Financial Accounting

PGDM (2021-23)-Term I

Rajesh Pathak

Indian Institute of Management, Raipur

Overview of Long-Lived Assets
• Property, Plant & Equipment or PPE (IndAS16)
• Long-lived assets - Resources that are held for an extended time, such as land,
buildings, equipment, natural resources, and patents
• These assets help produce revenues over many periods by facilitating the
production and sale of goods or services to customers.

• As per IndAS: Property, plant and equipment are tangible items that:
• (a) are held for use in the production or supply of goods or services, for rental to others, or for
administrative purposes; and
• (b) are expected to be used during more than one period.

An item of property, plant and equipment that qualifies for recognition as an asset shall be
measured at its cost.
Cost Elements
• The cost of an item of property, plant and equipment comprises:
• (a) its purchase price, including import duties and non-refundable purchase
taxes, after deducting trade discounts and rebates.
• (b) any costs 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) the initial estimate of the costs of dismantling and removing the item and
restoring the site on which it is located, the obligation for which an entity
incurs either when the item is acquired or as a consequence of having used the
item during a particular period.
IndAS 16
• Depreciable amount is the cost of an asset, or other amount substituted for cost, less its residual value.
• Depreciation is the systematic allocation of the depreciable amount of an asset over its useful life
• 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 its disposal at the end of its useful life
• 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
• An impairment loss is the amount by which the carrying amount of an asset exceeds its recoverable amount.
• The residual value of an asset is the estimated amount that an entity would currently obtain from disposal of
the asset, after deducting the estimated costs of disposal, if the asset were already of the age and in the
condition expected at the end of its useful life
• Useful life is: (a) the period over which an asset is expected to be available for use by an entity; or (b) the
number of production or similar units expected to be obtained from the asset by an entity.
Recognition and Subsequent Measurement
• Initial Recording
• The cost of an item of property, plant and equipment shall be recognized as an asset if, and only
if:
• (a) it is probable that future economic benefits associated with the item will flow to the entity; and
• (b) the cost of the item can be measured reliably.

• Subsequent Recording:
• Cost model (cost-Acc Dep.)
• After recognition as an asset, an item of property, plant and equipment shall be carried at its cost less
any accumulated depreciation and any accumulated impairment losses.
• Revaluation model
• After recognition as an asset, an item of property, plant and equipment whose fair value can be
measured reliably shall be carried at a revalued amount.
• Revaluations shall be made with sufficient regularity to ensure that the carrying amount does not differ
materially from that which would be determined using fair value at the end of the reporting period
Revaluation Requirements
• 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.

• If an asset’s carrying amount is increased as a result of a revaluation, the increase shall be recognised in
other comprehensive income and accumulated in equity under the heading of revaluation surplus.

• If an asset’s carrying amount is decreased as a result of a revaluation, the decrease shall be recognised
in profit or loss. However, the decrease shall be recognised in other comprehensive income to the
extent of any credit balance existing in the revaluation surplus in respect of that asset. The decrease
recognised in other comprehensive income reduces the amount accumulated in equity under the
heading of revaluation surplus
Other Requirements
• The residual value and the useful life of an asset shall be reviewed at least at each
financial year-end and, if expectations differ from previous estimates, the
change(s) shall be accounted for as a change in an accounting estimate.

• The carrying amount of an item of property, plant and equipment shall be

derecognised:
• (a) on disposal; or
• (b) when no future economic benefits are expected from its use or disposal.
• The gain or loss arising from the derecognition of an item of property, plant and equipment
shall be included in profit or loss when the item is derecognized.
Long-Lived Assets
• Terms for allocation of costs over time:
• Depreciation - allocation of the cost of tangible assets to the periods in which
the assets are used
• Depletion - allocation of the cost of natural resources to the periods in which
the resources are used
• Amortization - allocation of the cost of intangible assets to the periods that
benefit from these assets

• Land is not depreciated because it does not wear out or become

obsolete. Moreover, it doesn’t have limited useful life either.
Straight-Line Depreciation
• Straight-line depreciation - a method that spreads the depreciable
value evenly over the useful life of an asset

Depreciation A cq u is itio n co s t - Res id u al v alu e


expense Years o f u s efu l life
Straight-Line Depreciation
• A truck with a cost of $41,000 and a residual value of $1,000 has a
useful life of 4 years. Depreciation expense is calculated as follows:

($41,000 - $1,000) / 4 = $10,000*

*Depreciation is the same each year for the life of the asset.
Depreciation Based on Units
• Unit depreciation - a depreciation method based on units of service
when physical wear and tear is the dominating influence on the useful
life of the asset
• A depreciation rate per unit is determined by dividing the depreciable value
(cost less residual value) by the useful life in units.
• To determine depreciation expense, the actual usage of the asset is multiplied
by the depreciation rate.
Depreciation Based on Units
• A truck with a cost of $41,000 and a residual value
of $1,000 has a useful life of 200,000 miles.
During the year, the truck is driven for 45,000
miles. Depreciation expense is calculated as
follows:
($41,000 - $1,000) / 200,000 = $.20 per mile
45,000 x $.20 = $9,000*

*Depreciation over the life of the asset will fluctuate as the

usage of the asset fluctuates.
Declining-Balance Depreciation
• Accelerated depreciation - any depreciation method that writes off
depreciable costs more quickly than the ordinary straight-line
method based on expected useful life

• Double-declining-balance (DDB) depreciation - the most popular

form of accelerated depreciation
• It is computed by doubling the straight-line rate and multiplying the
resulting DDB rate by the beginning book value.
Declining-Balance Depreciation
• Computing DDB depreciation:
• Compute a rate by dividing 100% by the number of years of useful life.
• Double the rate.
• Ignore the residual value, and multiply the asset’s book value at the beginning
of the year by the DDB rate.
• Stop depreciation when the book value approaches the residual value.
Declining-Balance Depreciation
• A truck with a cost of $41,000 and a residual value
of $1,000 has a useful life of 4 years. Double-
declining-balance depreciation expense is
calculated as follows:

100% / 4 = 25% x 2 = 50% per year

Year 1: $41,000 x 50% = $20,500*
Year 2: ($41,000 - $20,500) x 50% = $10,250*

*Depreciation over the life of the asset declines

each year.
Comparing and Choosing Depreciation Methods
• Companies do not always use the same depreciation methods for all
types of depreciable assets.
• The choice of depreciation alternatives comes from several places:
• Tradition or use by other companies in the industry
• Better matching of expenses with revenues
• The nature of the industry and the equipment and the goals of management
 Effects of Depreciation on Income Taxes
• Depreciation is a deductible noncash expense for income tax
purposes.
• If depreciation expense is higher, taxes are lower, and more cash can be
kept for use in the business.
• Accelerated depreciation generally has higher depreciation expense.

• Depreciation does not generate cash, but it does have a cash

benefit if it results in lower taxes.
Contrasting Long-Lived Asset Expenditures With Expenses
• Expenditures - purchases of goods or services, whether for
cash or on credit

• Asset-related expenditures that will benefit more than one

year are capitalized.
• Capital expenditures add new fixed assets or increase the capacity,
efficiency, or useful life of an existing fixed asset.

• Expenditures that provide a benefit lasting one year or less

are expensed in the current year.
More on PPE
Special Cases:
• Trade-ins/Exchanges:
• Similar Vs. Dissimilar Asset

• Self-constructed assets

• Basket Purchase

• Natural Resources
• Full cost method Vs. Successful effort methods
Case 7-3: Stafford Press