Financial Accounting

Topic 2: Accounting for Plant Assets

Sessions 4 - 6
Plant assets were 26.5% of
non-current assets and 16.8%
of total assets, in 2020.
Textbook readings

• Chapter 4 (An Overview of Accounting for Assets)

• Chapter 5 (Depreciation of Property, Plant and Equipment)

• Chapter 6 (Revaluations and Impairment Testing of Non-current

Assets)
Learning objectives
• Understand the definition, recognition criteria, and measurement of an (plant)
asset.
• Be able to explain how to calculate the acquisition cost of a plant asset.
• Understand the role of accounting in allocating the depreciable amount of a
non-current asset over the asset’s expected useful life.
• Understand how to calculate depreciation using the three main methods.
• Know the disclosure requirements of IAS 16 Property, Plant and Equipment as
they pertain to depreciation.
• Understand what an ‘impairment loss’ is and know how to account for one in
accordance with IAS 36 Impairment of Assets.
 Topic 2: Accounting for Plant Assets
Agenda
(Plant) Asset: definition and recognition criteria

Determining the acquisition cost of plant assets

Depreciation

Disposals of plant assets

Impairment of plant assets

(Plant) Asset: definition and recognition criteria
Definition of an asset
• The Conceptual Framework’s definition of an asset:
A resource controlled by the entity as a result of past events and from
which economic benefits are expected to flow to the entity.

• Three essential characteristics emerge:

1) Expected to provide future economic benefits
2) Must be controlled by the entity
3) Transaction or event giving rise to the control must have occurred.
What are plant assets?
also known as Property, Plant and Equipment (PPE)
• These are resources that have:
• physical substance (a definite size and shape) –> tangible assets,
• are used in the operations of a business,
• are not intended for sale to customers,
• are expected to provide service to the company for a number of years ->
non-current assets.

• IAS 16 Property, Plant and Equipment deals with various issues

associated with the recognition, measurement and disclosure of PPE.
Recognition criteria for (plant) assets
(IAS16, §7)

• Recognize cost of a plant item as an asset if, and only if:

(a) it is probable that future economic benefits associated with the item will
flow to the entity; (example?)

and

(b) the cost of the item can be measured reliably.

Why does this matter?

In 2001 and 2002, WorldCom pretended that

$3.8bn in normal operating expenses - in fact,
routine network maintenance - qualified as
investment. That allowed the company to spread
the cost over a number of years, instead of having
to account for it all at once.
Unsurprisingly, that made its profits look much,
much better than they were! It also artificially
inflated the company's value.
Determining the acquisition cost of plant assets
What is meant by cost (IAS 16)
• The Cost Principle requires that companies record plant assets at cost.

• Cost consists of all expenditures necessary to acquire an asset and

make it ready for its intended use, including:
• Its purchase price, including import duties & non-refundable 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 management; and
• the initial estimate of the costs of dismantling and removing the item and
restoring the site on which it is located, …
What is meant by cost (IAS 16)
• ‘Directly attributable costs’ would include:
• employee costs arising from the construction/acquisition;
• costs of site preparation;
• initial delivery and handling costs;
• installation and assembly costs;
• costs of testing; and
• professional fees.
----------------------------------------------------------------------------------------------
• These DO NOT form part of the cost:
• costs of opening a new facility/introducing new product/service;
• staff training costs; and
• administration and other general overhead costs.
Determination of acquisition cost - illustration
Lew Company Ltd. acquires real estate at a cash cost of HK$2.000.000. The property
contains an old warehouse that is razed at a net cost of HK$60.000 (HK$75.000 in costs
less HK$15.000 proceeds from salvaged materials). Additional expenditures are the
attorney’s fee, HK$10.000, and the real estate broker’s commission, HK$80.000.

Determine the amount to be reported as the cost of the land, and pass the required journal
entry on the day of purchase.

Cash price of property 2.000.000

Net removal cost of warehouse 60.000
Attorney's fees 10.000
Real estate broker’s commission 80.000
Cost of Land 2.150.000 Dr. Land 2.150.000
Cr. Cash 2.150.000
Yucca

machine

What will be the journal

entry on 1 March 2018?
Acquisition of plant asset other than by cash
• If acquired in exchange for equity instruments (e.g. shares), then ‘cost’ is
the fair value of the equity instruments issued.

• If acquired in exchange of another item of plant assets, then ‘cost’ is the

fair value of the asset given up.
• here, a gain or loss on disposal will also be recognized (= carrying amount of asset
being exchanged minus its fair value).

• IFRS 13 Fair Value Measurement defines fair value 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”.
 Exercise
Determine the acquisition cost of the asset for Joy plc, & state the
journal entry to record the acquisition.

Assume that Joy plc is acquiring a portable building from Davies plc for the
following consideration:
Cash £150,000
Shares 100,000 shares with a market value per share of £1.90
Land Joy is going to transfer title of some rural land to Davies (carrying value of
£120,000; market value of £95,000)
Liabilities Joy has agreed to take legal responsibility for Davies’ bank loan of £65,000
Legal fees pertaining to the acquisition: £9,000, which will be paid one month later
Components approach (IAS16, §44)
• Certain types of plant assets might comprise a number of individual
component parts, each with a different useful life. e.g., aircrafts, ships,
manufacturing plant,…
Recognition of separate asset categories

• Illustration: Gilmore acquired a manufacturing plant for €3,900,500. The

purchase price includes land (55%), buildings (35%), machinery (8%), and
inventory of raw materials (2%). The amounts between brackets refer to the
proportional parts of the purchase price for each separate item. The journal entry
on the purchase date will be:
Dr. Land €2,145,275
Dr. Building €1,365,175
Dr. Machinery €312,040
Dr. Inventory €78,010
Cr. Bank €3,900,500
Outback Steakhouse opened a new restaurant on the site of an existing building. It paid the
owner $260,000 for the land and building, of which it attributes $52,000 to the land and
$208,000 to the building. Outback incurred legal costs of $12,600 to prepare the legal
documents for the purchase. It also paid $35,900 to renovate the building to make it
suitable for Outback’s use. Property insurance on the land and building was $12,000 for the
first year, of which $4,000 pertained to the period of renovation and the remainder to the
period after opening. Property taxes on the land and building for the first year equaled
$15,000 ($5,000 for period during renovation; remainder for period after opening).
Calculate the amounts that Outback should include
in the Land account and in the Building account.
Depreciation
What is depreciation
The process of allocating to expense the cost of a plant asset over its
useful (service) life in a rational and systematic manner.

 Applies to land improvements (not land), buildings, and equipment.

 Depreciable, because the revenue-producing ability of asset will decline over

the asset’s useful life.

 A company’s choice of depreciation policies can have a significant impact on

its profits and reported assets.
Factors in computing depreciation

Cost Useful Life Salvage (or Residual) Value

Depreciation methods
• Management selects the method it believes best measures an
asset’s contribution to revenue over its useful life.

• 3 methods:
• Straight-line (or linear)
• Declining-balance
• Units-of-activity Use of depreciation
methods in major U.S.
companies
Depreciation methods - illustration

• Billy’s Pizza purchased a small delivery truck on January 1, 2010. The company
has a calendar year reporting period.

• Required: Compute annual depreciation expense using the following methods:

(a) Straight-line;
(b) Declining-balance; and
(c) Units-of-activity.
(a) Straight-line method
• Companies expense the same amount of depreciation for each year
of the asset’s useful life.

• First, we need to determine the asset’s depreciable cost.

This implies a
depreciation rate
of 20%.
(a) Straight-line method = 13000 minus
Accum. Deprec.

2010 Depreciation expense (EXP+) 2,400

Journal
Entry Accumulated depreciation (XA+) 2,400
(a) Straight-line method (partial year)
Thomson Financial

Thomson Financial acquired a mainframe computer on January 1, 2011

for €10,000,000. The computer had an estimated life of six years and a
€1,000,000 salvage value. The firm uses the straight-line depreciation
method. On January 1, 2013 TF discovers that new technologies make
it likely that the computer will last only four years in total and that the
estimated salvage value is only €600,000. Compute the amount of
depreciation expense for 2013 for this change in depreciable life and
salvage value. Assume that the change does not represent an
impairment loss.
(b) Declining-balance method
• Produces a decreasing annual depreciation expense over the asset’s
useful life.
• Rate applied to book (carrying) value.
• A common declining-balance rate is double the straight-line rate.
• called “double-declining-balance (DDB) method”

For 2010:
(b) Declining-balance method

674
(c) Units-of-activity method
• Suited to equipment whose activity can be measured in units of
output, miles driven, or hours in use.

• Calculate depreciation cost per unit, where depreciable cost is cost

less salvage value.

• Expense varies based on units of activity.

(c) Units-of-activity method
An exercise on depreciation methods
Comparison of
depreciation methods
 Cost
principle

Fair value
principle

Depreciation
method
Expenditures during useful life

Ordinary repairs Additions and improvements

• Expenditures to maintain the • Costs incurred to increase the
operating efficiency and operating efficiency, productive
productive life of the unit. capacity, or useful life of a plant
asset.
• referred to as capital expenditures
• To be expensed. (remember WorldCom?) • To be capitalized (i.e., carried
• Debit -> repair (or maintenance) forward as an asset).
expense. • Debit -> the affected plant asset
account.
Revision of depreciation rate & method
• Residual value, useful life and method must be reviewed at least
annually (IAS 16, § 51).
• revise rate if the expected useful life or residual value are different from that
previously expected
• change method where there is a significant change in pattern of benefits

• Revisions can have significant effects on profits!

• Any material changes in depreciation charges need to be disclosed as

a change in accounting estimate, in accordance with IAS 8 Accounting
Policies, Changes in Accounting Estimates and Errors.
Disposals of plant assets
Ways to dispose off plant assets

 Accounting treatment in general:

• Record depreciation up to the date of disposal.
• Eliminate the asset by (1) debiting Accumulated Depreciation, and (2) crediting
the asset account.
Sale of plant assets
• Compare the book value of the asset with the proceeds received
from the sale:
• if proceeds exceed the book value, a gain on disposal occurs.
• if proceeds are less than the book value, a loss on disposal occurs.
Sale of plant assets - illustration
On July 1, 2010, Wright Company sells some office furniture. The office furniture originally cost
$60,000. As of January 1, 2010, it had accumulated depreciation of $41,000. Depreciation for the
first six months of 2010 is $8,000. Prepare the journal entry to record this sale.

Case 1: furniture sold for $16,000 cash Case 2: furniture sold for $9,000 cash

Journal entry on July 1: Journal entry on July 1:

Cash Dr. 16,000 Cash Dr. 9,000
Accumulated depreciation Dr. 49,000 Accumulated depreciation Dr. 49,000
Office equipment Cr. 60,000 Loss on disposal Dr. 2,000
Gain on disposal Cr. 5,000 Office equipment Cr. 60,000
ICS item
Zora exercise
• Uploaded on IESEG-Online, under Sessions 4-6.
Impairment of plant assets
Impairment of plant assets - illustration
Wildwood Properties owns an apartment building that has a carrying value of €15

million on January 1, 2013. The highway department has decided to construct a new

highway near the building which substantially decreases it attractiveness to tenants.

Wildwood estimates that it will now collect rentals from the building for €1.4 million a

year for the next 6 years (undiscounted amounts) and that it will sell the building at that

time for €4 million. An appropriate rate to discount cash flows is 10% annual.
Indications of impairment
IAS 36
Impairment of Assets
External sources Internal sources
• Decline in asset’s market value • Obsolescence/physical damage
• Significant changes (market, • Significant changes
technology, legal, economic) (restructuring, discontinuation)
• Increase in interest rates • Internal reporting evidence
• Carrying amount > market
capitalization
 Accounting for impairment of plant assets
1) Obtain the carrying value of the asset immediately prior to impairment
testing as: Carrying value = acquisition cost – accumulated depreciation.

2) Impair if carrying value > recoverable amount,

where recoverable amount = higher of (a, b)
a: fair value less costs to sell
b: value in use (= P.V. of future cash flows expected to be derived from asset)

3) Report an impairment loss (expense) in the ICS, and report the asset
at its recoverable amount in the BS.
Impairment of plant assets - illustration
• Wildwood Properties owns an apartment building that has a carrying value of €15
million on January 1, 2013. The highway department has decided to construct a new
highway near the building which substantially decreases its attractiveness to tenants.
Wildwood estimates that it will now collect rentals from the building for €1.4 million a
year for the next 6 years (undiscounted amounts) and that it will sell the building at
that time for €4 million. An appropriate rate to discount cash flows is 10% annual.
Compute the amount of any impairment loss under IFRS.
• Carrying value of building = €15,000,000
• Recoverable amount = value in use = P.V. of expd. cash flows from building =
(€1,400,000 * 4.3553) + (€4,000,000 * 0.5645) = €8,355,420
• As carrying value > recoverable amount,
impairment necessary of 15,000,000 – 8,355,420 = €6,644,580 (loss)
PRESENT
VALUES
 PRESENT
VALUE OF
CONSTANT
ANNUITIES
Superbank Ltd.
Superbank Ltd. acquired some machinery at a cost of €2,250,000. As at 30 June 2014,
the machinery had accumulated depreciation of €450,000 and an expected
remaining useful life of 4 years.
On 30 June 2014, it was determined that the machinery’s sales value is €1,300,000
and that the costs associated with making the sale would be €60,000. Alternatively,
the machine could be used internally for another 4 years and it is expected that the
net cash flows to be generated from the machine will be €440,000 over each of the
next four years. It is assessed that at 30 June 2014 the market required a rate of
return of 5% on this type of machinery.
a) Determine whether any impairment loss needs to be recognized in relation to
the machinery and, if so, provide the appropriate journal entry at 30 June 2014.
b) Provide the appropriate journal entry to account for depreciation in 2015.
Revaluation of plant assets: Gain situation
• Suppose Pernice Ltd. purchases equipment on Jan. 1, 2020, for HK$1,000,000. It
has a useful life of 5 years and no residual value. At the end of 2020, independent
appraisers determine that the asset has a fair value of HK$850,000. To first record
the depreciation expense and then the revaluation of this equipment, the
company will make the following journal entries on Dec. 31:
Depreciation Expense 200,000 assuming
straight-line
Accumulated Depreciation - Equipment 200,000 method
eliminating acc.
Accumulated Depreciation - Equipment 200,000
dep., before the
revaluation.
Equipment 200,000
Carrying value
Equipment 50,000 of equipment =
HK$800,000
Revaluation Surplus 50,000
Reported as other revaluing equipment to its fair value of
comprehensive income; HK$850,000, and recording the
part of owner’s equity corresponding gain
Wrapping up Sessions 4-6:
Exercise for practice
Hanoi Ltd exercise
• Uploaded on IESEG-Online, under Sessions 4-6.
 *End of Topic 2*
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