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PPE Review for A

Accounting (Far Eastern University)

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FINANCIAL ACCOUNTING REVIEW: Property, Plant and Equipment

NATURE OF PROPERTY, PLANT AND EQUIPMENT

Property, plant, and equipment (PPE) are tangible items that:
• Are held for use in the 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.

MEASUREMENT AT INITIAL RECOGNITION

An item of PPE is initially measured at cost.

Elements of cost
The cost of a PPE comprises the following:
➢ Its purchase price, including import duties, nonrefundable purchase taxes, after deducting trade discounts and rebates.
➢ 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 the management.
➢ The initial estimate of the costs of dismantling, removal and site restoration costs on which the PPE is located, for which the
entity incurs an obligation by acquiring or using the asset other than to produce inventories.

Summary of initial cost basis for different modes of acquisition

Mode of acquisition Initial cost basis

Cash basis Cash price equivalent + Other directly attributable costs

Deferred/installment basis Cash price equivalent (CPE), the difference between CPE and total
payment is recognized as interest over the credit period.

If CPE is not available, Determine present value of future cash flows

using an imputed interest rate.

On account with available cash discounts Invoice price less cash discounts, whether taken or not

Issuance of own Eq. Sec. 1. FV of property received

2. FV of shares issued
3. Par (or stated) value of shares issued

Issuance of bonds payable 1. FV of bonds issued

2. FV of property received
3. Face value of bonds

Lump sum purchase Lump-sum price (basket price) is allocated to the individual assets based
on their relative fair values at date of purchase.

Exchange 1. With commercial substance ➔ Fair value of property given +

cash payment – cash received
➢ G/L on exchange is fully recognized

2. Without commercial substance ➔ Carrying value of property

given + cash payment – cash received
➢ G/L on exchange is not recognized

Trade-Ins 1. Fair value of property received

2. Fair value of property given up + cash payment
3. Trade-in value of asset given up + cash payment

T-In Value = Cash price without T-In – Cash price with T-In

Donation From non-shareholder ➔ Fair value + other directly attributable costs

➢ Unrestricted – Credit to Income
➢ Restricted – Initially recognized as liability, income when
conditions are satisfied.

From shareholder ➔ at FV → Credit to Donated capital

➢ Donation-related expense are charged to donated capital

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Self-construction Materials + Labor + Overhead + Other directly attributable costs

Any internal profits or savings on construction are eliminated.

CAPITALIZABLE COSTS OF SPECIFIC ITEMS OF PROPERTY, PLANT AND EQUIPMENT

LAND
1. Purchase price
2. Legal fees for establishing clean title
3. Broker commission
4. Escrow fees
5. Fees for registration and transfer of title
6. Cost of relocation or reconstruction of property belonging to others in order to acquire possession
7. Mortgages, encumbrances and interest on such mortgages assumed by the buyer
8. Unpaid taxes up to date of acquisition assumed by the buyer
9. Cost of survey
10. Payments to tenants to induce them to vacate the land in order to prepare the land for its intended use but not to make room
for the construction of new building
11. Cost of permanent improvements such as cost of clearing, cost of grading, leveling and landfill
12. Cost of option to buy the acquired land.
- If the land is not acquired, the cost of option is expensed immediately.

Special assessments
Special assessments are taxes paid by the landowner as a contribution to the cost of public improvements. These are treated as part of
the cost of the land.

LAND IMPROVEMENTS
Land improvements not subject to depreciation are charged to the land account. Examples of these are:
1. Cost of grading, leveling and landfill
2. Cost of subdividing and other cost of permanent improvement

Land improvements that are depreciable are charged to land improvements account. Examples of these are:
1. Fences
2. Water systems
3. Drainage systems
4. Sidewalks
5. Pavements and costs of trees, shrubs and other landscaping

These are depreciation over their useful life.

BUILDING
Through purchase
1. Purchase price
2. Legal fees incurred in connection with the purchase
3. Unpaid taxes up to date of purchase assumed by the buyer
4. Interests, mortgage, liens and other encumbrances assumed by the buyer
5. Payments to tenants to induce them to vacate the building
6. Any renovating or remodeling costs incurred to put the building purchased in a condition suitable for the intended use.

Through self-construction
1. Materials used, labor employed and overhead directly attributable to construction
2. Building permit or license
3. Architect fee
4. Superintendent fee
5. Cost of excavation
6. Cost of temporary building used as construction office and tools or materials shed
7. Expenditures incurred during the construction period such as borrowing cost on construction loan and insurance
8. Expenditures for service equipment and fixtures made a permanent part of the structure
9. Cost of temporary safety fence around construction site and cost of subsequent removal thereof
- However, the construction of a permanent fence after the completion of the building is recognized as land improvement.
10. Safety inspection fee

Sidewalks, pavements, parking lot, driveways

1. If such expenditures are part of the blueprint for the construction of the new building, these are charged to the
buildings account.

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2. If these expenditures are incurred not in connection with the construction of a new building, these are charged to land
improvements.

Claims for damages

When insurance is taken during the construction of a building, the cost of insurance is charged to the building because it is
necessary and a reasonable cost of bringing the building into existence.

However, when insurance is not taken and the entity is required to pay claims for damages for injuries sustained during the
construction, the payment for such should be expensed outright because the damages represent management negligence in
procuring insurance and are not a reasonable and necessary cost of construction.

Building fixtures (e.g., shelves, cabinets and partitions)

1. If such expenditures are immovable in the sense that these are attached to the building in such a manner that the removal
may destroy the building, these are charged to the building account.
2. If such expenditures are movable, these are charged to the furniture and fixtures and depreciated over their useful life.

Ventilating system, lighting system, elevator

If installed during construction, these are charged to the building account. Otherwise, these are charged to building improvements
and depreciated over their useful life or remaining life of the building, whichever is shorter.

PIC Interpretation on Land and Building acquired at Basket Price

➢ If the old building is still usable, the single cost is allocated to land and building based on relative fair value.
➢ If the old building is already unusable, the single cost is assigned to land only.

PIC Interpretation on Usable Old Building demolished

1. If the old building is demolished immediately to make room for construction of a new building:
➢ Any allocated carrying amount of the usable old building is recognized as a loss.
➢ The net demolition cost (demolition cost less salvage value) is capitalized as cost of the new building. However, it is
capitalized as cost of land if the old building is demolished to prepare the land for its intended use but not to make
room for the construction of new building.

2. If the old building is demolished at a later period to make room for the construction of new building
➢ The carrying amount of the old building is recognized as a loss.
➢ The net demolition cost (demolition cost less salvage value) is capitalized as cost of the new building.
➢ If the old building is subject to a contract of lease, any payments to tenants to induce them to vacate the old building shall
be capitalized as cost of the new building.

MACHINERY
When machinery is purchased, the cost normally includes the following:
1. Purchase price
2. Freight, handling, storage and other cost related to the acquisition
3. Insurance while in transit
4. Installation cost, including site preparation and assembling
5. Cost of testing and trial run, and other costs necessary in preparing the machinery for its intended use.
6. Initial estimate of cost of dismantling and removing the machinery and restoring the site on which it is located, and for which
the entity has a present obligation.
7. Fees paid to consultants for advice on the acquisition of the machinery.
8. Cost of safety rail and platform surrounding machine.
9. Cost of water device to keep machine cool.

If a machinery is removed and retired to make room for the installation of a new one, the removal cost not previously recognized as a
provision is charged to expense.

The VAT on the purchase of machinery is not capitalizable but charged to input tax to be offset against output tax. However, any
irrevocable or nonrefundable purchase tax is capitalized as cost of the machinery.

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DEPRECIATION METHODS

Cost - Residual value

Straight-line depreciation =
Estimated useful life

Useful life, beginning of year

SYD depreciation = Cost - Residual value x
Sum-of-the-years' digits (SYD)

SYD = n*(n+1)
2

2
Double-declining balance depreciation = CV, beginning x
n

1.5
150%-declining balance depreciation = CV, beginning x
n

Output method depreciation = Actual output x Depreciation rate

Cost - Residual value

Depreciation rate =
Est. output

Notes:
1. For declining balance depreciation methods, residual values are not considered in computing depreciation expense. It is only
considered in the final year of depreciation.
2. Any change in the depreciation methods, useful life or residual value is accounted for prospectively as a change in accounting
estimate.

MEASUREMENT MODELS OF PPE

1. Cost model
2. Revaluation model

YEAR-END MEASUREMENT OF PPE

➢ Lower of carrying value and recoverable value
✓ Recoverable value is the higher between fair value less cost to sell and value in use
▪ Value in use is the PV of future net cash flows expected to be derived from continuing use of the asset. The
discount rate to be used is a pre-tax discount rate.

REVERSAL OF IMPAIRMENT
An impairment loss recognized for an asset in prior years shall be reversed if there has been a change in the estimate of the recoverable
amount.

The increased carrying amount of an asset due to a reversal of an impairment loss shall not exceed the carrying amount that would have
been determined, had no impairment loss been recognized for the asset in prior periods.

DEPLETION
Depletion is the systematic allocation of the depletion base of a natural resource over the period the natural resource is extracted.
Depletion is normally computed using the output method.

𝐷𝑒𝑝𝑙𝑒𝑡𝑖𝑜𝑛 = 𝐴𝑐𝑡𝑢𝑎𝑙 𝑜𝑢𝑡𝑝𝑢𝑡 𝑥 𝐷𝑒𝑝𝑙𝑒𝑡𝑖𝑜𝑛 𝑟𝑎𝑡𝑒

𝐶𝑜𝑠𝑡 𝑜𝑓 𝑚𝑖𝑛𝑖𝑛𝑔 𝑝𝑟𝑜𝑝𝑒𝑟𝑡𝑦 − 𝑠𝑎𝑙𝑣𝑎𝑔𝑒 𝑣𝑎𝑙𝑢𝑒

𝐷𝑒𝑝𝑙𝑒𝑡𝑖𝑜𝑛 𝑟𝑎𝑡𝑒 =
𝐸𝑠𝑡𝑖𝑚𝑎𝑡𝑒𝑑 𝑟𝑒𝑐𝑜𝑣𝑒𝑟𝑎𝑏𝑙𝑒 𝑢𝑛𝑖𝑡𝑠

Cost of mining property is composed of the following:

➢ Purchase price
➢ Other directly attributable costs
➢ PV of restoration cost
➢ Capitalizable exploration costs
➢ Capitalizable development costs

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Revision of depletion rate

The changes in estimate are to be handled currently and prospectively, if necessary.

𝐶𝑉 + 𝑎𝑑𝑑′ 𝑙 𝑐𝑎𝑝𝑖𝑡𝑎𝑙 𝑒𝑥𝑝𝑒𝑛𝑑𝑖𝑡𝑢𝑟𝑒𝑠 − 𝑠𝑎𝑙𝑣𝑎𝑔𝑒 𝑣𝑎𝑙𝑢𝑒

𝑅𝑒𝑣𝑖𝑠𝑒𝑑 𝑑𝑒𝑝𝑙𝑒𝑡𝑖𝑜𝑛 𝑟𝑎𝑡𝑒 =
𝑅𝑒𝑣𝑖𝑠𝑒𝑑 𝑟𝑒𝑚𝑎𝑖𝑛𝑖𝑛𝑔 𝑟𝑒𝑐𝑜𝑣𝑒𝑟𝑎𝑏𝑙𝑒 𝑢𝑛𝑖𝑡𝑠, 𝑏𝑒𝑔.

DEPRECIATION OF MINING EQUIPMENT

Development costs are classified as either (1) tangible equipment costs or (2) intangible development costs. Intangible development
costs form part of the depletion base of the natural resource. Tangible equipment costs are depreciated separately.

Tangible equipment costs are identified either movable or immovable. Movable tangible equipment are those that can be used from one
extracting site to another. They have alternative use even after the natural resource is fully depleted. Movable tangible equipment is
depreciated over its useful life.

Immovable tangible equipment are those that cannot be used in other extracting sites after the reserves in one site are fully depleted.
They have no further use after the natural resource is fully depleted. These are depreciated over the shorter of useful life or mining
period.
➢ If useful life is shorter, the equipment is depreciated using regular depreciation methods
➢ If mining period is shorter, the equipment is depreciated using the output method.

Liquidating dividends
Distribution to owners are normally made out of the balance of any unrestricted retained earnings. Any amount declared in excess of
unrestricted retained earnings is called liquidating dividends.

Entities normally cannot declare dividends from its legal capital because of the trust fund doctrine. The trust fund doctrine provides that
the share capital of a corporation is held as trust fund for the protection of its creditors. Therefore, no part of such capital shall be
distributed to the owners unless the corporation is dissolved or liquidated.

However, for wasting asset entities, the wasting asset doctrine applies rather than the trust fund doctrine. Under the wasting asset
doctrine, due to the irreplaceable nature of the entity’s assets, dividends can be declared not only to the extent of unrestricted retained
earnings but also for the balance in accumulated depletion to the extent that it is realized and not yet liquidated.

Unrestricted retained earnings XX

Add: Accumulated Depletion XX
Less: Capital liquidated (XX)
Less: depletion in EI (XX)
Maximum amount of dividend XX

-nothing follows-

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