1. Chapter 5 - PROPERTY, PLANT AND EQUIPMENT (IAS16, IAS23, IAS20, IAS40)
ACTG 6580
Chapter 5 - PROPERTY, PLANT AND EQUIPMENT (IAS16, IAS23, IAS20, IAS40)

2. Definition of Property, Plant and Equipment
IAS16 defines property, plant and equipment as "tangible items that:
(a) are held for use in the production or supply of goods or services, for rental to others, or for administrative purposes; and
(b) are expected to be used during more than one period."
This definition covers the majority of the tangible non-current assets that might normally be held by a business entity.

3. Recognition of Property, Plant and Equipment
An item of property, plant and equipment should be recognised as an asset if and only if:
(a) it is probable that future economic benefits associated with the item will flow to the entity concerned, and
(b) the cost of the item can be measured reliably.
Routine servicing, repair and maintenance costs are not capital expenditures. But the cost of major replacements should be treated as capital expenditures and recognised as an addition to the carrying amount of the asset concerned.

4. Initial Measurement of Property, Plant and Equipment
On initial recognition, property, plant and equipment should be measured at cost. Cost includes:
Purchase price, including import duties and non-refundable purchase taxes, less trade discounts
Costs that are directly attributable to bringing the item to the location and condition necessary for it to be operated as intended
The estimated costs of dismantling and removing the item and restoring the site on which the item is located, as long as the obligation to meet these costs is incurred when the item is acquired

5. Subsequent Measurement of Property, Plant and Equipment
After initial recognition, items of property, plant and equipment may be measured using either:
The cost model; items are carried at cost less any accumulated depreciation and less any accumulated impairment losses.
The revaluation model; items are carried at fair value at the date of revaluation, less any subsequent accumulated depreciation and less any subsequent accumulated impairment losses.

6. Periodic Valuation Carrying value
US GAAP
Revaluation of fixed assets is not allowed.
IFRS
If a company chooses to account for PP&E and natural resources at fair value using the revaluation method:
Cost or fair value must be applied to an entire class of PP&E.
Different classes can have different policies.
Fair value is the amount at which an asset could be exchanged in an arm’s length transaction between knowledgeable and willing parties.
A professional appraiser may be used to establish fair value.
Revaluations must be performed periodically to ensure the carrying value of that asset class is not materially different than its fair value.

7. Periodic valuation Carrying value
IFRS
Accounting for revaluation:
Increases in value should be credited through OCI to a revaluation surplus account in equity, unless it reverses a loss that was previously expensed, in which case that portion may be credited to income.
Decreases in value should be expensed unless it reverses a previous revaluation surplus account relating to the same asset. That portion can be debited through OCI to the revaluation surplus account in equity.
If the revalued basis of an asset exceeds the cost basis, there will be an increase in annual depreciation. To the extent there is an increase in depreciation expense, per IAS , an entity may reverse the portion of reserve surplus related to this increase by debiting revaluation surplus and crediting retained earnings. Alternatively, this transfer may be computed upon disposal.

8. Periodic valuation Carrying value
IFRS
Accounting for revaluation (continued):
When an asset is disposed of, any remaining related revaluation surplus account in equity may be transferred to retained earnings. The revaluation surplus can never be credited to income.
If an asset is revalued, an entity may account for the accumulated depreciation at the date of revaluation in two ways:
Depreciation elimination method: The accumulated depreciation can be eliminated against the asset itself.
Proportionate restatement method: The accumulated depreciation can be restated proportionately with the change in the gross carrying value of the asset so that the carrying value of the asset after revaluation equals its revalued amount.

9. Periodic valuation Carrying value
In 2006, Ernst & Young LLP provided an overview of 65 selected large, multinational companies reporting using IFRS. Only one company used the revaluation option for any of its PP&E.
In a recent study, Hans B. Christensen and Valeri Nikolaev of the University of Chicago Booth School of Business looked at the valuation choices made by 1,539 German and UK companies in the first year of preparing IFRS financial statements. They found that only 3% of the companies chose to use fair value accounting for at least one class of assets.  

10. Periodic Valuation Example 1:
A company that reports using IFRS acquired weight-lifting equipment on January 1, 2011, at a cost of $10,000. This is the company’s only equipment. The company uses fair value for its equipment using IAS 16. On December 31, 2012, the net book value is $8,000 (cost of $10,000 less accumulated depreciation of $2,000), while the fair value is determined to be $8,800.
What journal entries would be required to record the revaluations in 2012?

11. Periodic valuation Carrying value
Example 1 solution:
Accumulated depreciation $ 2,000
Equipment $ 2,000
(To eliminate accumulated depreciation.)
Equipment $ 800
Revaluation surplus – equipment (OCI) $ 800
(To write equipment up to fair value.)

12. Periodic Valuation Example 2:
A company that reports using IFRS acquired an excavator on January 1, 2010, at a cost of $10,000. This excavator represents the company’s only piece of equipment. The company uses fair value for its equipment using IAS 16. This excavator is being depreciated on a straight-line basis over its 10-year useful life. There is no residual value at the end of the 10-year period. In both 2010 and 2011, depreciation would be $1,000. On December 31, 2011, the fair value is determined to be $8,800. On December 31, 2013, the fair value is determined to be $5,000. The company’s accounting policy is to reverse a portion of revaluation surplus related to the increased depreciation expense.
Determine what accounts would be impacted if this activity is recorded for 2010 through 2013.

13. Periodic valuation Example 2 solution: 2010: Equipment $ 10,000 2012:
Cash $ 10,000
(To record purchase of equipment.)
Depreciation expense $ 1,000
Accumulated depreciation $ 1,000
(To record depreciation.)
2011:
Depreciation expense $ 1,000
Accumulated depreciation $ 1,000
Accumulated depr $ 2,000
Equipment $ 1,200
Revaluation surplus
– equipment (OCI) 800
(To record revaluation.)
2012:
Depreciation expense $ 1,100
Accumulated depreciation $ 1,100
(To record depreciation.)
Reval. surplus – equip. (OCI) $ 100
Retained earnings $ 100
(To reverse portion of reserve surplus related to increased depreciation expense. Note that this journal entry is optional.)

14. Periodic valuation Example 2 solution (continued): 2013:
Depreciation expense $ 1,100
Accumulated depreciation $ 1,100
(To record depreciation.)
Reval. surplus – equip. (OCI) $ 100
Retained earnings $ 100
(To reverse portion of reserve surplus related to increased depreciation expense. Note that this journal entry is optional.)
Accumulated depreciation $ 2,200
Reval. surplus – equip. (OCI)
Loss ,000
Equipment $ 3,800
(To record devaluation of equipment.)

15. Depreciation
IAS16 defines depreciation as "the systematic allocation of the depreciable amount of an asset over its useful life".
Depreciable amount is "the cost of an asset, or other amount substituted for cost, less its residual value".
Residual value is "the estimated amount that an entity would currently obtain from disposal of the asset, after deducting the estimated costs of disposal…".
Useful life is "the period over which an asset is expected to be available for use by an entity …".

16. Purpose of depreciation
The sole purpose of charging depreciation is to allocate an expense between accounting periods. In particular:
The depreciation process makes no attempt to show assets at their current values.
Charging depreciation does not guarantee that there will be funds available to replace assets when they come to the end of their useful lives.

17. Review of residual values and useful lives
The residual value and useful life of property, plant and equipment should be reviewed at least at the end of each financial year.
If expectations differ from previous estimates, these should be accounted for as a change in an accounting estimate in accordance with IAS8.
The asset's depreciable amount is revised to reflect any change in residual value and then this amount is allocated as depreciation over the remainder of the asset's expected useful life.

18. Depreciation methods
The depreciation method chosen in relation to an item of property, plant and equipment should match the usage pattern of that item.
Available depreciation methods include:
the straight-line method;
the diminishing balance method;
the units of production method.

19. Review of depreciation methods
The depreciation method applied to an item of property, plant and equipment should be reviewed at least at the end of each financial year. If the usage pattern of the asset has changed, the depreciation method should be changed accordingly.
A change in depreciation method is accounted for as a change in an accounting estimate in accordance with the requirements of IAS8.

20. Cost allocation issues Depreciation
US GAAP
Depreciable base: component depreciation is allowed, but is rarely done because it complicates the accounting.
IFRS
Depreciable base: IAS states, “each part of an item of property, plant and equipment with a cost that is significant in relation to the total cost of the item shall be depreciated separately.”

21. Depreciation Example 3:
A company acquires a truck at a cost of $60,000. The service life is expected to be four years. Based on reliable historical data, the company believes the truck can be sold at the end of four years for $10,000. Additionally, the tires must be replaced every two years. The transmission must be replaced every three years. On the initial date of acquisition, the tires have a cost of $4,000 and the transmission has a cost of $6,000.
What is the depreciable base and service life using US GAAP and IFRS?
Assume the company chooses not to use component
depreciation using US GAAP.

22. Depreciation Example 3 solution: Depreciable base
Service life US GAAP IFRS
Truck 4 years $ 50,000 $ 40,000
Tires 2 years – 4,000
Transmission 3 years – 6,000
$ 50,000 $ 50,000

23. IFRS Depreciation Example 3 solution: Service life Depr. Basis Depr.
Truck 4 years $ 40,000 $ 10,000
Tires 2 years 4,000 2,000
Transmission 3 years 6,000 2,000
$ 50,000 $ 14,000

24. Disposition
Example 4:
A company acquired its only building on January 1, 2010, at a cost of $4 million. The building has a 20-year life and is being depreciated on a straight-line basis. On December 31, 2011, the net book value of the building was $3.6 million. The company revalued the building when the fair value of the building was $3.78 million on December 31, On December 31, 2013, the company sold the building for $3.6 million.
The company’s accounting policy is to reverse a portion of the surplus account related to increased depreciation expense.
Show the journal entry to record the sale.

25. Disposition Example 4 solution:
The entry to record the sale would be as follows:
Cash $ 3,600,000
Accumulated depreciation 420,000
Revaluation surplus (OCI) 160,000
Building cost 3,780,000
Gain on sale 240,000
Retained earnings 160,000
Note: if the asset hadn’t been revalued, the NBV of the building would have been $3.2 million (cost of $4.0 million less $200,000 depreciation x 4 years). If the building was sold for $3.6 million, the gain would have been $400,000.
Since the building was revalued, the depreciation expense over the four years was $820,000 ($200,000 in 2010 and 2011 and $210,000 in 2012 and 2013). Reserve surplus was reduced by $20,000 during this period with the credit applied directly to retained earnings. Reserve surplus can never be credited to income. Therefore, after reversing the remaining reserve surplus of $160,000 to retained earnings, the resulting gain is $240,000.

26. Main disclosure requirements of IAS16
For each class of property, plant and equipment:
The measurement bases used;
The depreciation methods used;
The gross carrying amount and accumulated depreciation at the beginning and end of the accounting period;
A reconciliation of the carrying amount at the beginning and end of the period, showing additions, disposals, revaluation increases and decreases, depreciation, impairment losses and any other movements.

27. Borrowing costs
IAS23 defines borrowing costs as "interest and other costs that an entity incurs in connection with the borrowing of funds".
Borrowing costs that are directly attributable to the acquisition, construction or production of a "qualifying asset" must be capitalised as part of the cost of that asset.
Other borrowing costs are recognised as an expense in the period in which they are incurred.

28. Qualifying assets
Qualifying assets are those which take a substantial period of time to get ready for use or sale.
The capitalisation of borrowing costs should begin when:
(a) expenditure is being incurred on the asset;
(b) borrowing costs are being incurred, and
activities are in progress that are necessary so as to prepare the asset for its intended use or sale.
Capitalisation ends when substantially all of the activities necessary to prepare the asset for its intended use or sale are complete.

29. Acquisition Interest costs during construction
US GAAP
Interest costs are capitalized to the extent that these costs could have been avoided had the expenditures been used to repay the debt rather than to acquire or construct the asset.
IFRS
Borrowing costs related to a loan obtained specifically to acquire or construct the asset are capitalized in their entirety (reduced by any income from temporary investment of these funds).
Borrowing costs related to funds obtained for a purpose other than acquisition or construction of the asset are determined by applying an average capitalization rate to the expenditures on the asset.

30. Acquisition Interest costs during construction
US GAAP
Interest revenue cannot be netted against interest cost.
IFRS
Interest revenue is netted against interest cost. When funds borrowed to finance the acquisition of a qualified asset are temporarily invested, the interest cost should be reduced by any investment income earned on these funds.

31. Acquisition Interest costs during construction
Example 5:
To finance construction of a qualifying asset, the company borrows $250,000 on January 1, 2011, at an interest rate of 8%. The company makes the following disbursements during the 24-month construction period: $100,000 on January 1, 2011; $50,000 on June 30, 2011; $50,000 on January 1, 2012, and $50,000 on June 30, Construction of the asset is completed on December 31, 2012, and it is ready for its intended use. During the construction period, excess funds are invested, which earn 5% in 2011 and 4% in 2012.
What is the amount of interest that should be capitalized using US GAAP and IFRS?

32. Acquisition Interest costs during construction
Example 5 solution:
US GAAP: The interest cost capitalized for the two-year period of $28,000 is calculated by determining the portion of the interest cost the company incurs during the construction of the building that theoretically could have been avoided. Interest revenue is not netted against interest expense.
Date
Amount disbursed
Months outstanding
Weighted disbursement
January 1, 2011
$ 100,000
24/12
$ 200,000
June 30, 2011
50,000
18/12
75,000
January 1, 2012
12/12
June 30, 2012
6/12
25,000
Weighted-average accumulated expenditures
$ 350,000
Interest capitalized at an 8% interest rate
$ 28,000

33. Acquisition Interest costs during construction
Example 5 solution (continued):
IFRS: IAS 23 allows all the interest cost incurred of $40,000 (250,000 x 8% x 2 years) to be capitalized less the income earned from temporary investment of those borrowings (paragraph 12). Therefore, under IFRS, the investment income earned is calculated as follows:
Thus, the net interest cost to be capitalized for this asset is $32,750 ($40,000-$7,250) using IFRS.
Date
Amount available
Earnings rate
Year
Investment income
January 1, 2011
$ 150,000 5%
1/2
$ 3,750
June 30, 2011
100,000
2,500
January 1, 2012
50,000 4%
1,000
June 30, 2012 – 0%
$ 7,250

34. Government Grants (IAS20)
Government grants should be recognised in profit or loss "over the periods in which the entity recognises as expenses the related costs which the grants are intended to compensate".
Therefore a grant for the acquisition of an asset should be recognised when calculating profit or loss for the periods in which depreciation is charged on that asset.
The grant may be credited to a deferred income account and then systematically transferred to the statement of comprehensive income over the useful life of the asset, or
The grant may be deducted from the carrying amount of the asset. This will result in reduced depreciation charges over the asset's useful life.

35. Investment Property (IAS40)
Investment property is property (land and buildings) which is “held ... to earn rentals or for capital appreciation or both, rather than:
(a) for use in the production or supply of goods or services;
(b) for administrative purposes, or
(c) for sale in the ordinary course of business".

36. Measurement of Investment Property
Initial measurement is at cost. Subsequently, investment property may be measured using either:
The fair value model; the property is carried at fair value; gains and losses on adjusting fair value are recognised in the calculation of profit or loss each year. No depreciation taken.
The cost model; the property is carried at cost less any accumulated depreciation and less any accumulated impairment losses.