Module 4 – Property, Plant and Equipment

Lesson 1 Definition, Recognition and Initial Measurement of Property, Plant and Equipment

Property, plant and equipment are tangible assets that are held for use in production or
supply of goods or services, for rental to others, or for administrative purposes, and are expected to
be used during more than one period.

Accordingly, the major characteristics in the definition of property, plant and equipment
are:

 Tangible assets – items of PPE have physical substance

 Used in normal operations – items of PPE are used in the production or supply of goods or
services, for rental, or for administrative purposes
 Long-term in nature – items of PPE are expected to be used from more than a year

Examples of Items of PPE

1. Land used in business

2. Land held for future plant site
3. Building used in business
4. Equipment used in the production of goods
5. Equipment held for environmental and safety reasons
6. Equipment held for rentals
7. Major spare parts and long-lived stand-by equipment
8. Furniture and fixture
9. Bearer plants

Recognition of PPE

The cost of an item of property, plant and equipment shall be recognized as an asset only if:

 it is probable that future economic benefits associated with the item will flow to the entity;
and
 the cost of the item can be measured reliably.
Initial Measurement

An item of PPE that qualifies for recognition as an asset shall be measured at cost. Cost is
the amount of cash or cash equivalent paid and the fair value of other consideration given to
acquire an asset at the time of acquisition or construction.

 PPE necessary for environmental and safety resources

Elements of Costs

1. Purchase price, including non-refundable purchase taxes (excluding VAT), after deducting
trade discounts and rebates.
2. 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 the management.
3. Present value of decommissioning and restoration costs to the extent that they are
recognized as obligation

Note: Cost -> cash price equivalent -> if payment is deferred -> %. If asset is acquired in exchange
for other non-monetary asset -> fair value

Directly Attributable Costs

Examples of directly attributable costs that qualify for recognition are:

 Costs of employee benefits arising directly from the construction or acquisition of PPE;
 Costs of site preparation;
 Initial delivery and handling costs (e.g., freight costs);
 Installation and assembly costs;
 Testing costs, net of disposal proceeds of samples generated during testing; and (ex. P1,000
(testing cost) – P500 (sold at) = P500 (additional))
 Professional fees.

Cost Not Qualifying for Recognition

Examples of costs that are expensed rather than recognized as element of cost of property,
plant and equipment are:

 Cost of opening a new facility

  Cost of introducing a new product or services, including cost of advertising and promotion
 Cost of conducting business in a new location or with a new class of customer, including
cost of staff training
 Administration and other general overhead cost
 Cost incurred while an item capable of operating in the manner intended by management
has yet to be brought into use or is operated at less than full capacity
 Initial operating loss
 Cost of relocating or reorganizing part or all of an entity's operations

Cessation of Capitalizing Costs to PPE

Recognition of costs in the carrying amount of an item of PPE ceases when the item is in the
location and condition necessary for it to be capable of operating in the manner intended by
management.

Measurement of Cost

The cost of an item of PPE is the cash price equivalent at the recognition date. If payment
is deferred beyond normal credit terms, the difference between the cash price equivalent and the
total payment is recognized as interest over the period of credit unless such interest is capitalized
in accordance with PAS 23 Borrowing Costs.

Ex. P55,000 2 years at 0% interest. If cash payment, discount of P5,000.

If cash price equivalent:

PPE 50,000

Discount on N/P 5,000

N/P 55,000

If deferred:

Interest expense 2,500

Discount 2,500
Acquisition Through Issuance of Share Capital

Philippine GAAP provides that if share are issued for consideration other than actual cash,
the proceeds shall be measured by the fair value of the consideration received. Accordingly, where
a property is acquired through the issuance of share capital, the property shall be measured at an
amount equal to the following in the order of priority:

1. Fair value of the property received

2. Fair value of the share capital
3. Par value or stated value of the share capital

Ex. Cost = 400,000 & FV = 500,000. 4,000 shares of stock with P100 par value, market price = P150

1. If fair value of the property received is given

PPE 500,000
OSC (Ordinary Share Capital) 400,000 = 4,000 x 100
SP (Share Premium) 100,000
2. If fair value of the property received is not given but fair value of the share capital is given
PPE 600,000 = 4,000 x 150
OSC 400,000
SP 200,000
3. If fair values of the property received and of the share capital are not given but par value or
stated value of the share capital is there
PPE 400,000 = 4,000 x 100
OSC 400,000 - no gain or loss / SP

Acquisition Through Issuance of Bonds Payable

PFRS 9, paragraph 5.1.1, provides that asset acquired by issuing bonds payable (a contract
of indebtness – liability) is measured in the following order:

1. Fair value of bonds payable

2. Fair value of asset received
3. Face amount of bonds payable

Ex. 1B/1,000 = 1M

Ex. Equipment: Fair Value: P1,000,000, 1,000 bonds with P1,000 face value quoted at 98 (MP)
 1. If fair value of the bonds payable is given
Equipment 980,000 = 1M X .98
Discount 20,000
Bonds Payable (BP) 1,000,000
2. If fair value of the bonds payable is not given but fair value of asset received is given
Equipment 1,000,000
BP 1,000,000
3. If fair value of the bonds payable and asset received is not given but face amount of bonds
payable is there
Equipment 1,000,000 = 1,000 x 1,000
BP 1,000,000

Acquisition Through Exchange

If the exchange has commercial substance, the asset received from the exchange is
measured using the following order of priority:

1. Fair value of asset Given up

2. Fair value of asset Received
3. Carrying amount of asset Given up

If the exchange lacks commercial substance, the asset received from the exchange is
measured at the carrying amount of asset given up (doesn’t affect the cash flow). Commercial
substance is a new notion and is defined as the event or transaction causing the cash flows of the
entity to change significantly by reason of the exchange.

Ex.

Machinery A B
Cost 1,000,000 1,500,000
Accumulated Depreciation 300,000 600,000
Fair Value 500,000 600,000

1. If fair value of asset given up is given

Machinery B 500,000
Accumulated Depreciation (AD) 300,000
 Loss on exchange 200,000 - squeeze
Machinery A 1,000,000
2. If fair value of asset given up is not given but fair value of asset received is given
Machinery B 600,000
AD 300,000
Loss on exchange 100,000 - squeeze (opposite gain on exchange)
Machinery A 1,000,000
3. If fair value of asset given up and asset received is not given but carrying amount of asset
given up is given (C – AD of A)
Machinery B 700,000 = 1,000,000 – 300,000 so no loss/gain
AD 300,000
Machinery A 1,000,000

Example of exchange that lacks commercial substance: when the cost of two aircon of two buildings
is almost equal so if they exchange their assets, it will lack commercial substance.

Construction

The cost of self-constructed asset is determined using the same principles as for an acquired
asset and usually includes:

1. Direct cost of materials

2. Direct cost of labor
3. Indirect cost and incremental overhead specifically identifiable or traceable to the
construction

Ez. Construction in progress xx to Building xx

Cash xx Construction in progress xx

The cost of abnormal amount of wasted material, labor or overhead incurred in the
production of self-constructed asset is not included in the cost of the asset.

 Normal: wasted materials

 Abnormal: rebuilding of a wall due to carelessness – debit to outright ezpense
Lesson 2: Subsequent Measurement and Derecognition of PPE

Subsequent to initial recognition, an entity shall choose either:

 the cost model

 the revaluation model

as its accounting policy and shall apply that policy to an entire class of PPE.

 Major inspections, overhunting, replacement of parts

Cost Model

After recognition, an item of PPE is measured at its cost less any accumulated depreciation
and any accumulated impairment losses.

Depreciation

Depreciation is the systematic allocation of the depreciable amount of an asset over its
estimated useful life. When computing for depreciation, each part of an item of PPE with a cost that
is significant in relation to the total cost of the item shall be depreciated separately.

Depreciation begins when the asset is available for use, i.e., when it is in the location and
condition necessary for it to be capable of operating in the manner intended by management.
Depreciation ceases when the asset is derecognized or when it is classified as “held for sale” under
PFRS 5, whichever comes earlier.

 Depreciation amount means how much = cost – residual value

 Useful life means how long, which is either in period or number of units
 Systematic basis means how or in what manner, such as depreciation method
 Journal entry: debit profit or loss (asset) and credit PPE

Selection of Depreciation Method

There are various methods of depreciation. The entity shall select the method that most
closely reflects the expected pattern of consumption of the future economic benefits embodied in
the asset. However, a depreciation method that is based on revenue that is generated by an activity
that includes the use of an asset is not appropriate.
  Straight-line method - depreciation is recognized evenly over the life of the asset by
dividing the depreciable amount by the estimated useful life.
Depreciation = (Historical cost – Residual value) ÷ Estimated useful life
 Production method - assumes that depreciation is more a function of use rather than
passage of time. The useful life of the asset is considered in terms of the output it produces
or the number of hours it works. Thus, depreciation is related to the estimated production
capability of the asset and is expressed in a rate per unit of output or per hour of use.
Ex. A printer can only print 1,000,000 pages at 50,000 pesos
= 50,000/1,000,000 = 1/20 or 0.05
(1) Printed 100,000 for this year (100,000 x 1/20 per page = 5,000)
Note: hard to estimate
 Diminishing balance or accelerated methods - provide higher depreciation in the earlier
year and lower depreciation in the later years of the useful life of the asset. Thus, these
methods result in a decreasing depreciation charge over the useful life. It is based on the
philosophy that new assets are generally capable of producing more revenue in the earlier
years than in the later years.

Note: method – can use different methods for different PPE (except for land)

Changes in depreciation method, useful life, and residual value

A change in depreciation method, useful life, or residual value is a change in accounting

estimate accounted for prospectively. Prospective accounting means the change affects only the
current period and/or future periods. The change does not affect past periods.

Ex. Straight-line method (SLM) to Production method (PM)

1,000,000

200,000 - SLM

800,000 - PM

Note: This means that changes will only affect the present and future. Its opposite is called
retrospectively, which means it will also affect the past. However, it is not the case of PPE.
Revaluation Model

After recognition as an asset, an item of PPE whose fair value can be measured reliably shall
be carried at a revalued amount, being its fair value at the date of the revaluation less any
subsequent accumulated depreciation and subsequent accumulated impairment losses. (Ex. Land
because its value increases. For cost, it will not move)

Revaluation Surplus

Fair value* xx

Less: Carrying amount (xx)

Revaluation of surplus – gross of tax xx

*The fair value is determined using an appropriate valuation technique, taking into account the
principles set forth under PFRS 13. (in equity)

Ex. Equipment 1,000,000 - for it to be 2,000,000

Revaluation surplus 1,000,000

Frequency of Revaluation

For items with significant and volatile changes in fair value, annual revaluation is
necessary. For items with insignificant changes in fair value, revaluation may be made every 3 or
5 years.

Revaluation applied to all assets in a class

If an item of PPE is revalued, the entire class of PPE to which that asset belongs shall be
revalued. The items within a class of PPE are revalued simultaneously to avoid selective revaluation
of assets and the reporting of amounts in the financial statements that are a mixture of costs and
values as at different dates.

Subsequent accounting for revaluation surplus (if carrying amount increases = credit)

Revaluation is initially recognized in other comprehensive income (in equity) unless the
revaluation represents impairment loss or reversal of impairment loss, in which case it is
recognized in profit or loss. Subsequently, the revaluation surplus is accounted for as follows:
 1. If the revalued asset is non-depreciable, the revaluation surplus accumulated in equity is
transferred directly to retained earnings when the asset is derecognized.
2. If the revalued asset is depreciable, a portion of the revaluation surplus may be transferred
periodically to retained earnings as the asset is being used.

Notes:

 If carrying amount also increases, credit to income = if reverses previous decrease in profit
or loss
 If carrying amount decreases, either debit to expenses or to equity = if reverses previous
increase in revaluation surplus

Derecognition

The carrying amount of an item or PPE shall be derecognized:

 on disposal; or
 when no future economic benefits are expected from its use or disposal

turns to gain or loss -> net disposal proceeds – carrying amount