by-store basis; and
(b) the business is run on a store-by-store basis or on a region/city basis.
All of Megastore Ltd’s stores are located in different suburbs and probably have
different customer bases. So, although A is managed at a corporate level, A
generates cash inflows that are largely independent of those of Megastore Ltd’s
other stores. Therefore, it is likely that A is a cash-generating unit.
Case 3 (Example 1E, Illustrative Examples, AASB 136) – The primary purpose of
the building is to serve as a corporate asset, supporting MEL Ltd’s manufacturing
activities. Therefore, the building as a whole cannot be considered to generate cash
inflows that are largely independent of the cash flows for the entity as a whole. So, it
is likely that the cash-generating unit for the building is MEL Ltd as a whole.
15 Similar to individual assets, an entity must assess whether any indicators of impairment
exist at reporting date for a cash-generating unit. If there is an indication that a cash-
generating unit is impaired, the recoverable amount of the unit must be determined (para.
66).
For cash-generating units to which goodwill has been allocated, impairment testing
must be conducted annually, or more often if there is an indication of impairment (para.
90). Testing for impairment involves comparing the carrying amount of the unit
(including any allocated goodwill), with the recoverable amount of the unit. An
impairment loss must be recognised if the carrying amount of the cash-generating unit
exceeds the recoverable amount of the unit (paras 90, 104).
Recognition of an impairment loss for a cash-generating unit is governed by
paragraph 104. If there is any allocated goodwill, this asset is first written down and the
remaining impairment loss is allocated to the other assets in proportion to their carrying
amounts. If there is no allocated goodwill, the impairment loss is allocated to the assets
in proportion to their carrying amounts. There is a limit to the write-down on assets
within a cash-generating unit. Paragraph 105 stipulates that in allocating an impairment
loss, the carrying amount of an asset shall not be reduced below the highest of: its fair
value less costs to sell, its value-in-use, or zero.
16 A subsequent reversal of an impairment loss for a cash-generating unit is dealt with in

the same way as for an individual asset with the exception of goodwill allocated to the
unit. An impairment loss previously recognised for goodwill cannot be reversed in
subsequent periods (para. 124). The rationale is that any increase in goodwill in
subsequent periods following the recognition of an impairment loss is likely to be the
result of an increase in internally generated goodwill rather than a reversal of the
impairment loss for externally purchased goodwill (para. 125).
For the remaining assets in a cash-generating unit, the reversal of impairment is
allocated to these assets in proportion to their carrying amounts (para. 122). The reversal
8
is to be recognised immediately in profit or loss unless the unit is carried at revalued
amounts in accordance with AASB 116. In this case, the reversal is treated as a
revaluation increase (paras 122, 119). Paragraph 123 imposes a ceiling on impairment
reversals – the carrying amounts of asset units shall not be increased above the lower of
(a) recoverable amount (if determinable), and (b) the carrying amount that would have
been determined had not impairment loss been recognised for the asset in prior periods.
17 The word ‘depreciation’ has an everyday non-accounting usage with a variety of

meanings. In some uses of the word, it means a physical deterioration in an object or
property and, in other uses, it means a fall in the object’s value. The distinction between
these two uses is, in many cases, blurred or indistinct. An expression such as ‘If you
leave your car in the rain it will depreciate,’ has some components of both meanings of
the word. The car will depreciate in the sense that it will physically deteriorate (for
example, it may rust) and, as a consequence, it will lose value-in-exchange. In general
usage, the word ‘depreciate’ means both a physical deterioration and a fall in expected
selling price.
18 Depreciation is a word in common usage meaning physical deterioration or a fall in

expected selling price. Accountants use the word in a completely different sense; as an
allocation of an asset’s depreciable amount over its useful life to recognise the
consumption of the asset’s future economic benefits. Non-accountants have difficulty in
appreciating that accountants use the word ‘depreciation’ in a narrow technical sense. As
a result, financial reports may be misunderstood. The significance of depreciation
expense is misinterpreted. Some of this confusion could perhaps be reduced if
accountants used a term without common usage. The term ‘amortisation’ has been
suggested. It is already used for some intangible assets and its use could be extended to
all depreciable, or amortisable, assets.
19 The argument presented in the financial report is difficult to sustain. The company
should treat land and buildings as two separate assets. Each should be measured
separately. It seems as though the land should be revalued upwards with the increment
recognised directly in equity as a revaluation surplus and the building should be revalued
downwards with the decrement recognised as an expense. The land with the higher
carrying amount is not depreciable. The building with the lower carrying amount is
depreciable, but the depreciation expense would be lower than at present.
It is difficult to accept the argument that a building that is being used has reached the
end of its useful life. If its economic life had expired, it would be sold or otherwise
disposed of.
20 The annual report justifies the non-depreciation of the buildings on grounds that are not
acceptable. The fact that the buildings have increased in value is irrelevant for
accounting depreciation. The argument is probably based on an impression that
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depreciation means a fall in expected selling price. While this is a common usage of the
word, it is not the accounting meaning. It should be noted that an increase in value may
mean an increase in the building’s residual value at the end of its useful life. Such an
increase may reduce depreciable amount and depreciation expense, but it cannot be used
as an excuse for not recognising depreciation.
Resorting to materiality to justify the non-depreciation of buildings is also
unacceptable. Even if depreciation of buildings is not material, it should still be recorded.
However, it may be reported as an indistinguishable part of total depreciation expense.
The tax deductibility of depreciation on the buildings is also an irrelevant
consideration. If the service potential of the buildings has been reduced during the
period, then the accounts should recognise this reduction. Even where expenses are not
allowable deductions for tax purposes, this does not justify their non-recognition for
accounting purposes.
21 (a) The managing director probably believes that depreciation is a valuation adjustment.
This leads to his/her view that depreciation expense should be increased to reduce
book value to expected realisable value. While this is a widely held non-accounting
interpretation of depreciation, it is not the accounting meaning of the word.
Accounting uses the word to mean the allocation of an asset’s depreciable amount
over its estimated useful life to record the consumption of the asset’s future
economic benefits. It is apparent that the managing director has confused everyday
usage of the word with its accounting meaning.
The production manager has also misunderstood the accounting meaning of the
word depreciation. He/she has interpreted it as physical deterioration. While this is a
common everyday usage of the word, it is not the accounting meaning. The physical
condition of the asset is not a consideration for accounting depreciation. However, if
the maintenance of the asset has extended its useful life beyond that originally
expected, then this may be a valid reason for a reduced depreciation charge.
(b) Market value may be a relevant consideration in determining depreciation expense
only to the extent that it influences the depreciable amount or useful life. A change
in current market value may mean a change in the expected residual value at the end
of the asset’s useful life. This will change depreciable amount and depreciation
expense. There is also a possibility that changes in market value may influence the
period during which the entity will use the asset. For example, an increase in value-
in-exchange (net market value) above value-in-use may encourage the entity to sell
the asset rather than to use it.
(c) A reduction in the efficiency of an asset may change depreciation expense if the
reduction was not expected when the useful life was initially estimated. An
unexpected reduction in efficiency may reduce the anticipated useful life of the asset
and consequently increase depreciation expense. However, if the reduction in
efficiency was anticipated, it should already be incorporated into the original
estimate of useful life.
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22 This statement must be interpreted with some caution. In a strict historical cost
accounting system, the statement is incorrect. The cash flow occurs when the asset is
acquired and prepared for use, and when ‘betterment’ expenditures are made. The asset
is basically a prepaid expense and depreciation is an allocation of that cash flow to the
periods when the service potential of the asset is used. However, under a modified
historical cost accounting system where the depreciable amount includes a revaluation
increment, depreciation of that increment is not an allocation of an earlier cash outflow
and is an expense ‘which does not involve a cash flow’. In some circumstances,
therefore, depreciation expense may not be associated with a cash flow.
It should be noted that the statement implies that all other expenses involve cash
flows. In some cases, the expenses are an allocation of previously incurred cash
outflows. In other cases, the expenses are in anticipation of cash outflows. While it is
wise to be suspicious of dogmatic, all-inclusive assertions, it is difficult to think of an
expense that is not associated with a past, present or a future cash outflow.
23 Depreciation is not a source of cash. It is an allocation of a non-current asset’s

depreciable amount over its estimated useful life. The impossibility of depreciation as a
source of cash can be illustrated by the case of an entity which did nothing during a
period except depreciate its assets. Assume that its statement of financial position at the
beginning of the period is as follows:
_________________________________________________________________
Cash at bank $100
Depreciable assets 900 Equity $1000
$1000 $1000
_________________________________________________________________
At the end of the period, the statement of financial position is as follows:

_________________________________________________________________
Cash at bank $100
Depreciable assets (net) 810 Equity $910
$910 $910
_________________________________________________________________
Depreciation expense of $90 has had no impact on cash. It is obvious that increases in
the cash of the entity must come from an outside entity. Cash does not arise
spontaneously. It must come from somewhere. If no outside entity is providing cash, then
cash cannot increase. As depreciation does not involve an outside entity providing cash,
it cannot be a source of cash.
24 Tax considerations are sometimes used to justify accounting procedures. For example,
assets may be depreciated using the rates adopted for tax purposes or the cost of new
assets are adjusted to incorporate the tax implications of the sale of the trade-in asset. As
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a general rule, tax considerations should be irrelevant in determining accounting
procedures. Accounting procedures should be chosen to ensure that the objectives of
accounting are achieved. The elements of financial statements should be recognised and
reported in a way that is consistent with the Framework and with Accounting Standards.
Taxation rules, on the other hand, are designed to be as objective as possible and to
produce revenue for the government in accordance with its current policy objectives.
Concurrence of the objectives of financial reporting and the government’s current policy
objectives is unlikely. The determination of taxable income on the one hand, and entity
profit and financial position on the other, have different objectives and should be based
on different definitions and recognition rules. Using tax rules for accounting purposes
could result in misleading financial reports.
25 In relation to for-profit entities, this statement is correct, as paragraph 15 of AASB 116

requires an asset to be initially recognised at cost. However, for not-for-profit entities,
paragraph Aus15.1 requires that where an asset is acquired at no cost, or for a nominal
cost, the cost is its fair value as at the date of acquisition. In this case, the asset would be
depreciated over its estimated useful life.
26 As a general rule, the cost of an asset should include the fair value of all assets
surrendered or used up in its acquisition and construction. If overhead is incurred in the
construction of an asset, then the cost of that asset should include an amount for that
overhead. There are, however, some problems with fixed factory overhead. It is generally
agreed that where normal production is curtailed to provide the capacity to construct the
asset, a portion of fixed factory overhead should be included in the cost and depreciable
amount of the constructed asset. This allocation should leave the unit cost of the product
that is usually manufactured the same as before the construction commenced. However,
where there is excess capacity, the position is less clear. With excess capacity, the asset
can be constructed with no change in the output of the usual product. If the constructed
asset is charged with some fixed factory overhead, the unit cost of the usual product will
fall and profits will rise. This does not seem to be a sensible outcome. If fixed factory
overhead is not charged to the constructed asset, the unit cost of the usual product will
remain unchanged, but the depreciable amount of the constructed asset will be less.
Which of these alternatives is the most desirable is a matter of opinion. We prefer not
charging fixed factory overhead to the constructed asset to avoid variations in the cost of
goods manufactured and sold.
27 Depreciation allocates the depreciable amount of an asset over its estimated useful life.
In practice, this means depreciating the asset so that it is carried at close to its expected
realisable value at the end of its useful life. The expected realisable value of the asset is
seen as the ‘target’ of the depreciation process. The asset is written down to this target or
the asset is written down to its market value at the end of its life. Thus, the depreciation
process is viewed as a valuation process. This interpretation of accounting depreciation
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misconstrues its nature. The depreciation process is one of allocating the cost (or
depreciable amount) of the asset over its useful life. Residual value at the end of the
asset’s useful life is more helpfully viewed as a refund of part of the original cost of the
asset. Suppose, for example, that an asset with a cost of $10 000 is expected to produce
10 000 units of output over its useful life. The unit cost is therefore $1. However, if the
asset has a residual value of $1000 at the end of its useful life, the expected cost per unit
of output is ($10 000 – $1000)  10 000 or 90 cents. In other words, residual value is not
a target but an adjustment to the depreciable amount.
28 AASB 123 defines borrowing costs as interest and other costs that an entity incurs in
connection with the borrowing of funds (para. 5). Examples include:
(a) interest expense calculated using the effective interest method as described in AASB
139 ‘Financial Instruments: Recognition and Measurement’ on bank overdrafts and
short-term and long-term borrowings;
(b) finance charges in respect of finance leases recognised in accordance with AASB
117 ‘Leases’; and
(c) exchange differences arising from foreign currency borrowings to the extent that
they are regarded as an adjustment to interest costs (para. 6).
29 If interest is a cost necessarily incurred during a construction period and it can be traced
unequivocally to the project, then it should be capitalised as part of the cost of that
project. It is argued that interest is as much a cost of construction as labour or materials
and provided it is directly traceable to the project, it should be capitalised.
The counter argument, that interest during the construction period should not be
capitalised, falls into two categories. The first is that not all projects are financed by
borrowing with interest as a cost. Some projects are financed by equity and some from
retained profits. These sources of finance are not costless although they do not involve an
obvious cash outflow, such as interest. If it is appropriate to capitalise interest, then it
should also be appropriate to capitalise the cost of equity. However, the idea seems to be
only to capitalise interest. This is not so much an argument against interest capitalisation
but an argument to extend it to capitalising the cost of all sources of finance.
The second and more substantive argument is that it is not possible to trace the cost
of particular sources of finance to particular projects. It is argued that finance should be
regarded as a pool comprised of debt and equity from which all projects are financed.
There is an optimum composition for this pool of finance which determines whether it is
augmented by debt or equity when there is a need to enlarge the pool. If there is too
much debt in the pool, it will be augmented by a new equity issue or by restricting
dividends. Projects are not financed by the addition to the pool of finance but by the pool
itself in the proportions of debt and equity in that pool. This argument does not say that,
in some circumstances, the cost of finance should not be capitalised. Rather, it says that
if it is capitalised, then it should be at the current weighted average cost of the pool of
capital rather than at the cost of the marginal addition to the pool.
13
30 AASB 123 defines a qualifying asset as:
‘an asset that necessarily takes a substantial period of time to get ready for its intended
use or sale’. (para. 5)
Deciding whether an asset is a qualifying asset is not simply a matter of the time taken to
get it ready for its intended use or sale. For example, if an asset took a long time to
construct merely because of inefficiencies, labour disputes or the allocation of resources
to other projects, it would not be a qualifying asset because it did not ‘necessarily’ take a
substantial period of time to get ready for its intended use or sale. For an asset to be a
qualifying asset, its nature must require a ‘substantial period of time to get ready for its
intended use or sale’ even if it is constructed or produced in the shortest possible period
of time.
Qualifying assets include long-term construction projects, such as the construction of
ships, dams, roads, power generation plants and buildings.
31 The basic requirement of AASB 123 is outlined in paragraph 8, which states that an entity
shall capitalise borrowing costs that are directly attributable to the acquisition,
construction or production of a qualifying asset as part of the cost of that asset. All other
borrowing costs are to be recognised as an expense in the period in which they are
incurred.
Paragraph 10 suggests that the borrowing costs attributed to a qualifying asset are
those that would have been avoided had the asset not been acquired, constructed or
produced. AASB 123 defines a qualifying asset as ‘an asset that necessarily takes a
substantial period of time to get ready for its intended use or sale’ (para. 5). Qualifying
assets include long-term construction projects, such as the construction of ships, dams,
roads and buildings.
If it is decided that there are borrowing costs that can be attributed to a qualifying
asset, the period during which capitalisation should occur begins when:
(a) expenditures for the asset are being incurred;
(b) borrowing costs are being incurred; and
(c) activities that are necessary to prepare the asset for its intended use or sale are in
progress (para. 17).
Capitalisation of borrowing costs continues for as long as these conditions exist and ends
when ‘substantially all the activities necessary to prepare the qualifying asset for its
intended use or sale are complete’ (para. 22).
Determining the amount that should be capitalised depends on whether the borrowing
is specifically to acquire, construct or produce the asset or whether the borrowing is for
general purposes. For specific borrowing, paragraph 12 of AASB 123 requires that:
To the extent that an entity borrows funds specifically for the purpose of obtaining a
qualifying asset, the entity shall determine the amount of borrowing costs eligible for
capitalisation as the actual borrowing costs incurred on that borrowing during the
period less any investment income on the temporary investment of those borrowings.
14
Example 8.6 illustrates the capitalisation of borrowing costs that relate to specific
qualifying assets.
For general borrowing, paragraph 14 of AASB 123 deals with funds borrowed
generally.
To the extent that an entity borrows funds generally and uses them for the purpose
of obtaining a qualifying asset, the entity shall determine the amount of borrowing
costs eligible for capitalisation by applying a capitalisation rate to the expenditures
on that asset. The capitalisation rate shall be the weighted average of the borrowing
costs applicable to the borrowings of the entity that are outstanding during the
period, other than borrowings made specifically for the purpose of obtaining a
qualifying asset. The amount of borrowing costs that an entity capitalises during a
period shall not exceed the amount of borrowing costs it incurred during that period.
This is illustrated in Example 8.7.
32 Paragraph 11 of AASB 123 provides examples of when such difficulties may occur.
These situations include when the financing activity of an entity is co-ordinated
centrally. Difficulties also arise when a group uses a range of debt instruments to
borrow funds at varying rates of interest, and lends those funds on various bases to
other entities in the group. Other complications arise through the use of loans
denominated in or linked to foreign currencies, when the group operates in highly
inflationary economies, and from fluctuations in exchange rates. As a result, the
determination of the amount of borrowing costs that are directly attributable to the
acquisition of a qualifying asset is difficult and the exercise of judgement is required.
33 Fair value is 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
(AASB 13 ‘Fair Value Measurement’, para. 9). The measurement of fair value less
costs to sell is elaborated on in paragraphs 28–29 of AASB 136. Costs of disposal
include items such as legal costs, stamp duty, costs of removing the asset, and direct
incremental costs to ready the asset for its sale (para. 28).
Value-in-use is defined as ‘the present value of the future cash flows expected to
be derived from an asset or cash-generating unit’ (para. 6). Estimating an asset’s
value-in-use is a two-step process requiring, first, the estimation of net future cash
flows from the continued use and disposal of an asset and, second, the application of
an appropriate discount rate.
As noted in paragraph 53A of AASB 136, fair value reflects the assumptions of
market participants pricing an asset, whereas value-in-use reflects factors that may be
specific to a particular entity that are not applicable to entities in general. Often times,
15
information on the following four is not available to market participants, and therefore
it is not reflected in fair value:
a) additional value derived from grouping assets (e.g. creation of portfolio of
investment properties in different locations);
b) synergies between the asset being measured and other assets;
c) legal rights (restrictions) specific only to the current owner of the asset; and
d) tax benefits or burdens specific to the current owner of the asset.
16
PROBLEMS
1 (a) Chelmer Ltd

Irrespective of whether the cost model or revaluation model is used to measure the
item of PP&E, the equipment will be initially recorded at cost.
Cost =
Purchase price (incl. import duties) (para. 16(a) AASB 116) $60 000
Installation and assembly costs (para. 17(d) AASB 116) $1 300
Testing costs net of proceeds from selling any items $1 500
produced while bringing the asset to that location and condition
($2 000 – $500) (para. 17(e), AASB 116) $62 800
By 16 October 2014
Property plant and equipment Dr $62 800
Cash, payables etc. Cr $62 800
Cash Dr $6 000
Car park fee income Cr $6 000
(Para. 21, AASB 116 – Incidental operations are not necessary to bring the PP&E to
the location and condition necessary for it to be capable of operating in the manner
intended by management. Thus, income and expenses from incidental operations are
recognised in profit and loss as per normal.)
Training expense Dr $3 200

Advertising expense Dr 1 400
(Para. 19(c) costs of staff training necessary to deal with a new class of customer is
not an item of PP&E; para 19(b) advertising costs to market the new product to be
produced from the equipment are not an item of PP&E.)
(b) Two years later

Property, plant and equipment Dr $20 000
(Para. 11, AASB 116 – such an item of PP&E qualifies for recognition as an asset
because it enables Chelmer Ltd to derive future economic benefits from related
assets in excess of what could be derived had it not been acquired.)
17
2 Graceville Ltd
Irrespective of whether the cost model or revaluation model is used to measure the item
of PP&E, the equipment will be initially recorded at cost.
Cost =
Purchase price (para. 23 AASB 116) $50 000
Delivery and handling costs (para.17(c) AASB 116) $4 000
Engineering fees (17(f) AASB 116) $1 200
$55 200
1 November 2014
Accounts payable Cr $50 000

Accounts payable, cash etc. Cr $5 200
During January 2015

Repairs and maintenance expense Dr 900
Accounts payable, cash etc. Cr 900
(Para. 12 AASB 116 – not included as part of the carrying amount of PP&E.)
The holding costs of $5 000 were incurred because the asset was operating at less than
full capacity. Since the asset is in the location and condition necessary for it to be
capable of operating in the manner intended by management, the holding costs of $5 000
are not included in the carrying amount of PP&E (para. 20, AASB 116).
1 November 2015
Accounts payable Dr 50 000
Interest expense Dr 15 000
Cash at bank Cr 65 000
(Para 23, AASB 116 – where payment is extended beyond normal credit terms, the
difference between the cash equivalent and total payment is recognised as interest over
the period of credit.)
18
3 (a) Clayfield Company
Details of interest paid and received on this borrowing in each of the years during
which the bridge is constructed are as follows:
Year ended: Interest paid Interest received Net interest paid
30 June 2012 $900 000* $220 000 $680 000
30 June 2013 900 000 160 000 740 000
30 June 2014 900 000 90 000 810 000
30 September 225 000** 15 000 210 000
2014
*[$15 000 000  6%]
** [$15 000 000  6%]  3/12mths = $225 000
(b) AASB 123 requires that borrowing costs be recognised as expenses when they are
incurred, except where they are attributable to the acquisition, construction or
production of a qualifying asset. In the latter case, the borrowing costs are to be
capitalised.
Is the bridge a qualifying asset?
Yes, since the bridge will take three years to construct it is an asset that necessarily
takes a substantial period of time to get ready for its intended use or sale (para. 4,
AASB 123).
Are the borrowing costs directly attributable to the acquisition, construction or
production of the bridge?
Yes, borrowing was undertaken to construct the bridge. That is, the costs would have
been avoided had the bridge not been constructed (para. 13)
Therefore, the borrowings costs are to be capitalised as part of the cost of the bridge
during its construction.
What amount of borrowing costs should be capitalised?
Paragraph 15 requires capitalisation of the actual borrowing costs incurred on the
borrowing undertaken specifically for the purpose of obtaining a qualifying asset
less any investment income on the temporary investment of those borrowings.
The borrowing costs incurred during the delay in construction due to high water
levels amount to $225 000 ([$15 000 000  6%] x 3/12mths). Paragraph 23 of AASB
123 requires that capitalisation of borrowing costs be suspended during extended
periods in which active development is interrupted. However, paragraph 24 provides
an exception to this general rule. Capitalisation of borrowing costs is not suspended
when a temporary delay is a necessary part of getting an asset ready for its intended
use – e.g. if high water levels delay construction and this is common during the
construction period in the geographic region involved. This is the case for Clayfield
Company since the high water levels during the rainy season are consistent with the
19
long-term weather patterns rather than the recent period of drought.
Therefore, the $225 000 borrowing costs incurred between December and January
are still to be capitalised as part of the cost of the qualifying asset.
Year ended: 30 June 2012 30 June 2013

1 Interest paid
Interest expense Dr $900 000 $900 000
Cash at bank Cr $900 000 $900 000
Building under construction Dr 900 000 900 000
Interest expense Cr 900 000 900 000
2 Interest received
Cash at bank Dr $220 000 $160 000
Interest revenue Cr $220 000 $160 000
Interest revenue Dr 220 000 160 000
Building under Cr 220 000 160 000
construction
Year ended 30 June 2014

The borrowing costs would continue to be capitalised for the building until
substantially all the activities necessary to prepare the qualifying asset for its
intended used or sale are complete (para. 25, AASB 123). In the absence of any
information provided in the question, and since the project was delayed by three
months due to high water levels, it is argued that ‘substantially all the activities
necessary’ to complete the bridge are yet to be completed. Thus, the borrowing costs
for the year ended 30 June 2014 will be capitalised.
1 Interest paid
Interest expense Dr $900 000
Cash at bank Cr $900 000
Building under construction Dr 900 000
Interest expense Cr 900 000
2 Interest received
Cash at bank Dr $90 000
Interest revenue Cr $90 000
Interest revenue Dr 90 000
Building under construction Cr 90 000
30 September 2014
Any outstanding interest is received and paid on the date construction is completed.
At this point, since ‘substantially all the activities necessary’ to complete the bridge
are completed, the borrowing costs will not be capitalised.
30 September 2014
1 Interest paid
Interest expense Dr $225 000
20
2 Interest received
Interest revenue Cr $15 000
4 Durango Ltd
1 July 2010
______________________________________________________________
Plant and equipment Dr $100 000
______________________________________________________________
30 June 2011
______________________________________________________________
Depreciation expense Dr $5000
Accumulated depreciation Cr $5000
($100 000/20 years = $5 000 p.a.)
______________________________________________________________
30 June 2012
______________________________________________________________
Depreciation expense Dr $5 000
Accumulated depreciation Cr $5 000
Accumulated depreciation Dr 10 000

Plant and equipment Cr 10 000
Plant and equipment Dr 90 000

Revaluation surplus Cr 90 000
(Fair value ($180 000) – carrying amount ($90 000)
= $90 000 revaluation increment)
______________________________________________________________
30 June 2013
______________________________________________________________
($180 000/18 years = $10 000 p.a.)
______________________________________________________________
30 June 2014
______________________________________________________________

Revaluation surplus Dr 90 000
21
Revaluation expense Dr 20 000
= $110 000 revaluation decrement)
______________________________________________________________
1 July 2014
______________________________________________________________
Plant and equipment Cr $50 000
Gain on sale Cr $10 000
______________________________________________________________
5 (a) Clayton Corporation

30 June 2012 – Record revaluation
______________________________________________________________
Accumulated depreciation Dr $500 000
Asset Cr $500 000
(5 years  [$1000 000/ 10 years])
Asset Dr 300 000
= $300 000 revaluation increment)
Carrying amount now $800 000
Annual depreciation $800 000 / 5 years = $160 000
______________________________________________________________
30 June 2014 – Record depreciation, revaluation and sale
______________________________________________________________
The asset would be revalued prior to sale because its carrying amount must not be
materially different from fair value:

Asset Cr 320 000
(Carrying amount is $800 000 – 320 000
= $480 000)
Asset Dr 120 000

(FV – CA = $600 000 – $480 000)
Cash at bank Dr 600 000

Asset Cr 600 000
Revaluation surplus Dr 420 000
22
Retained earnings Cr 420 000
($120 000 + $300 000)
______________________________________________________________
Summary of financial statement impact (30 June 2014):
Effect on comprehensive statement of income:
Increase expense ($160 000)
Increase income Nil
Net decrease in profit ($160 000)
Effect on statement of financial position:

Increase in cash $600 000
Decrease in PPE $(480 000)
Increase retained earnings $260 000
(b) No, the answer remains the same.

At 30 June 2012, there is an indicator of impairment (para. 12, AASB 136) in that an
adverse technological change is expected to impact the plant. This means that the
recoverable amount of the plant should be estimated. It is $800 000 (the higher of
fair value less costs to sell ($800 000 – $0) and value-in-use ($600 000)). The
recoverable amount must be compared with the plant’s carrying amount. After the
revaluation the carrying amount is $800 000. Since the carrying amount is equal to
the recoverable amount, there is no impairment of the plant to be recognised.
6 Vanguard Company
Cost Basis
1 July 2011
Acquisition of the asset
_________________________________________________________________
Asset Dr $500 000
_________________________________________________________________
30 June 2012
Recording depreciation
_________________________________________________________________
($500 000/10 years = $50 000 p.a.)
_________________________________________________________________
* Indicators of impairment are present
* Comparison of carrying amount ($450 000) and recoverable amount ($360 000)
reveals an impairment loss of $90 000
23
Recording Impairment Loss
_________________________________________________________________
Impairment loss Dr 90 000

Accumulated impairment losses Cr 90 000
_________________________________________________________________
30 June 2013
_________________________________________________________________
($360 000/9yrs = $40 000 p.a.)
_________________________________________________________________
* Indicators of impairment reversal are present
Carrying amount $320 000
Recoverable amount $340 000
Potential reversal $20 000
Ceiling on reversal = $400 000 ($500 000 − $100 000(2yrs x $50

000p.a.)
Recoverable amount = $340 000
The recoverable amount is below the ceiling therefore the full
reversal may be recorded.
Reversal of impairment
_________________________________________________________________
Accumulated impairment losses Dr $20 000
Reversal of impairment loss Cr $20 000
_________________________________________________________________
30 June 2014
_________________________________________________________________
($340 000/8 years)
_________________________________________________________________
* Indicators of impairment are present
* Comparison of carrying amount of $297 500($340 000 – 42 500) and recoverable
amount ($245 000) reveals that there is an impairment loss of $52 500 to be
recognised.
24
Recording impairment loss
_________________________________________________________________
Impairment loss Dr $52 500

Accumulated impairment losses Cr $52 500
_________________________________________________________________
31 December 2014
Recording six months’ depreciation
_________________________________________________________________
($245 000 / 7 years = $35 000 p.a.
For ½ year = $17 500)
_________________________________________________________________
Recording asset sale

_________________________________________________________________
Accumulated impairment losses Dr 122 500
Asset Cr $500 000
Gain on sale Cr 7 500
7 Theseus Company
1 July 2011
_________________________________________________________________
Asset Dr $750 000
Cash/payables Cr $750 000
_________________________________________________________________
30 June 2012
Recognising impairment loss
▪ Indicators of impairment are present.
▪ Comparison of carrying amount of $750 000 and recoverable amount ($700 000)
reveals that there is an impairment loss ($50 000) to be recognised.
_________________________________________________________________
_________________________________________________________________
30 June 2013
Recognition of the reversal of the impairment loss
▪ Indicators of a reversal of impairment are present.
25
▪ Comparison of carrying amount of $700 000 and recoverable amount ($730 000)
reveals that there is a potential reversal of impairment ($30 000) to be recognised.
▪ The impairment reversal does not exceed the ceiling imposed by AASB 136 – the
carrying amount of the asset had no previous impairment been recognised ($750
000) – so the reversal can be recognised.
_________________________________________________________________
_________________________________________________________________
30 June 2014
Recognition of the reversal of the impairment loss
▪ Comparison of carrying amount of $730 000 and recoverable amount ($760
000) reveals that there is a potential reversal of impairment ($30 000) to be
recognised.
▪ The impairment reversal exceeds the ceiling imposed by AASB 136 – the
000) – so only a $20 000 reversal can be recognised.
_________________________________________________________________
_________________________________________________________________
1 July 2014
Sale of the asset
_________________________________________________________________
Asset Cr $750 000
_________________________________________________________________
8 Atropos Company
The carrying amount of the asset in the absence of any impairment losses would be as
follows:
Cost Accumulated Carrying

depreciation amount
30 June 2011 $1 200 000 $100 000 $1 100 000
30 June 2012 1 200 000 200 000 1 000 000
30 June 2013 1 200 000 300 000 900 000
30 June 2014 1 200 000 400 000 800 000
26
1 July 2010
_________________________________________________________________
Asset Dr $1 200 000
Cash at bank Cr $1 200 000
_________________________________________________________________
30 June 2011
Recognising depreciation
_________________________________________________________________
($1 200 000/12 years = $100 000 p.a.)
_________________________________________________________________
Recognise asset impairment

▪ Comparison of carrying amount of $1 100 000 ($1 200 000 − $100 000) and
recoverable amount ($1 000 000) reveals that there is an impairment loss ($100
000) to be recognised.
_________________________________________________________________

_________________________________________________________________
30 June 2012
_________________________________________________________________
($1 000 000  11 years)
_________________________________________________________________

▪ Comparison of carrying amount of $909 091 ($1 200 000 – $190 909 accum.
depreciation – 100 000 accum. impairment losses) and recoverable amount
($900 000) reveals that there is an impairment loss ($9 091) to be recognised.
_________________________________________________________________

_________________________________________________________________
27
30 June 2013
_________________________________________________________________
($900 000  10 years)
_________________________________________________________________

▪ Comparison of carrying amount of $810 000 ($1 200 000 – 280 909 accum.
dep’n – $109 091 accum. impairment losses) and recoverable amount ($800
000) reveals that there is an impairment loss ($10 000) to be recognised.
_________________________________________________________________

_________________________________________________________________
30 June 2014
_________________________________________________________________
($800 000  9 years)
_________________________________________________________________
Recognise reversal of impairment loss

▪ Comparison of carrying amount of $711 111 ($1 200 000 – 369 798
accumulated depreciation – 119 091 accumulated impairment losses) and
recoverable amount ($850 000) reveals that there is a potential reversal of
impairment ($138 889) to be recognised.
▪ The impairment reversal exceeds the ceiling imposed by AASB 136 – the
000) – so only an $88 889 reversal can be recognised ($800 000 – $711 111).
_________________________________________________________________
Reversal of impairment loss Cr 88 889
_________________________________________________________________
Recognise sale of asset

_________________________________________________________________
28
Asset Cr $1 200 000
_________________________________________________________________
9 Watson Ltd
1 June 2012 – Purchase
_________________________________________________________________
Industry Land Parcel Dr $3 000 000
Cash Cr $3 000 000
Beach Land Parcel Dr 2 350 000
Cash Cr 2 350 000
_________________________________________________________________
30 June 2013 – Revaluation increment Industry Land

_________________________________________________________________
Industry Land Parcel Dr 500 000
($3 500 000 − $3 000 000 = $500 000)
_________________________________________________________________
30 June 2013 – Impairment loss Beach Land

Is there any indication of impairment of the asset?
There are indicators of asset impairment (para. 12, AASB 136):
1. There is decline in the market value of the land greater than would be expected as a
result of normal wear and tear; and
2. There is evidence of physical damage (landslides).
Therefore, need to test for impairment. This involves estimating recoverable amount and
comparing it with the carrying amount of the asset.
What is the recoverable amount?
Recoverable amount is defined in paragraph 6 as the higher of its fair value less costs to
sell ($1 900 000) and its value-in-use ($500 000), and in this case the asset’s recoverable
amount is equal to $1 900 000.
Is there an impairment loss?
If the carrying amount of the asset is greater than its recoverable amount, the asset shall
be reduced to its recoverable amount. That reduction is an impairment loss (para. 59). In
this case the carrying amount of the asset ($2 350 000) is greater than its recoverable
amount ($1 900 000), so there is an impairment loss of $450 000.
29
Recognition of the impairment loss
Since the cost model is used, any impairment loss is recognised immediately in profit or
loss (para. 60).
_________________________________________________________________
_________________________________________________________________
30 June 2014 – Revaluation of Industry Land

Para. 5 of AASB 136 requires that the revaluation requirements of AASB 116 be applied
before applying the requirements of AASB 136.
Is the carrying amount of Industry Land different to fair value?

Yes, the carrying amount ($3 500 000) is greater than fair value ($2 900 000), so a
revaluation decrement ($600 000) must be recorded.
_________________________________________________________________
Revaluation surplus Dr $500 000
Loss on revaluation Dr 100 000
Industry Land Parcel Cr $600 000
_________________________________________________________________
Impairment of Industry Land

Is there any indication of impairment of the asset?
There is an indicator of asset impairment (para. 12, AASB 136):

1. Restructuring of Watson Ltd which will likely lead to the closure of its
manufacturing division which is located on the Industry land parcel.
Therefore, need to test for impairment. This involves estimating recoverable amount and
comparing it with the carrying amount of the asset.
sell ($2 400 000) and its value-in-use ($2 500 000), and in this case the asset’s
recoverable amount is equal to $2 500 000.
Is there an impairment loss?
If the recoverable amount of an asset is less than its carrying amount, the carrying
amount of the asset shall be reduced to its recoverable amount. That reduction is an
impairment loss (para. 59). In this case the carrying amount of the asset ($2 900 000) is
greater than its recoverable amount ($2 500 000), so there is an impairment loss of $400
000.
30
Recognition of the impairment loss
Since the revaluation model is used, any impairment loss is accounted for as a
revaluation decrement.
_________________________________________________________________
_________________________________________________________________
30 June 2014 – Reversal of Impairment of Beachside Land

Is there an indication of reversal of impairment?
Yes − the assumption is provided in the question that there are indicators for a potential
reversal of any prior impairment losses recognised for the Beach land parcel.

sell ($2 500 000) and its value-in-use ($500 000), and in this case the asset’s recoverable
amount is equal to $2 500 000.
Is there a potential reversal of impairment?

If the recoverable amount of an asset is greater than its carrying amount, there is a
potential reversal. In this case the carrying amount of the asset ($1 900 000) is less than
its recoverable amount ($2 500 000), so there is a potential reversal of an impairment
loss of $600 000.
Does the reversal exceed the ceiling imposed by AASB 136?

The revised carrying amount of an asset cannot exceed the carrying amount had no
previous impairment loss been recognised. In this case, the ceiling was $2 350 000.
Therefore, only $450 000 of the potential impairment reversal can be recognised.
_________________________________________________________________
Reversal of impairment loss (revenue) Cr 450 000
_________________________________________________________________
31
10 1 July 2011
Acquisition of asset
Equipment Dr 4,000,000
Cash Cr 4,000,000
30 June 2012
Record depreciation
Depreciation Expense ($4M/4 years) Dr 1,000,000
Accumulated depreciation Cr 1,000,000
($4 000 000/4 years = $1 000 000 p.a.)
Revalue asset
Accumulated Depreciation Dr 1,000,000
Equipment Cr 1,000,000
Revaluation expense/loss Dr 90,000

Equipment Cr 90,000
(carrying amount $3 000 000 – fair value $2 910 000 = $90 000).
After the revaluation, the carrying amount is now $2 910 000
Impairment loss?
Indicators of impairment are present, therefore calculate recoverable amount:
Value-in-use $2 950 000
FV – costs to sell $2 910 000 – $50 000 $2 860 000
Value-in-use > FV less costs to sell
Recoverable amount $2 950 000 > CA $2 910 000, therefore no impairment is
recognised
30 June 2013
Record depreciation
Depreciation Expense ($2.91M/3 years) Dr 970 000
Accumulated depreciation Cr 970 000
Revaluation?
Carrying amount = $2 910 000 – $970 000 (accum. dep’n) = $1 940 000 = fair value.
Therefore, no revaluation is required.
Impairment loss?
Indicators of impairment are present, therefore calculate recoverable amount:
FV – costs to sell $1 940 000 – $80 000 $1 860 000
32
RA$1 880 000 < CA $1 940 000, therefore an impairment loss of $60 000 should be
recognised.
Record impairment loss

Accumulated impairment Cr 60 000
Statement of Financial Position 30 June 2013:

Equipment (revalued amount) $2 910 000
Less Accumulated depreciation ($970 000)
Less Accumulated impairment (60 000) (1 030 000)
Equipment carrying amount $1 880 000
30 June 2014
Record depreciation
Depreciation expense ($1.88M/2 years) 940 000
Accumulated Depreciation 940 000
The carrying amount now $940 000 ($1 880 000 – 940 000 current addition to accum.
dep’n)
Impairment reversal?
Indicators of impairment reversal, calculate recoverable amount:
FV – costs to sell $1 140 000 – $40 000 $1 110 000
RA of $1 160 000 > CA $940 000, potential increase $220 000
The ceiling = fair value so maximum asset increase:

FV ($1 140 000 – CA $940 000) 200 000
Record impairment reversal of $200 000:

(1) Write back accumulated depreciation/impairment
Accum. Depreciation (970 000 + 940 000) Dr 1 910 000
Accumulated impairment Dr 60 000
Equipment Cr 1 970 000
(2) Recognise impairment reversal Equipment now recorded at carrying amount $940
000
Equipment Dr 200 000
Revenue (reversal of impairment loss) Cr 60 000
Revenue (reverse revaluation expense) Cr 90 000
33
Balance sheet measurement 30 June 2014:
Equipment at fair value $1 140 000
11 (a) Is there an indication of impairment?

Yes, there is an increase in interest rates that will reduce fair value calculations
involving future cash flows of the cash-generating unit.
It is provided in the question and is equal to $510 000.
Is there an impairment of the assets?
Yes, the carrying amount of the cash-generating unit ($530 000) is greater than its
recoverable amount ($510 000). There is an impairment loss of $20 000.
Recognition of impairment loss?
The impairment loss of $20 000 is apportioned over the assets by reference to their
carrying amounts.
Asset 1 $4 528 120/530  $20 000)
Asset 2 $6 792 (180/530  $20 000)
Asset 3 $8 680 (230/530  $20 000)
$20 000
30 June 2014
Accumulated impairment losses – Asset 1 Cr $4528
Accumulated impairment losses – Asset 2 Cr 6792
Accumulated impairment losses – Asset 3 Cr 8680
(b) Yes, the answer changes. The allocated goodwill is first written down and the
remaining impairment loss is allocated to the other assets in proportion to their
carrying amounts.
Asset 1 $2 264 (120/530  $10 000)
Asset 2 $3 396 (180/530  $10 000)
Asset 3 $4 340 (230/530  $10 000)
$10 000
34
30 June 2014
Goodwill Cr $10 000
Accumulated impairment losses – Asset A Cr 2264
Accumulated impairment losses – Asset B Cr 3396
Accumulated impairment losses – Asset C Cr 4340
12
Period ended
30 June 2012
There are indicators of impairment, so calculate recoverable amount. The recoverable amount
is $171 831 and the carrying amount is $220 000, therefore recognised an impairment loss of
$48 169.
Recoverable amount:
Fair value < value-in-use
$78 000 < $171 831
Year Future cash flows Discounted cash flows (10%)

2013 $44 300 $40 273
2014 42 900 35 454
2015 41 100 30 879
2016 49 450 33 775
2017 50 650 31 450
$171 831

Period ended 30 June 2013

No indicators of impairment.
Depreciation expense Dr 34 366

($171 831/ 5 years = $34 366 p.a.)
Period ended 30 June 2014

Capitalise the betterment expenditure of $50 000 since it is enhancing the future economic
benefits of the asset.
Machinery Dr 50 000
Cash, payables etc. Cr 50 000
35
End of period
Depreciation expense Dr 46 829
($171 831 carrying amount
Less 34 366 accum. depreciation
Plus 50 000 betterment expenditure
Equals $187 465
$187 465/4 years = $46 866 depreciation expense)
The enhancement expenditure has increased the expected future cash flows from the
machinery, so the recoverable amount of the machine must be recalculated (para. 110 and
para. 111 of AASB 136).
The recoverable amount ($162 839) is greater than the carrying amount of $140 599 ($187
465 less $46 866 accum. depreciation), therefore there is a potential reversal of impairment
equal to $22 240.
Recoverable amount:
Fair value < value-in-use
$80 000 < $162 839
Year Future cash flows Discounted cash flows (10%)

2015 $69 900 $63 545
2016 66 100 54 628
2017 59 450 44 666
$162 839
The reversal cannot result in a carrying amount of the machinery that exceeds the carrying
amount had it not previously been impaired (i.e. depreciated historical cost).
Date Cost Accum. Dep’n Carrying Amount

30/06/2013 $220 000 $44 000 $176 000
30/06/2014 176 000
+ 50 000
226 000 56 500 $169 500
The recoverable amount of $162 839 does not exceed the depreciated historical cost of $169
500, therefore the full reversal of impairment can be recorded as follows:

Reversal of impairment loss (income) Cr 22 240
36
13 (a) Revaluation model and the gross method for recording accumulated
depreciation:
Machinery Asset (Cost of Acquisition 1/7/2011) $4 800 000

Accumulated depreciation
$4 800 000/8 years × 2 years (1 200 000)
Carrying amount 30 June 2013 3 600 000
Ratio fair value/carrying amount 30/6/13: $4 680 000/$3 600 000 = 1.30
Gross asset, accumulated depreciation and carrying amount must be 130% of present
recorded amounts after the revaluation. Must increase each recorded amount by 30%.
30 June 2013
Machinery ($4 800 000 × 30%) 1 440 000
Accumulated depreciation ($1 200 000 × 30%) 360 000
Revaluation surplus (FV $4 680 000 – $3 600 000 CA) 1 080 000
Revalue to fair value use gross method for accumulated depreciation. Remaining life now 6
years.
30/6/2013 Revalued carrying amount

Machinery (cost $4 800 000 × 130%) OR ($4 800 000 + $1 440 000) $6 240 000
Accumulated Depreciation $1 200 000 × 130% OR ($1 200 000 + $360 000) (1 560 000)
Carrying amount (fair value) 4 680 000
Annual depreciation recorded in 2013–2014

EITHER $6 240 000/8 yrs. original life** = $780 000
OR Revalued CA $4 680 000/6 yrs. Remaining life = $780 000
** This will not work if there is a residual value that does not change proportionately.
(b) Revaluation model and the net method for recording accumulated depreciation:
Machinery Asset (Cost of Acquisition 1/7/2011) $4 800 000
Accumulated depreciation
$4 800 000/8 years × 2 years (1 200 000)
Carrying amount 30 June 2013 3 600 000
30 June 2013
Accumulated depreciation 1 200 000
Machinery 1 200 000
Write back existing accumulated depreciation
Machinery FV $4 680 000 – CA $3 600 000 1 080 000

Revaluation reserve 1 080 000
Depreciation expense 2013–2014

$4 680 000/6 yrs remaining life = $780 000
37
14 Reliable Company
(a) 1972–1981
______________________________________________________________
($2 000 000 – 60 000)/40 years = $48 500 p.a.
______________________________________________________________
(b) 1982–1999
______________________________________________________________
Carrying amount at 31/12/81 = $1 515 000 = $2 000 000 – 485 000 (48 500  10
years)
C.A. $1 515 000
Addition $500 000
$2 015 000
Annual depreciation expense = $64 500 [($2 015 000 – $80 000)/30 years)]
______________________________________________________________
(c) 2000–2031
______________________________________________________________
Carrying amount at 31/12/99 = $854 000 = $2 015 000 – $1 161 000 (64 500 × 18
years)
Annual depreciation expense = $24 188 [($854 000 – $80 000)/32 years)]
______________________________________________________________
15 Defiant Company
(a) 2005–2009
$60 000 − 4000

Depreciation = = $7000 per annum.
8
______________________________________________________________
______________________________________________________________
38
(b) 2010–2014
$60 000 − 35 000 − 4500
Depreciation = = $4100 per annum.
5
______________________________________________________________
______________________________________________________________
39

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Issues in Financial Accounting 15th Edition Henderson Solutions Manual

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Issues in Financial Accounting 15th

Edition Henderson Solutions Manual

After studying this chapter you should be able to:

1 distinguish between current and non-current assets;

recognition and measurement of property, plant and equipment;

4 calculate borrowing costs expense;

revaluation of property, plant and equipment;

6 understand the requirements of AASB 136 ‘Impairment of Assets’ in relation to asset

7 understand the impairment test in AASB 136 ‘Impairment of Assets’;

8 understand the nature of depreciation;

9 identify some practical problems in accounting for depreciation expense; and

depreciating property, plant and equipment.

(b) The principal requirements of AASB 116 are as follows:

6 Paragraph 37 of AASB 116 describes an asset class as ‘a grouping of assets of a similar

(b) It is possible that an asset previously considered impaired may be favourably

16 A subsequent reversal of an impairment loss for a cash-generating unit is dealt with in

17 The word ‘depreciation’ has an everyday non-accounting usage with a variety of

18 Depreciation is a word in common usage meaning physical deterioration or a fall in

23 Depreciation is not a source of cash. It is an allocation of a non-current asset’s

At the end of the period, the statement of financial position is as follows:

25 In relation to for-profit entities, this statement is correct, as paragraph 15 of AASB 116

1 (a) Chelmer Ltd

Training expense Dr $3 200

(b) Two years later

Property plant and equipment Dr $5 200

During January 2015

*[$15 000 000  6%]

** [$15 000 000  6%]  3/12mths = $225 000

Year ended: 30 June 2012 30 June 2013

Year ended 30 June 2014

Accumulated depreciation Dr 10 000

Plant and equipment Dr 90 000

Accumulated depreciation Dr 20 000

Revaluation surplus Dr 90 000

5 (a) Clayton Corporation

Accumulated depreciation Dr 320 000

Asset Dr 120 000

Cash at bank Dr 600 000

Revaluation surplus Dr 420 000

Effect on statement of financial position:

(b) No, the answer remains the same.

Impairment loss Dr 90 000

Ceiling on reversal = $400 000 ($500 000 − $100 000(2yrs x $50

Impairment loss Dr $52 500

Recording asset sale

Cost Accumulated Carrying

Recognise asset impairment

Impairment loss Dr 100 000

Recognise asset impairment

Impairment loss Dr 9 091

Recognise asset impairment

Impairment loss Dr 10 000

Recognise reversal of impairment loss

Recognise sale of asset

30 June 2013 – Revaluation increment Industry Land

30 June 2013 – Impairment loss Beach Land

What is the recoverable amount?

Is there an impairment loss?

30 June 2014 – Revaluation of Industry Land

Is the carrying amount of Industry Land different to fair value?

Impairment of Industry Land

There is an indicator of asset impairment (para. 12, AASB 136):

What is the recoverable amount?

Is there an impairment loss?