Accounting for Property, Plant and Equipment (Acquisition, Depreciation and Revaluation)

7/22/2019 Accounting for Property, Plant and Equipment (Acquisition, Depreciation and Revaluation)

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ACCG224 – Session 1, 2014Week 4

Accounting for Property, Plant andEquipment (Acquisition, Depreciation

and Revaluation)



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Readings (BEFORE the lecture!)

ACCG224 textbook:

Leo (9e): Chpt. 7

Additional resources (available on iLearn):

AASB 116, AASB 123

Please note:

The lectures will not strictly follow these slides. It is expected and requiredthat you know the contents of the readings BEFORE the lecture. Considerthese slides as a summary and guideline for the lectures (and later for yourrevision) where we will have more examples and discussions around thetopics.

Also, this week’s slides have blanks within certain examples. It is a goodexercise to try to fill the blanks BEFORE the lecture and compare yourattempts with the solutions discussed in the lecture.



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Learning objectives

1. Understand the nature of property, plant and equipment (PPE);

2. understand the criteria for initial recognition of PPE;

3. understand how to measure PPE on initial recognition;

4. explain the alternative ways, in which PPE can be measured

subsequent to initial recognition;

5. understand the nature and calculation of depreciation;

6. explain the cost model of measurement;

7. explain the revaluation model of measurement;

8. understand the factors to consider when choosing whichmeasurement model to apply;

9. account for derecognition;

10. implement the disclosure requirements of AASB 116.



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Relation to weeks 2 and 3

Conceptual framework: general principles about

definition,

recognition and

measurement

of assets and liabilities.

Now we look at specific accounting standards in relation to aparticular type of assets:

property, plant and equipment (PPE) (AASB 116).

Including tax implications (AASB 112).



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Overview AASB 116:

Property, Plant and Equipment (PPE) Definition

Initial recognition of an asset

Subsequent measurement:

Depreciation:- allocating the depreciable amount of a non-current asset over the

asset’s expected useful life;

- factors that must be considered in determining the useful life of adepreciable asset;

- various approaches (straight-line, sum-of-digits, declining balance,

production basis) for this allocation; Cost Model

Revaluation Model

Derecognition

Disclosure requirements



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The nature of PPE

AASB 116 defines PPE as:

tangible items;

with a specific use within the entity;

that are expected to be used during more than one period (ie. theyare non-current in nature).

AASB 116 specifically excludes:

assets held for sale – AASB 5

biological assets – AASB 141

mineral rights/reserves – AASB 6

For some purposes, PPE is divided into classes, e.g.

land, buildings, machinery, ships, aircraft, motor vehicles, furnitureand fixtures, office equipment.

also special rulesfor investment

property –

AASB 140



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Initial recognition of PPE

Cost recognised as an asset if:

it is probable that economic benefits will flow to the entity,and

the cost can be reliably measured.

Where future economic benefits are not expected to flow to theentity, costs incurred should be expensed.

Component parts (with different useful lives) are required to be

separately accounted for:

for example, an aircraft:

- the engine, frame and fittings of an aircraft are likely to havedifferent useful lives.



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Initial measurement of PPE

PPE is initially measured at cost, which includes:

purchase price (at fair value);

directly attributable costs required to bring the asset to thelocation and condition necessary for it to operate;

borrowing costs (AASB 123);

Initial estimate of costs of dismantling, removing the item orrestoring the site.

includes duties and taxes but excludes rebates and discounts

for example, an offshore oil platform

more details on next slide

interest paid to finance acquisition, construction or production until ready for use,if for a substantial period of time



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Directly attributable costs

„Directly attributable costs‟ include

a) costs of employee benefits arising from the construction oracquisition of the item of property, plant and equipment;

b) costs of site preparation;

c) initial delivery and handling costs;

d) installation and assembly costs;

e) costs of testing whether asset is functioning properly, after

deducting the net proceeds from selling any itemsproduced while bringing the asset to that location andcondition (e.g. samples);

f) professional fees.



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Measurement subsequent to initial

recognition AASB 116 allows a choice of two possible measurement models:

cost model;

revaluation model.

Accounting policy choice of this decision based primarily on relevanceof information.

The policy that is chosen must be applied to a whole class of assets.

May change policy, but only if it results in reliable and more relevantinformation.

Under both models, PPE with a limited useful life need to bedepreciated.

Each model will be discussed in detaillater

Refer to section 7.6 of text for examples of what constitutes a class of assets



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Depreciation – fundamentals

AASB 116 includes the following definitions:

Depreciation:

the systematic allocation of the depreciable amount of anasset over its useful life.

Depreciable amount:

the cost of an asset less its residual value (or otherappropriate amounts substituted for cost – eg. fair value).

Residual value:

the estimated value of the asset at the end of its useful life tothe entity.

Useful life:

the period over which an asset is expected to be used by anentity/the number of production (or similar) units expected tobe obtained by the entity.



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Depreciation – fundamentals (cont‟d)

Depreciation is an allocation process designed to reflect thedecline in the value of the asset in a pattern consistent with theconsumption of economic benefits by the entity.

AASB 116 does not specify how this allocation process shouldbe undertaken.

Various depreciation methods are used in practice. Commonmethods are discussed on the following slides.

Please note that depreciation applies to both the cost and therevaluation model!

In all cases, depreciation expense isrecognised with the following journal:

DR Depreciation expense

CR Accumulated depreciation



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Depreciation – common methods

Straight-line method:

assumption: asset used evenly throughout its life;

this method is appropriate when benefits to be derived from

the asset are expected to be evenly received throughout theasset’s useful life;

annual depreciation amount:

cost (or revalued amount)- residual (salvage) valueuseful life



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Depreciation – common methods(cont‟d)

Diminishing balance method:

assumption: more benefits received in earlier years of thelife of asset;

depreciation expense is calculated on the asset’s opening

written-down value x depreciation rate;

written-down value:

- cost (or revalued amount) less accumulated depreciation;

depreciation rate:

1residual value

cost or revalued amountuseful life



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Units of production method:

based on expected use or output of asset;

depreciation expense for the period is calculated as:

units produced in current period

total expected production cost or revalued amt - residual value



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Sum-of-digits method:

this method is appropriate where useful life might be relatedmore to production output than time and when economic

benefits expected to be derived are greater in the earlyyears than later years

depreciation expense:

- (cost - residual value) is multiplied by successively smallerfractions to calculate depreciation expense;

- numerator in fraction - changes each year, and is the yearsremaining of the asset’s useful life at the beginning of the

period;

- example for the 2nd year if useful life = 5 years:

(cost or revalued amt residual value) 4

15 (=1+2+3+4+5)



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Depreciation – useful life

Management should consider the following factors whenestimating the useful life of an asset:

expected use;

physical wear and tear;

technical or commercial obsolescence;

legal or similar limits.

Useful life is subject to periodic review.

Land is not subject to depreciation as it does not have a limiteduseful life.



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The cost model

AASB 116 requires that assets are carried at cost less anyaccumulated:

depreciation;

impairment losses.

Repair and maintenance costs are expensed as incurred, notcapitalised.

Capitalisation requires (at time of expenditure) increased

probable future economic benefit: for example, replacement of car engine.

discussed in week 6



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The revaluation model - fundamentals

As an alternative to the cost model AASB 116 allows therevaluation model to be used for classes of assets.

Revaluation: adjustment of PPE’s carrying amount so that it

reflects its current fair value.

Measurement basis is fair value (FV).

Frequency of revaluations is not specified, but must beperformed with sufficient regularity such that the carrying

amount of assets is not materially different from their FV. Revaluation performed on a class basis.

Accounting performed on an asset-by-asset basis.



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The revaluation model – accounting onan asset-by-asset basis

Cost Accumulate

ddepreciation

Carryingvalue

Fair valueIncrement/(decrement)

Plant A 200,000 100,000 100,000 150,000

Plant B 140,000 40,000 100,000 80,000

TOTAL 340,000 140,000 200,000 230,000

50,000

(20,000)

30,000

A Ltd has decided to change from the cost model to therevaluation model to account for plant.

At 30 June 2013 A Ltd owned the following plants:

A revaluation increment will be recorded for Plant A and arevaluation decrement will be recorded for Plant B.

class ofassets



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The revaluation model:revaluation increments

Increments are

credited to equity: “asset revaluation surplus” (ARS) account;

through other comprehensive income (OCI);

not part of profit/loss (P&L) for the year.

The revaluation of plant A would be recorded as follows:

Dr Accum. depreciation 100,000 *

Cr Plant 50,000 **Cr Gain on revaluation (OCI) 50,000 ***

* Removal of existingaccumulated depreciation

** Cost - FV(200,000 – 150,000) = 50,000 *** Amount of increment



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The revaluation model:revaluation increments (cont‟d)

AASB 116 requires the tax effects of the revaluation to be consideredand the ARS account to be recognised net of the resulting tax effect.

This is achieved by debiting a special type of income tax expense as

part of other comprehensive income (OCI) and crediting a deferred taxliability (DTL).

An upwards revaluation of an asset creates a taxable temporarydifference (TTD) leading to a deferred tax liability (DTL).

For plant A this would be calculated as:

CA – TB = TTD x 30% = DTL

150,000 – 100,000 = 50,000 x 30% = 15,000

Based on new FV of asset

Assumes that taxand acct. depn. rates

are the same



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The revaluation model:revaluation increments (cont‟d)

The tax effect for plant A would be recorded as follows:

Dr Income Tax Expense (OCI) 15,000Cr Deferred tax liability 15,000

Combined entry:

Dr Accum. depreciation 100,000Dr Income tax expense (OCI) 15,000

Cr Plant 50,000Cr Deferred tax liability 15,000Cr Gain on revaluation (OCI) 50,000

At year end the OCI accounts are closed against the ARS:

Dr Gain on revaluation (OCI) 50,000Cr Income tax expense (OCI) 15,000Cr Asset revaluation surplus (ARS) 35,000



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The revaluation model:revaluation decrements

The accounting treatment of a revaluation decrement is asfollows:

immediate recognition of an expense;

no extra tax-effect entries beyond the tax-effect worksheet.

The revaluation of Plant B would be recorded as follows:

Dr Accum. depreciation 40,000 *Dr Loss on revaluation (P&L) 20,000 **

Cr Plant 60,000 ****Removal of existingaccumulated depreciation

***Cost - FV

(140,000 – 80,000) = 60,000

**Amount of decrement

Please note: The loss on revaluation (P&L) leads to a temporary difference and deferred taxesas well. However, since it is part of the accounting profit (P&L) we deal with it together with

all other differences between accounting profit and taxable income (see week 3 topic).



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The revaluation model:reversing previous increments

A decrement reversing a previous incrementeliminates any ARS before recognising an expense.

In relation to plant B, assume that a gross revaluationincrement of $10,000 had been made in 2011.



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The revaluation model:reversing previous increments (cont‟d)

The revaluation of plant B would be recorded asfollows:

Dr Accum. depreciation 40,000

Dr Deferred tax liability 3,000Dr Loss on revaluation (OCI) 10,000Dr Loss on revaluation (P&L) 10,000

Cr Income tax expense (OCI) 3,000Cr Plant 60,000

Workings for journalGross decrement 20,000Reversal of prev. increment (10,000) – tax effect 3,000DR to P&L 10,000

Please note: Here again, the loss on revaluation (P&L) leads also to a temporary differenceand deferred taxes. We would deal with it together with all other differences

between accounting profit and taxable income. What would the journal entryfor this effect be?



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The revaluation model:reversing previous increments (cont‟d)

At year end the OCI accounts are closed against ARS:

Dr Income tax expense (OCI) 3,000

Dr Asset revaluation surplus (ARS) 7,000Cr Loss on revaluation (OCI) 10,000



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The revaluation model:reversing previous decrements

An increment reversing a previous decrement isrecognised through profit/loss (P&L).

Any excess is recorded as other comprehensiveincome (OCI) and increases ARS (net of related taxeffects).

In relation to plant A, assume that a revaluation

decrement of $15,000 had been made in 2011.



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The revaluation model: reversingprevious decrements (cont‟d)

The revaluation of plant A would be recorded asfollows:

Dr Accum. depreciation 100,000

Dr Income tax expense (OCI) 10,500Cr Plant 50,000Cr Gain on revaluation (P&L) 15,000Cr Gain on revaluation (OCI) 35,000Cr Deferred tax liability 10,500

Working for journalGross increment 50,000Reversal prev. decrement (15,000) (P&L)Gain on revaluation (OCI) 35,000Less: tax effect (30%) (10,500)CR to ARS 24,500

Please note: The P&L part of the gain onrevaluation is a reversal of a previous loss onrevaluation (P&L). It reverses also theassociated temporary difference and deferredtaxes when we account for differences betweenaccounting profit and taxable income.



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The revaluation model: reversingprevious decrements (cont‟d)

At year end the OCI accounts are closed against ARS:

Dr Gain on revaluation (OCI) 35,000

Cr Income tax expense (OCI) 10,500Cr Asset revaluation surplus (ARS) 24,500



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The revaluation model:depreciation of revalued assets

When an asset is revalued, the depreciation chargeto be recorded over the remaining useful life of theasset is recalculated by reference to the fair value of

the asset.



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The revaluation model:comprehensive example

On 30 June 2011 the statement of financial position of A LTD showedthe following non-current assets after charging depreciation:

Description $Building 300,000 Accumulated depreciation - Building (100,000)

Plant 120,000 Accumulated depreciation - Plant (40,000)



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The revaluation model:comprehensive example (cont‟d)

The company has adopted the revaluation model for the measurementof all property, plant and equipment. This has resulted in therecognition in previous periods of an asset revaluation surplus for thebuilding of $ 14,000. The plant consists of a machine purchased on the

1 July, 2010. On 30 June 2011, an independent valuer assessed thefair value of the building to be $160,000 and the plant to be $ 90,000.The income tax rate is 30%.

Required:

1. Prepare the journal entries to revalue the building and the plant as at

30 June 2011.2. Assume that the building and plant had remaining useful lives of 5 years

and 4 years respectively, with zero residual value. Prepare the journalentries to record depreciation expense for the year ended 30 June 2012using the straight line method.



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1. 30/06/2011

Dr Accumulated depreciation – building 100 000Dr Loss on revaluation (OCI) 20 000Dr Deferred tax liability 6 000

Dr Loss on revaluation (P&L) 20 000Cr Income tax expense (OCI) 6 000Cr Building 140 000

Dr Income tax expense (OCI) 6 000Dr Asset revaluation surplus (ARS) – building 14 000

Cr Loss on revaluation (OCI) 20 000

Please note: If we did the journal entry for the tax effect of the loss on revaluation(P&L) right away it would look like

Dr DTA 6,000Cr Income Tax expense 6,000



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1. 30/06/2011 (cont‟d)

Dr Accumulated depreciation – plant 40 000Dr Income tax expense (OCI) 3 000

Cr Plant 30 000

Cr Gain on revaluation (OCI) 10 000Cr Deferred tax liability 3 000

Dr Gain on revaluation (OCI) 10 000Cr Income tax expense (OCI) 3 000Cr Asset revaluation surplus (ARS) – plant 7 000



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2. 30/06/2012

Dr Depreciation expense – building 32 000Cr Accumulated depreciation – building 32 000

($160 000/5)

Dr Depreciation expense – plant 22 500Cr Accumulated depreciation – plant 22 500

($90 000/ 4)



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The revaluation model:transfers from ARS

Transfers may be made from the ARS in the followingcircumstances:

When a revalued asset is derecognised (ie scrapped or

sold) → the balance in the ARS may be transferred toretained earnings.

When a revalued asset is being depreciated → the ARS

may be progressively transferred to retained earnings overthe useful life of the asset.

Bonus share issues may be made from the ARS

DR ARSCR Retained earnings

DR ARSCR Share capital



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Choosing between the models

There is a cost disincentive to adopt the revaluationmodel (Australian experience).

Cost model harmonises with U.S. GAAP.

Revaluation model provides increased relevance &reliability.



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Accounting for gains/losses fromderecognition

Note: Assets classified ‘held for sale’ are treated according to AASB 5→ the following applies only to PPE which has not been classified as

‘held for sale’.

Gain or loss from derecognition of an item of property, plant and

equipment is to be calculated as the difference between (AASB 116):

net disposal proceeds (if any); and

the asset’s carrying amount.

Derecognition

the point in time when an asset is removed from the statement of financial

position (balance sheet):

- when an asset is sold; or

- when no future economic benefits are expected from an asset’s use or

disposal.



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Accounting for gains/losses fromderecognition (cont‟d)

Example:

A Ltd acquired a machine on 1 July 2007 for $50,000;

Useful life = 4 years; residual value = $10,000;

On 1 July 2009 the machine was sold for $45,000. The journal entries to account for the sale are:

Dr Cash 45,000Cr Proceeds on sale 45,000

Dr Carrying amount of asset 30,000Dr Accumulated depreciation 20,000Cr Machine 50,000

The gain on sale is $45,000 - $30,000 = $15,000 It is common toshow this gain on

sale net in theincome statement



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Accounting for gains/losses fromderecognition (cont‟d)

When an revalued asset is sold, any resultingbalance in the revaluation surplus (AASB 116)

may be transferred directly to retained earnings;

cannot be transferred to profit/loss (i.e. the so-called‘recycling’ is not allowed);

hence, for non-current assets under the revaluationmodel any gain on sale shown in profit/loss will be less

than for assets under the cost model.



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Disclosure requirements

For each class of property, plant and equipment thefollowing must be disclosed (AASB 116):

measurement basis used for gross carrying amount;

depreciation methods used;

useful lives or depreciation rates used;

gross carrying amount and accumulated depreciationat beginning and end of period;

reconciliation of carrying amount at beginning and endof period.



Disclosure requirements (cont‟d)

The required disclosures regarding asset revaluations(AASB 116) are:

effective date of revaluation;

whether an independent valuer was involved;

methods and assumptions applied;

extent to which fair values were determined, with reference toobservable prices in active markets or recent market transactions;

for each revalued class, the carrying amount if the cost model wasused;

the revaluation surplus, indicating the change for the period andany restrictions on distribution of the balance to shareholders.

Documents

Accounting for Property, Plant and Equipment (Acquisition, Depreciation and Revaluation)