INTERMEDIATE ACCOUNTING 1- CONTINUATION

PROPERTY, PLANT AND EQUIPMENT (PPE)

are tangible assets (with physical substance) that are held for use in production or supply of goods or
services, for rental to others, or for administrative purposes, and are expected used during more than
one period.

Examples of property, plant and equipment:

a. Land g. Motor vehicle
b. Land improvements h. Furniture and fixtures
c. Building i. Office equipment
d. Machinery j. Patterns, molds and dies
e. Ship k. Tools
f. Aircraft l. Bearer plants

Recognition of property, plant and equipment

a. It is probable that future economic associated with the asset will flow to the entity
b. Cost of the asset can be measured reliably

Treatment for most spare parts and servicing equipment - are usually carried as inventory and recognized
as an expense when consumed. However, major spare parts and stand-by equipment qualify as
property, plant and equipment when the entity expects to use them during more than one period.

Measurement at recognition (Initial Recognition)

PPE Shall be measured at cost, which is the amount of cash or cash equivalent paid and the fair
value o/ the other consideration given to acquire an asset at the time of acquisition or construction.

Elements of cost:
a. Purchase price, including import duties and nonrefundable purchase taxes, after deducting
trade discounts and rebates
b. 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
c. 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 attributable

Directly attributable costs (capitalizable):

a. Costs of employee benefits arising directly from the acquisition of PPE
b. Cost of site preparation
c. Initial delivery and handling
d. Installation and assembly cost
e. Professional fees
f. Costs of testing whether the asset is functioning properly

Costs not qualifying for recognition (expensed):

a. Costs of opening a new facility
b. Costs of introducing a new product or service, including costs of advertising and promotion
c. Costs of conducting business in a new location or with a new class of customer, including costs of
staff training
 d. Administration and other general overhead costs
e. Costs incurred while an item capable of operating in manner intended by management has yet to
brought into use or is operated at less than full capacity
f. Initial operating losses
g. Costs of relocating or reorganizing part or all of an entity’s operations.

Measurement after recognition (Subsequent Recognition)

Initial recognition, an entity shall choose either the cost model or the revaluation model as the
accounting policy for PPE. The entity shall apply such accounting policy to an entire class of property, plant
and equipment.

1. Cost model means that PPE are carried at cost less any accumulated depreciation and
accumulated impairment loss.

2. Revaluation model means that PPE are carried at revalued carrying amount, which is the fair
value at the date of revaluation less any subsequent accumulated depreciation and
subsequent impairment loss.

Ways in the acquisition of property

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

I. Acquisition on a cash basis

The cost of an item of property, plant and equipment is the cash price equivalent at the
recognition date. The cost of asset acquired on a cash basis simply includes the cash paid plus directly
attributable costs such as freight, installation cost and other cost necessary in bringing the asset b the
location and for the intended use.

Moreover, when several assets are acquired at a “basket price" or 'lump sum price", it is necessary to
apportion the single price to the assets acquired on the basis of relative fair value.

II. Acquisition on account

When an asset is acquired on account subject to discount, the cost of the asset is equal to the
invoice 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. Cash discounts are generally considered as "reduction of cost” and not as income

III. Acquisition on installment basis

When payment for item of plant and equipment is deferred normal credit terms, the

The excess of the installment price over the cash price is treated as an interest to be amortized over the
credit period
Illustration: A machinery is purchased at an installment price of P350,000. The terms are P50,000 down and the
balance payable in three equal annual installments. The cash price of the machinery is P290,000. A promissory note
is issued for the installment balance of P300,000.

To record acquisition
Machinery 290,000
Discount on note payable 60,000
Note payable 300,000
Cash 50,000

To record the 1st installment

Note payable 100,000
Cash 100,000

To amortize the discount on note payable

Interest expenses* 30,000
Discount on note payable 30,000

The fractions are developed from the note payable outstanding each year and then multiplied
with the discount (interest income of the seller)
Note Payable Fraction Interest expense*
1st year 300,000 3/6 30,000
2nd year 200,000 2/6 20,000
3rd year 100,000 1/6 10,000
600,000 60,000

No Available Cash Price – the asset is recorded at tan amount equal to present value of all payments using
an implied interest rate

Illustration: A machinery is acquired at an installment price of P700,000. The terms are P100,000 down
and the balance payable in three equal annual installments. A note is issued for the balance of P600,000.
There is no cash price for the machinery. However, the implied interest rate for this type of note is 10%.

Using the implied interest, the present value of an ordinary annuity of 1 is 2.487 for three periods. The
computation and journal entries are as follows:
Down payment 100,000
Present value of note payable (200,000 x 2.487) 497,400
Total cost of machinery 597,400

Note Payable 600,000

Present value of note payable 497,400
Implied interest 102,600
*PV is computed using this formula [ (1 - (1 +i^-n ) ) / i]
 To record acquisition
Machinery 597,400
Discount on note payable 102,600
Note payable 600,000
Cash 100,000

To record the 1st installment

Note payable 200,000
Cash 200,000

To amortize the discount on note payable

Interest expenses 49,740
Discount on note payable 49,740

Amortization of discount on note payable - effective interest method is used to amortize discount as
interest expense and computed as follows:

Interest
Period Payment (A) Principal (C = A - B) Present Value (D = D - C)
(B = D X %)
Jan. 1 497,400
1st Year 200,000 49,740 150,260 347,140
2nd Year 200,000 34,714 165,286 181,854
3rd Year 200,000 18,146 181,854 -
*18,146 has been rounded off to zero out present value

Statement Classification and presentation:

Current Liability: Non-Current Liability:

Note Payable 200,000 Note Payable 200,000
Discount on note payable (34,714) Discount on note payable (18,146)
Carrying Amount 165,286 Carrying Amount 181,854

IV. Issuance of Share Capital

The property shall be measured following in the order of priority:
a. Fair value of the property received
b. Fair value of share capital
c. Par value or stated value of the share capital

Illustration: A piece of land is acquired by issuing 20,000 shares with par value of P50. At the time of
acquisition, the fair value of the land is P1,600,000 and the share is quoted at P90 per share.
 Fair value of the land is used
Land 1,600,000
Share capital (20,000 x P50) 1,000,000
Share premium 600,000

Fair value of the share capital is used

Land (20,000 x 90) 1,800,000
Share capital 1,000,000
Share premium 800,000

Par value of the share capital is used

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

V. Issuance of Bonds Payable

PFRS 9, par. 5.1.1 provides that the entity shall measure the financial liability at fair value plus transaction
costs that are directly attributable to the issue of the financial liability. The asset acquired by issuing bonds
payable is measured in the following order:
a. Fair value of the bonds payable
b. Fair value of asset received
c. Face amount of bonds payable

Illustration: A building is acquired by issuing bonds payable with face amount of P5,000,000. At the time
of acquisition, the fair value of the building is P6,000,000 and the quoted price of the bonds is P5,800,000.
Fair value of the bonds payable is used
Building 5,800,000
Bonds Payable 5,000,000
Premium on bonds payable 800,000

Fair value of the building is used

Building 6,000,000
Bonds Payable 5,000,000
Premium on bonds payable 1,000,000

Face amount of the bonds payable is used

Building 5,000,000
Bonds Payable 5,000,000

VI. Exchange
PAS 16, par. 24, provides that 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. However, the exchange is
recognized at carrying amount under the following circumstances:
a. The exchange transaction lacks commercial substance*
b. Fair value of the asset given or the fair value of the asset received is not reliably measured.
 Commercial substance – the event or transaction causing the cash flows of the entity to change
significantly by reason of the exchange.
The entity shall consider if the amount, timing and risk of cash flows from the new asset are
different from the cash flows of the old asset. Moreover, 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.

1. Exchange with commercial substance –cost of the property is equal to the following:
a. Fair value of the asset given plus any cash payment - on the part of the payor
b. Fair value of the asset given minus cash received – on the part of the recipient

Illustration: Aye and Bee exchanged equipment

Aye Bee
Equipment 1,600,000 2,000,000
Accumulated depreciation 900,000 1,350,000
Carrying amount 700,000 650,000
Fair value 600,000 800,000
Cash paid by Aye to Bee 200,000 200,000
The cash payment made is the difference in fair value.

BOOKS OF AYE (PAYOR) BOOKS OF BEE (RECIPIENT)

Equipment-new 800,000 Equipment-new 600,000
Accumulated depreciation 900,000 Accumulated depreciation 1,350,000
Loss on exchange 100,000 Cash 200,000
Equipment-old 1,600,000 Equipment-old 2,000,000
Cash 200,000 Gain on exchange 150,000

2. Exchange without commercial substance – the acquired item of PPE is measured at the carrying
amount of the asset given. No gain or loss is recognized. Any cash involved is added to the carrying
amount on the part of the payor and deducted on the part of the recipient.

Illustration: Yee and Zee exchanged assets

Yee Zee
Equipment 800,000 1,000,000
Accumulated depreciation 380,000 400,000
Carrying amount 420,000 600,000
Fair value 450,000 500,000
Cash paid by Yee to Zee 50,000 50,000
 BOOKS OF YEE (PAYOR) BOOKS OF ZEE (RECIPIENT)
Equipment-new 470,000 Equipment-new 550,000
Accumulated depreciation 380,000 Accumulated depreciation 400,000
Equipment-old 800,000 Cash 50,000
Cash 50,000 Equipment-old 1,000,000

Trade-in - is a form of exchange. This means that a property is acquired by exchanging another property
as part payment and the balance payable in cash any other form of payment in accordance with agreed
terms

Trade in involves a nondealer acquiring the asset from a dealer. Usually involves a significant
amount of cash and therefore, the transaction has commercial substance.

As an exchange with commercial substance, the new asset is recorded at the following in the order of
priority:
a. Fair value of asset given plus cash payment
b. Trade in value of asset given plus cash payment (in effect, this is the fair value of the asset
received)

Illustration: An entity traded an old equipment with a dealer for newer model.
Old Equipment: New Equipment:
Cost 1,400,000 List price 2,000,000
Trade in value of old
Accumulated depreciation 1,000,000 equipment -500,000
Carrying amount 400,000 Cash payment 1,500,000
Fair value 350,000
Trade-in value 500,000

Fair Value approach Trade in Value approach

Equipment-new 1,850,000 Equipment-new 2,000,000
Accumulated depreciation 1,000,000 Accumulated depreciation 1,000,000
Loss on Exchange 50,000 Equipment-old 1,400,000
Equipment-old 1,400,000 Cash 1,500,000
Cash 1,500,000 Gain on exchange 100,000

Fair Value approach Trade in Value approach

Fair value of asset given 350,000 Trade-in value of asset given 500,000
Cash payment 1,500,000 Cash payment 1,500,000
Cost of new asset 1,850,000 Cost of new asset 2,000,000

Fair value of asset given 350,000 Trade-in value of asset given 500,000
Less: Carrying amount -400,000 Less: Carrying amount -400,000
Loss on Exchange -50,000 Gain on exchange 100,000
Note: 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.

VII. Donation
At present, IFRS does not address donation or contribution. However, IFRS explicitly addresses
government grant.

In this regard, reference is made to local GAAP in relation to accounting for donation. Philippine GAAP
provides that contributions received from shareholders shall recorded at the fair value with the credit
going to donated capital.
.
Expenses incurred in connection with the donation, like payment of registration fees and legal fees shall
be charged to the donated capital account. The reason is that such expenses do not increase or enhance
the value of the asset.

However, directly attributable costs incurred subsequently, such as installation and testing cost necessary
to bring the donated asset to the location and for the intended use shall be capitalized.

Philippine GAAP further provides that entities sometimes receive from non-shareholders gifts or grants
of funds or other assets that are restricted for property and equipment additions.

Capital gifts or grants shall be recorded at fair value when received or receivable. Capital gifts or grants
are generally subsidies and therefore recognized as income.

In the rare case when capital gifts or grants are not subsidies, the offsetting credit is a liability until the
initial restrictions are met. When the initial restrictions are met, the liability is transferred to income.
VIII. Construction

Cost of self-constructed asset is determined using the same principles as for an acquired asset. It shall
include:
1. Direct cost of materials
2. Direct cost of labor
3. Indirect cost and incremental overhead specifically identifiable 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.

Illustration: An asset is constructed and the following costs are incurred:

Materials (normal, P1,000,000) 1,300,000
Labor (normal, P800,000) 1,000,000
Manufacturing overhead 900,000
3,200,000

Constructed Asset Finished Goods Total

Materials 300,000 1,000,000 1,300,000
Labor 200,000 800,000 1,000,000
Manufacturing overhead* 180,000 720,000 900,000
680,000 2,520,000 3,200,000

*Manufacturing overhead is computed on the basis of direct labor cost computed as follows:
Direct labor Fraction Overhead
Constructed asset 200,000 2/10 180,000
Finished goods 800,000 8/10 720,000
1,000,000 900,000

Saving or loss on construction

Where 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. On the other hand, if actual cost
is greater than the price at which the asset can be purchased from outside parties, the constructed asset
is recorded at actual cost no difference is not considered as a loss on the construction.

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.

However, if there is a 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, it is
believed that the excess shall be treated as loss chargeable against management. Future periods shall not
be burdened with management inefficiencies or errors.

PAS 16, paragraph 22, provides that the cast of abnormal amounts 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
Some operations in connection with the construction or development of an item of property, plant and
equipment but are not necessary to bring the item to the location and condition for the intended use.

These operations may before or during the construction or development activities. For example, income
may be earned through using a 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 or loss.

IX. Government Grants

PAS 20, PAR. 3, defines government grant as assistance by government in the form of transfer of resources
to an entity in return for part or future compliance with certain conditions relating to the operating
activities of the entity. Sometimes referred to as a subsidy, subvention or premium.

Recognition and Measurement

Government grant, including nonmonetary grant at fair value shall be recognized when there is
reasonable assurance that:
a. The entity will comply with the conditions attaching to the grant
b. The grant will be received

Classifications:
a. Grant related to the asset – whose primary condition is that an entity qualifying for the grant shall
purchase, construct or otherwise acquire long-term asset.
b. Grant related to income – residual definition

Accounting for Government Grant – shall be recognized as income on a systematic basis over the periods
in which an entity recognizes as expenses the related costs for which the grant is intended to compensate.

Illustration: An entity granted a large tract of land in Mindanao by the national government. The fair value
of the land is P60,000,0000 and requires that the entity construct refinery on the site.
Assuming cost of refinery is estimated to be P100,000,000 and the useful life is 20 years. Journal
entries to record the foregoing is as follows:

To record the grant of tract of land

Land 60,000,000
Deferred grant income 60,000,000

To record cost of refinery

Refinery 100,000,000
Cash 100,000,000

To record depreciation on refinery

Depreciation 5,000,000
Accumulated depreciation 5,000,000

To recognize the portion of grant as income

Deferred grant income 3,000,000
Grant income 3,000,000
Presentation of Government Grant
1. Government grant related to asset
a. By setting the grant as deferred income
b. By deducting the grant in arriving at the carrying amount of the asset
2. Government grant related to income
a. Presented in income statement either separately or under the general heading “other
income”
b. Alternatively, grant is deducted from the related expense.

DERECOGNITION
Means that the cost of the equipment together with the related accumulated depreciation shall
be removed from the accounts.

PAS 16, paragraph 67, provides that the carrying amount of an item of property, plant and equipment
shall be derecognized on disposal or when no future economic benefits are expected from the use or
disposal. Gain or loss from derecognition shall be included in profit or loss, which is determined as the
difference between net disposal proceeds and the carrying amount of the item.

Fully depreciated property

A property is said to be fully when the carrying amount is equal to zero, or the carrying amount is equal
to the residual value. In such a case, the asset account and the related accumulated depreciation account
are closed and the residual value is set up in a separate account.

However, 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 related accumulated depreciation ordinarily
shall not be remoted from the accounts. Entities are encouraged but not required to disclose fully
depreciated property.

Property Classified as Held for Sale

PFRS 5, paragraph 7, provides that an item of property plant and equipment 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 property, plant and equipment but presented separately as current
asset.

PFRS 5, paragraph 15, further provides that an entity shall measure a noncurrent asset classified as 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.

PFRS 5, paragraph 25, further provides that a noncurrent asset classified as held for sale shall not be
depreciated.
 Idle or abandoned property
PFRS 5, paragraph 13, provides that an entity shall not classify as held for sale a
noncurrent asset that is to abandoned. This is because 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 through usage but also through wear and tear and
obsolescence.

Noncurrent asset to abandoned includes an item of property, plant and equipment that
is to be used until the end of the economic life.

OPTIONAL DISCLOSURES
Entities are encouraged to disclose the following which may prove relevant to the
needs of financial statement users:

a. The carrying amount of temporarily idle property, plant and equipment.

b. The gross carrying amount of any fully depreciated property, plant and equipment still in
use.
c. The carrying amount of property, plant and equipment retired from active use
and classified as held for sale.
d. When the cost model is used, the fair value of property, plant and
equipment when this is materially different from the carrying amount

DEPRECIATION

Depreciation- a measure of the consumption of an item of PPE and should be calculated

on a systematic basis over the asset’s useful life.

 Depreciation = The systematic allocation of the depreciable amount over its

useful life Depreciable amount = Cost of asset (or other amount substituted for
cost) less its Residual Value.

 Residual value = Estimated amount that the entity would currently obtain form
the disposal of the asset, net of costs of disposal, if the asset were already in the
condition expected at the end of its useful life.

 Useful Life = The period over which an asset is expected to be available for use,
OR, The number of production units expected to be obtained from the asset.

ACCOUNTING FOR DEPRECIATION

Depreciation should commence once an asset is available for its intended use, which
may be different from when it is actually used, and ceases:
1. Either when the asset is classifies as ‘held for sale’
2. Or when the asset is derecognized, disposed of, or no future economic benefits
are expected from its use or disposal
 All assets classified as PPE should be depreciated, except land as this has unlimited
life.
 Depreciation is required even if the Fair value of the asset exceed its carrying
amount.
  IAS 16 makes clear that it is only if the Residual value exceeds the carrying amount
that depreciation would not be required.

METHODS FOR DEPRECIATION

Three alternative methods:

1. The Straight-line Method
2. The Double Declining Balance Method
3. The Units of Production Method/ Sum of the Units Method
4. The Sum of Years’ Digits Method

1. The Straight-Line Method- fixed (equal) depreciation per year

Formula:
Depreciation Expense = Cost – Residual Value X Number of months
Useful Life 12 months
Depreciation Expense = Cost –Residual Value X Straight-line Depreciation Rate X Number of
Months
12 Months
2. The Double Declining Balance Method – multiplying the CARRYING AMOUNT by a fixed rate (%) of
depreciation. Double declining rate = [ ]
Note:
 Carrying amount – Cost minus Accumulated Depreciation
 Do not deduct Residual Value if the depreciation method used is the Diminishing Balance
Method

Formula:
Depreciation Expense = Cost – Accumulated Depreciation X Deprecation % X Number of
Months
12 Months
3. Units of Production Method – depreciation using this method is calculated based
on the number of units produced during the year (ignore the number of months the machine was
used)

Depreciation Expense = Cost – Residual Value X Number of units produced during the year
Total Expected (estimated units to be produced over
the asset’s useful life)
4. Sum of Years Digits Method- depreciation is computed by applying a series of fractions to the
depreciable amount of the asset.
Formula:
SYD Denominator = Life x Life + 1
2
Note: fraction is derived by dividing the asset’s remaining useful life by the sum of digits in the life of
asset