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

Readings (BEFORE the lecture!)

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 your revision) where we will have more examples and discussions around the topics.

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

Learning objectives

1.

2.

3.

4.

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

understand the criteria for initial recognition of PPE;

understand how to measure PPE on initial recognition;

explain the alternative ways, in which PPE can be measuredsubsequent to initial recognition;

understand the nature and calculation of depreciation;

explain the cost model of measurement;

explain the revaluation model of measurement;

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

account for derecognition;

implement the disclosure requirements of AASB 116.

5.

6.

7.

8.

9.

10.

Conceptual framework: general principles about

definition,

recognition and

measurement

of assets and liabilities.

Now we look at specific accounting standards inparticular type of assets:

relation to a

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

Including tax implications (AASB 112).

Overview AASB 116:Property, Plant and Equipment (PPE)

DefinitionInitial 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 ModelRevaluation Model

DerecognitionDisclosure requirements

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 are non-current in nature).

more than one period (ie. they

AASB 116 specifically excludes: also special rulesfor investment

property – AASB 140

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.

Initial recognition of PPE

Cost recognised as an asset if:

it is probable that economic benefitsand

the cost can be reliably measured.

will flow to the entity,

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 have different useful lives.

Initial measurement of PPE

PPE is initially measured at cost, which includes:

purchase price (at fair value);

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

to the

borrowing costs (AASB 123);

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

for example, an offshore oil platform

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

more details on next slide

includes duties and taxes but excludes rebates and discounts

Directly attributable costs

„Directly attributable costs‟ include

a) costs of employee benefits arising fromacquisition of the item of property, plant

costs of site preparation;

initial delivery and handling costs;

installation and assembly costs;

the construction orand equipment;

b)

c)

d)

e) costs of testing whether asset is functioning properly, afterdeducting the net proceeds from selling any items produced while bringing the asset to that location and condition (e.g. samples);

professional fees.f)

Measurement subsequent to initialrecognition

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.

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

Each model will be discussed in detail later

Depreciation – fundamentals

AASB 116 includes the following definitions:

Depreciation:

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

Depreciable amount:

the cost of an asset less its residual value (or other

of an

appropriate amounts substituted for cost – eg. fair value).Residual value:

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

Useful life:

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

Depreciation – fundamentals (cont‟d)

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

AASB 116 does not specify how this allocation process should be undertaken.

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

Please note that depreciation applies to both therevaluation model!

cost and the

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

DR Depreciation expense

CR Accumulated depreciation

Depreciation – common methods

Straight-line method:

assumption: asset used evenly throughout its life;

this method is appropriate when benefits to be derived

fromthe asset are expected to be evenly received throughoutasset’s useful life;

annual depreciation amount:

the

cost (or revalued amount) - residual

(salvage) valueuseful

life

Depreciation – common methods(cont‟d)

Diminishing balance method:

assumption: more benefits received in earlier yearslife of asset;

of the

depreciation expense is calculated on the asset’s openingwritten-down value x depreciation rate;

written-down value:

- cost (or revalued amount) less accumulated depreciation;

depreciation rate:

residual value 1 useful life

cost or revalued amount

Depreciation – common methods(cont‟d)

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 cost valueor revalued amt- residualtotal expected production

Depreciation – common methods(cont‟d)

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 early years than later years

depreciation expense:- (cost - residual value) is multiplied by successively smaller

fractions to calculate depreciation expense;

numerator in fraction - changes each year, and is the years remaining of the asset’s useful life at the beginning of the period;

-

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

(cost or revalued amt residual value) 4 15 (=1+ 2 + 3 + 4 + 5)

Depreciation – useful life

Management should consider the followingestimating the useful life of an asset:

factors when

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 notuseful life.

have a limited

The cost model

AASB 116 requires thataccumulated:

depreciation;

impairment losses.

assets are carried at cost less any

Repair and maintenance costs are expensedcapitalised.

as incurred, not

Capitalisation requires (at time of expenditure) increasedprobable future economic benefit:

for example, replacement of car engine.

discussed in week 6

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 thatreflects its current fair value.

Measurement basis is fair value (FV).

Frequency of revaluations is not specified, but must be performed 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.

it

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

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

theclass ofassets

At 30 June 2013 A Ltd owned the following plants:

ecrement)

A revaluation increment will be recorded for Plant Arevaluation decrement will be recorded for Plant B.

and a

CostAccumulate

d depreciation

Carrying value

Fair valueIncrement/(d

Plant A 200,000 100,000 100,000 150,000 50,000

Plant B 140,000 40,000 100,000 80,000 (20,000)

TOTAL 340,000 140,000 200,000 230,000 30,000

The revaluation model:revaluation increments

Increments are

credited to equity: “asset revaluationaccount;

through other comprehensive income

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

surplus” (ARS)

(OCI);

The revaluation of plant A

Dr Accum. depreciation

would be recorded as follows:

100,000 *CrCr

PlantGain on revaluation

50,000 **50,000 ***(OCI)

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

* Removal of existing accumulated depreciation

The revaluation model:revaluation increments (cont‟d) AASB 116 requires the tax effects of the revaluation to be considered

and 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 tax liability (DTL).

An upwards revaluation of an asset creates a taxable temporary difference (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% = 15,000Based on new FV of asset

Assumes that tax and acct. depn. rates

are the same

The revaluation model:revaluation increments (cont‟d) The tax effect for plant A would be recorded as follows:

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

Combined entry:

DrDr

Accum. depreciationIncome tax expense (OCI)

100,00015,000

CrCrCr

At year end

PlantDeferred tax liabilityGain on revaluation (OCI)

the OCI accounts are closed

50,00015,00050,000

against the ARS:

50,00015,000

Dr Gain on revaluation (OCI)CrCr

Income tax expense (OCI)Asset revaluation surplus (ARS) 35,000

The revaluation model:revaluation decrements

The accounting treatment of a revaluationfollows:

immediate recognition of an expense;

decrement is as

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

The revaluation of Plant B would be recorded as follows:

DrDr

Accum. depreciation 40,00020,000

***60,000***

Loss on revaluation (P&L)Cr Plant

Please note: The loss on revaluation (P&L) leads to a temporary difference and deferred taxes as well. However, since it is part of the accounting profit (P&L) we deal with it together withall other differences between accounting profit and taxable income (see week 3 topic).

***Cost - FV

(140,000 – 80,000) = 60,000

**Amount of decrement*Removal of existingaccumulated depreciation

The revaluation model:reversing previous increments

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

In relationincrement

toof

plant B, assume that a gross revaluation$10,000 had been made in 2011.

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

follows:B would be recorded as

DrDr Dr Dr

Accum. depreciationDeferred tax liabilityLoss on revaluation (OCI)Loss on revaluation (P&L)

40,0003,000

10,00010,000

CrCr

IncomePlant

tax expense (OCI) 3,00060,000

Please note: Here again, the loss on revaluation (P&L) leads also to a temporary difference and deferred taxes. We would deal with it together with all other differences between accounting profit and taxable income. What would the journal entry for this effect be?

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

The revaluation model:reversing previous increments (cont‟d) At year end the OCI accounts are

ARS:closed against

DrDr

Income tax expense (OCI)Asset revaluation surplus (ARS)

3,0007,000

Cr Loss on revaluation (OCI) 10,000

The revaluation model:reversing previous decrements

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

Any excess is recorded as other comprehensive income (OCI) and increases ARS (net of related effects).

In relation to plant A, assume that a revaluation decrement of $15,000 had been made in 2011.

tax

The revaluation model: reversingprevious decrements (cont‟d)

The revaluation of plant A wouldfollows:

be recorded as

DrDr

Accum. depreciationIncome tax expense (OCI)

100,00010,500

CrCr Cr Cr

PlantGain on revaluation (P&L) Gain on revaluation (OCI) Deferred tax liability

50,00015,00035,00010,500

Please note: The P&L part of the gain on revaluation is a reversal of a previous loss on revaluation (P&L). It reverses also the associated temporary difference and deferred taxes when we account for differences between accounting profit and taxable income.

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

The revaluation model: reversingprevious decrements (cont‟d)

At year end the OCI accounts areARS:

closed against

Dr Gain on revaluation (OCI) 35,000CrCr

Income tax expense (OCI) 10,50024,500Asset revaluation surplus (ARS)

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 ofthe asset.

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

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

The revaluation model:comprehensive example (cont‟d) The company has adopted the revaluation model for the measurement

of all property, plant and equipment. This has resulted in the recognition in previous periods of an asset revaluation surplus for the building of $ 14,000. The plant consists of a machine purchased on the1 July, 2010. On 30 June 2011, an independent valuer assessed the fair 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 at30 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 journal entries to record depreciation expense for the year ended 30 June 2012 using the straight line method.

The revaluation model:comprehensive example (cont‟d

)1. 30/06/2011

DrDr Dr Dr

Accumulated depreciationLoss on revaluation (OCI) Deferred tax liabilityLoss on revaluation (P&L)

– building 100 00020 000

6 00020 000

CrCr

Income tax expense (OCI)Building

6 000140 000

DrDr

Income tax expense (OCI)Asset revaluation surplus (ARS)

6 00014 000– building

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

The revaluation model:comprehensive example (cont‟d

)1. 30/06/2011 (cont‟d)

DrDr

Accumulated depreciation – plantIncome tax expense (OCI)

40 0003 000

CrCrCr

PlantGain on revaluation (OCI) Deferred tax liability

30 00010 000

3 000

Dr Gain on revaluation (OCI) 10 000CrCr

Income tax expense (OCI)Asset revaluation surplus (ARS)

37

000000– plant

The revaluation model:comprehensive example (cont‟d)2. 30/06/2012

Dr Depreciation expense – building 32 000Cr Accumulated depreciation

($160 000/5)– building 32 000

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

($90 000/ 4)

The revaluation model:transfers from ARS

Transfers may be made from the ARS in the followingcircumstances:

When a revalued asset is derecognised (ie scrapped orsold) → the balance in the ARS may be transferred toretained earnings.

When a revalued asset is being depreciated → the ARSmay be progressively transferred to retained earnings over the useful life of the asset.

Bonus share issues may be made from the ARSDR ARS

CR Share capital

DR ARSCR Retained earnings

Choosing between the models

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

Cost model harmonises with U.S. GAAP.

Revaluationreliability.

model provides increased relevance &

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 ordisposal.

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

Cr45,00045,000Proceeds on sale

DrDr

Carrying amount of assetAccumulated depreciationCr Machine

30,00020,000

50,000

It is common toshow this gain on sale net in the income statement

$45,000 - $30,000 = $15,000The gain on sale is

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 revaluation model any gain on sale shown in profit/loss will be less than for assets under the cost model.

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 depreciation at 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 was used;

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

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