Module On Intermediate Accounting 2 Unit 1 Part 1

UNIT 1
Topic 1: Property, Plant, and Equipment
Introduction
This module focuses on the accounting and reporting of property,
plant and equipment. It introduces the learner to the subject, guides the
learner through the official text, develops the learner’s understanding of
the requirements through the use of examples and indicates significant
judgments that are required in accounting for property, plant and
equipment. Furthermore, the module includes questions designed to test
the learner’s knowledge of the requirements and to develop the learner’s
ability to account for property, plant and equipment.
Learning Outcome:
 Understand the nature and characteristics of property, plant, and
equipment
 Identify specific items of property, plant, and equipment
 Know the recognition of property, plant, and equipment
 Understand the initial and subsequent measurement of property, plant, and
equipment
Learning Objectives:
 to distinguish items of property, plant and equipment from other assets of

an entity
 to identify when items of property, plant and equipment qualify for
recognition in financial statements
 to measure items of property, plant and equipment on initial recognition
and subsequently
 to present and disclose property, plant and equipment in financial
statements
 to identify when an item of property, plant and equipment is to be
derecognized or transferred to another classification of asset, and account
for that derecognition or transfer
 to demonstrate an understanding of the significant judgements that are
required in accounting for property, plant and equipment.
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Topic Outline:
1.1 Definition and Examples of 1.6 Derecognition of Property,

Property, Plant, and Equipment Plant, and Equipment
1.2 Recognition of Property, 1.7 Fully depreciated property
Plant, and Equipment 1.8 Property classified as held for
1.3 Measurement of Property, sale
Plant, and Equipment 1.9 Idle or abandoned property
1.4 Elements of Cost 1.10 Disclosures related to PPE
1.5 Acquisition of Property
Presentation of Topic:
1.1 Definition of Property, Plant, and Equipment- Property, plant and
equipment are tangible assets 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.
Examples- Items of Property, plant, and equipment:

 Land  Motor vehicle
 Land improvements  Furniture and fixtures
 Building  Office equipment
 Machinery  Patterns, molds, and dies
 Ship  Tools
 Aircraft  Bearer plants
1.2 Recognition of Property, Plant, and Equipment- An entity shall recognize

the cost of an item of property, plant and equipment as an asset if, and only if:
(a) it is probable that future economic benefits associated with the item will
flow to the entity, and (b) the cost of the item can be measured reliably.
Note: Major spare parts and stand-by equipment qualify as property,

plant and equipment when an entity expects to use them during more than one
period.
1.3 Measurement of Property, Plant, and Equipment- An entity shall measure

an item of property, plant and equipment at initial recognition at its cost. Cost
is the amount of cash or cash equivalent paid and the fair value of other
consideration given to acquire an asset at the time of acquisition or
construction.
1.4 Elements of Cost

The cost of an item of property, plant and equipment comprises all of the
following:
(a) its purchase price, including legal and brokerage fees, import duties and non-
refundable purchase taxes, after deducting trade discounts and rebates.
(b) 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. These can include the costs of site preparation, initial delivery and
handling, installation and assembly, and testing of functionality.
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(c) the initial estimate of the costs of dismantling and removing the item and
restoring the site on which it is located, the obligation for which an entity incurs
either when the item is acquired or as a consequence of having used the item
during a particular period for purposes other than to produce inventories during
that period.
The following costs are not costs of an item of property, plant and equipment, and
an entity shall recognize them as an expense when they are incurred:
(a) costs of opening a new facility. (e) costs incurred while an item
(b) costs of introducing a new capable of operating in the manner
product or service (including costs of intended by management has yet to
advertising and be brought into use or is operated at
promotional activities). less than full capacity
(c) costs of conducting business in a (f) initial operating losses
new location or with a new class of (g) costs of relocating or
customer reorganizing part or all of an entity’s
(including costs of staff training). operations
(d) administration and other general
overhead costs.
1.5 Acquisition of Property

Acquisition on Cash Basis- The cost of an item of property, plant, and
equipment is the cash price equivalent at the recognition date plus directly
attributable costs.
For example: On 1 January 2020 an entity purchased an item of equipment with a
purchase price of P600,000, plus P50,000 nonrefundable purchase taxes and
additional P30,000 freight and installation cost. The total cost of equipment is
P680,000.
Note: “basket price” or lump sum price - apportion the single
price to the assets acquired on the basis of relative fair value.
For example- land and building are acquired at a single cost.
Land and buildings are separable assets, and an entity shall account for
them separately, even when they are acquired together.
Acquisition on Account- the cost of the asset is equal to the invoice price minus
the discount regardless of whether the discount is taken or not, the reason is that a
reasonably wise management would take advantage of all discounts.
Illustration: An equipment is purchased for P100,000, 2/10, n/30. The purchase
maybe recorded using either the gross or net method.
Gross Method:
1) To record the acquisition:
Equipment 100,000
Accounts Payable 100,000
2) To record the payment within discount period:

Cash 98,000
Equipment (100,000x2%) 2,000
3) To record the payment beyond the discount period:

Purchase discount lost 2,000
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Cash 100,000
Equipment 2,000
Net Method:
Equipment 98,000
2) To record the payment within discount period:

Cash 98,000
3) To record the payment beyond the discount period:

Purchase discount lost 2,000
Cash 100,000
Acquisition on installment basis- if an asset is offered at a cash price and at an

installment price and is purchased at the installment price, the asset shall be
recorded at the cash price. The excess of the installment price over the cash price
is treated as an interest to be amortized over the credit period.
Illustration: A machinery is purchased at an installment price of 350,000. The
terms are P50,000 down and the balance payable in three equal annual
installments. The cash price of the machinery is P290,000. A promissory note is
issued for the installment balance of P300,000.
Machinery 290,000
Discount on note payable 60,000
Note Payable 300,000
Cash 50,000
2) To record the first installment payment:

Cash 100,000
3) To amortize the discount on note payable:

Interest expense 30,000
Note Payable Fraction Interest expense

First year 300,000 3/6 30,000
Second year 200,000 2/6 20,000
Third year 100,000 1/6 10,000
Total 600,000 60,000
If there is no available cash price- The asset is recorded then at an

amount equal to the present value of all payments using an implied
interest rate.
Illustration: A machinery is acquired at an installment price of P700,000. The

terms are P100,000 down and the balance payable in three equal annual
installments. A note is issued for the balance of P600,000. There is no available
cash price for the machinery. However, the implied interest rate for this type of
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note is 10%. Using the implied interest rate of 10%, the present value of an
ordinary annuity of 1 is 2.487 for three periods.
Down Payment 100,000
Present Value of Note Payable
(200,000x2.487) 497,400
Total Cost of the Machinery 597,400

Present Value of Note 497,400
Implied interest 102,600

Machinery 597,400
Cash 100,000
2) To record the first installment payment:

Cash 200,000
3) To amortize the discount on note payable:

Interest expense* 49,740
*Recall the effective interest method (discussed during Intermediate
Accounting I) in amortizing the discount on note payable as interest expense.
Acquisition by Issuance of share capital- Accordingly, where a property is

acquired through the issuance of share capital, the property shall be measured at
an amount equal to the following in order of priority:
1) FAIR VALUE of property received
2) FAIR VALUE of the share capital
3) PAR VALUE OR STATED VALUE of the share capital
4)
Acquisition by Issuance of bonds payable- Accordingly, the asset acquired by
issuing bonds payable is measured in the following order:
1) FAIR VALUE of bonds payable
2) FAIR VALUE of asset received
3) FACE AMOUNT of bonds payable
Exchange- PAS 16, paragraph 24 provides that the cost of an item of property,
plant, and equipment acquired in exchange for a nonmonetary asset or a
combination of monetary and nonmonetary asset is measured at fair value.
However, the exchange is recognized at carrying amount under the following
circumstances:
a) The exchange transaction lacks commercial substance.
b) The fair value of the asset given or the fair value of the asset received is
not reliably measurable.
Commercial substance- Commercial substance is a new notion and is
defined as the event or transaction causing the cash flows of the entity to
change significantly by reason of the exchange.
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Exchange- with commercial substance
If a property is acquired in an exchange, the cost of the property is equal to
the following:
a) Fair value of asset given plus any cash payment- on the part of the
payor
b) Fair value of asset given minus any cash received- on the part of the
recipient
Note: Gain or Loss on exchange= Fair value of the asset given less its
carrying amount
Exchange- with no commercial substance

If a property is acquired in an exchange, the cost of the property is equal to
the following:
c) Carrying amount of asset given plus any cash payment- on the part of
the payor
d) Carrying amount of asset given minus any cash received- on the part
of the recipient
Note: There is no gain or loss on exchange to be recognized when the
exchange lacks commercial substance
Trade in- is a form of exchange and involves a nondealer acquiring the
asset from a dealer. It usually involves a significant amount of cash and
therefore, the transaction has a commercial substance. And as an exchange
with commercial substance, the new asset is recorded at the following in
the order of priority:
a) Fair value of the asset given plus cash payment
b) Trade in value of asset given plus cash payment (in effect it is the fair
value of asset received)
Construction- the cost of self-constructed property, plant, and equipment
shall include:
1) Direct cost of materials
2) Direct cost of labor
3) Indirect cost and incremental overhead specifically identifiable or
traceable to the construction
1.6 Derecognition of PPE
- An entity shall derecognize an item of property, plant and equipment:
(a) on disposal, or
(b) when no future economic benefits are expected from its use or disposal.
- An entity shall recognize the gain or loss on the derecognition of an item

of property, plant and equipment in profit or loss when the item is
derecognized. An entity shall determine the gain or loss arising from the
derecognition of an item of property, plant and equipment as the
difference between the net disposal proceeds, if any, and the carrying
amount of the item.
1.7 Fully depreciated property- a property is said to be fully depreciated when

the carrying amount is equal to zero, or the carrying amount is equal to the
residual value. In such a case, the asset account and the related accumulated
depreciation account are closed and the residual value is set up in a separate
account.
1.8 Property classified as held for sale- PFRS 5, paragraph 7, provides that an
item of property, plant and equipment is classified as held for sale if the asset is
available for immediate sale in the present condition within one year from the
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date of classification as held for sale. Such asset shall be excluded from property,
plant, and equipment but presented separately as current asset. PFRS 5,
paragraph 15 further provides that an entity shall measure a noncurrent asset
classified as held for sale at the lower of carrying amount or fair value less cost of
disposal.
1.9 Idle or abandoned property- PFRS 5, paragraph 13 provides that an entity
shall not classify as held for sale a noncurrent asset that is to be abandoned.
Temporary idle activity or abandonment does not prelude depreciating the asset as
future benefits are consumed not only through usage but through wear and tear
and obsolescence.
1.10 Disclosures related to PPE
- An entity shall disclose the following for each class of property, plant and
equipment that was deemed appropriate:
(a) the measurement bases used for (aggregated with accumulated

determining the gross carrying impairment losses) at the beginning
amount. and end of the reporting period.
(b) the depreciation methods used. (e) a reconciliation of the carrying
(c) the useful lives or the amount at the beginning and end of
depreciation rates used. the reporting period showing
(d) the gross carrying amount and the separately:
accumulated depreciation
(i) additions.
(ii) disposals.
(iii) acquisitions through business combinations.
(iv) transfers to investment property if a reliable measure of fair value
becomes available
(v) impairment losses recognized or reversed in profit or loss
(vi) depreciation.
(vii) other changes.
This reconciliation need not be presented for prior periods.

The entity shall also disclose the following:
(a) the existence and carrying amounts of property, plant and equipment to
which the entity has restricted title or that is pledged as security for liabilities.
(b) the amount of contractual commitments for the acquisition of property,
plant and equipment.
Notes
- An entity is required to disclose sub-classifications of property, plant and
equipment in classifications appropriate to the entity. A class of assets is a
grouping of assets of a similar nature and use in an entity’s operations.
The following are examples of separate classes of
property, plant and equipment:
(a) land; (h) office equipment: and

(b) land and buildings; (i) investment property
(c) machinery; whose fair value cannot be
(d) boats; measured reliably without
(e) aircraft; undue cost or effort on an
(f) motor vehicles; ongoing basis.
(g) furniture and fixtures;
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APPLICATION:
Answer the questions below. Assume all amounts are material. Choose the
most correct statement/answer.
Question 1
Property, plant and equipment are defined as:
a. tangible assets held for sale in the ordinary course of business.
b. tangible assets held to earn rentals or for capital appreciation or both.
c. tangible assets held for use in the production or supply of goods or services, for
rental to others, or for administrative purposes, and expected to be used during
more than one reporting period.
Question 2
An entity operates a bed and breakfast from a building it owns. The entity also
provides its guests with other services including housekeeping, satellite television
and broadband internet access. The daily room rental is inclusive of these
services. Furthermore, upon request, the entity conducts tours of the surrounding
area for its guests. Tour services are charged for separately.
The entity should account for the building as:
a. property, plant and equipment
b. investment property
c. inventory
Question 3
An entity must measure its property, plant and equipment after initial recognition
at:
a. cost.
b. cost less any accumulated depreciation less any accumulated impairment
losses.
c. cost less any accumulated depreciation less any accumulated impairment losses
plus the cost of day-to-day servicing.
d. cost plus the cost of day-to-day servicing.
Question 4
An entity operates an executive aviation service. The entity’s only item of
property, plant and equipment is an aircraft that it acquired for P10,400,000. The
cost of the aircraft is attributed to its significant parts as follows: the jet engine
(60%), body and aviation equipment (30%) and furniture and fittings (10%).
A condition of operating an aircraft is that it is inspected by the aviation

authorities every three years. An inspection costs P400,000. The jet had been
inspected at the manufacturer’s expense before delivery to the entity. Aviation
regulations require the jet engine to be replaced when it has flown 2,000,000 air
miles. Management intends fitting a new engine to the aircraft when it requires
replacement so that the aircraft can be used for approximately 10 years, at which
time it intends to scrap the aircraft.
Management does not expect to replace the body of the aircraft or the aviation
equipment. However, management assesses the useful life of the furniture and
fittings as five years at which time they will be scrapped and replaced.
What is the cost of each of the significant parts of the aircraft that the entity must
depreciate separately?
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a. P6,240,000 jet engine, P3,120,000 body and aviation equipment and
P1,040,000 furniture and fittings.
b. P10,400,000 jet aircraft.
c. P6,000,000 jet engine, P3,000,000 body and aviation equipment and
P1,000,000 furniture and fittings.
Question 5
Facts are the same as in Question 4.
What depreciation methods are most appropriate for the entity to apply to
compute depreciation for the significant parts of the aircraft:
a. straight-line method for all parts of the aircraft.
b. units of production method, based on air miles flown, for the jet engines and
the straight-line method for all other parts of the aircraft.
c. units of production method, based on air miles flown, for all parts of the
aircraft.
d. diminishing balance method for all parts of the aircraft.
Question 6
A building is held by a subsidiary to earn rentals under an operating lease from its
parent. The parent manufactures its products in the rented building. The fair value
of the building can be measured reliably without undue cost or effort on an
ongoing basis.
The building is:
a. accounted for as an investment property by the subsidiary and an investment
property by the group.
b. accounted for as property, plant and equipment by both the subsidiary and the
group.
c. accounted for as investment property by both the subsidiary and the group.
d. accounted for as an investment property by the subsidiary and as an item of
property, plant and equipment by the group.
Question 7
On 1 January 2021 an entity acquired a building for P95,000, including P5,000
non-refundable purchase taxes. The purchase agreement provided for payment
(including payment of the purchase taxes) to be made in full on 31 December
2021. Legal fees of P2,000 were incurred in acquiring the building and paid on 1
January 2021. The building is occupied by the entity’s administrative staff. An
appropriate discount rate is 10 per cent per year.
The entity should measure the initial cost of the building at:
a. P102,000
b. P97,000
c. P88,364
d. P107,000.
Question 8
On 1 January 2019 an entity acquired a building for P100,000. At 31 December
2019 management:
 assessed the building’s useful life as 40 years from the date of acquisition
 assessed the building’s residual value as P20,000
 assessed the entity will consume the building’s future economic benefits
evenly over 40 years from the date of acquisition
 assessed the fair value of the building at P130,000.
The building is occupied by the entity’s sales staff.
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The entity should measure the carrying amount of the building on 31 December
2019 at:
a. P100,000
b. P98,000
c. P130,000
d. P127,250
Question 9
On 1 January 2020 the entity reassessed the property described in Question 8 as
follows:
 the building’s useful life as 60 years from the date of acquisition
 the building’s residual value as P10,000
 the entity will consume the building’s future economic benefits evenly
over 60 years from the date of acquisition
 the fair value of the building at P160,000.
The entity should measure the carrying amount of the building on 31 December
2020 at:
a. P96,508
b. P96,000
c. P160,000
d. P125,263
Question 10
On 1 January 2021 an entity acquired a tract of land for an undetermined purpose.
On 1 January 2024 the entity began to construct a building on the land for use as
its administrative headquarters. On 1 January 2028 the entity’s administrative
staff moved out of the building and into newly acquired premises. The building
was immediately rented to an independent third party under an operating lease.
On 31 December 2029 the entity accepted an unsolicited offer from the tenant to
purchase the building from the entity with immediate effect. The fair value of the
building can be determined reliably without undue cost or effort on an ongoing
basis.
The entity should account for the land and building respectively as:
a. both investment property from the date of acquisition of land (1 January 2021)
to the date of disposal of building (31 December 2029).
b. both investment property during 2021–2023 and as property, plant and
equipment during 2024–2029.
c. land is accounted as investment property during 2021–2023 and building is
accounted as investment property during 2028–2029 and as property, plant and
equipment during 2024–2027.
d. both property, plant and equipment during 2021–2027 and as investment
property during 2028–2029.
Feedback/Assessment
Test your knowledge of the requirements for accounting and properly
reporting items of property, plant and equipment by answering the questions
below.
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Question 1
On December 31, 2016, Fart Company purchased a machine in exchange for a
noninterest bearing note requiring eight payments of P200,000. The first payment
was made on December 31, 2016 and the others are due annually on December
31.
At date of issuance, the prevailing rate of interest for this type of note was 11%.
PV of an ordinary annuity of 1 at 11% for 8 periods 5.146
PV of an annuity of 1 in advance at 11% for 8 periods 5.712
1. What amount should be recorded as initial cost of the machine?

a. 1,600,000 b. 1,029,200 c. 1,400,000 d. 1,142,400
2. What is the discount on note payable on December 31, 2016?

a. 657,600 b. 457,600 c. 570,800 d. 0
3. What is the interest expense for 2017?

a. 125,664 b. 103,664 c. 113,212 d. 176,000
4. What is the carrying amount of note payable on December 31, 2017?

a. 1,200,000 b. 846,064 c. 742,400 d. 742,412
Question 2
Power Company made the following acquisitions during the year:
 Purchased for P5,400,000, including appraiser fee of P50,000, a
warehouse building and the land on which it is located. The land had an
appraised value of P2,000,000 and original cost of P1,400,000. The
building had an appraised value of P3,000,000 and original cost of
P2,800,000.
 Purchased an office building and the land on which it is located for
P7,500,000 cash and assumed an existing P2,500,000 mortgage. For realty
tax purposes, the property is assessed at P9,600,000, 60% of which is
allocated to the building.
1. What is the total cost of land?
a. 6,160,000 b. 5,840,000 c. 6,000,000 d. 5,000,000
2. What is the total cost of building?

a. 8,760,000 b. 9,240,000 c. 9,000,000 d. 7,760,000
Question 3
On September 1, 2016, Toron Company issued 100,000 treasury shares with P25
par value for a parcel of land to be held as investment property. The treasury
shares were acquired at a cost of P30 per share. The share had a fair market value
of P40 on September 1, 2016. The entity received P50,000 from the sale of scrap
when an existing structure on the site was immediately razed.
What is the initial cost of the land?
a. 4,000,000 b. 3,950,000 c. 3,000,000 d. 2,500,000
Question 4
Owl Company owns a tract of land that it purchased for P2,000,000. The land is
held as a future plant site and has a fair value of P2,800,000 on the date of
exchange. Fall Company also owns a tract of land held as a future plant site. Fall
paid P3,600,000 for the land upon purchase and the land has a fair value of
P3,800,000 on the date of exchange. On date of exchange, Owl exchanged its land
and paid P1,000,000 cash for the land owned by Fall. The configuration of cash
flows from land acquired is expected to be significantly different from the
configuration of cash flows of the land exchanged.
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At what amount should Owl record the land acquired in the exchange?
a. 2.800,000 b. 3,000,000 c. 3,200,000 d. 3,800,000
Question 5
Able Company exchanged a truck with a carrying amount of P1,200,000 and a
fair value of P2,000,000 for a truck and 200,000 cash. The fair value of the truck
received was P1,800,000.
The cash flows from the new truck are not expected to be significantly different
from the cash flows of the old truck.
At what amount should the truck received in the exchange be recorded?
a. 2,000,000 b. 1,400,000 c. 1,000,000 d. 1,800,000
Question 6
The cost of an item of property, plant and equipment comprises all of the
following, except
a. Purchase price
b. Import duties and nonrefundable purchase taxes
c. Any cost directly attributable in bringing the asset to the location and condition
for its intended use
d. Initial estimate of the cost of dismantling and removing the item and restoring
the site, the obligation for which the entity does not incur when the item was
acquired
Question 7
Costs directly attributable to bringing the asset to the location and condition for
the intended use include all of the following, except
a. Cost of employee benefit not arising directly from the construction and
acquisition of property, plant and equipment.
b. Cost of site preparation
c. Initial delivery and handling cost
d. Installation and assembly cost
Question 8
Costs that are expensed immediately include all of the following, except
a. Cost of opening a new facility

b. Cost of introducing a new product or service, including cost of advertising and
promotional activities
c. Cost of conducting business in a new location including cost of staff training
d. Cost of testing whether the asset is functioning properly
Question 9
Costs that are expensed immediately include all of following, except
a. Cost incurred while an item capable of operating in a manner intended by

management has yet to be brought into use, or is operated at less than full capacity
b. Initial operating loss
c. Cost of relocating or reorganizing part or all of an entity's operation
d. Professional fee arising directly from the acquisition of an item of property,
plant and equipment
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Question 10
Jose Company entered into a contract to acquire a new machine which had a cash
price of P2,000,000.
Down payment 400,000

Note payable in 3 equal annual installments 1,200,000
20,000 ordinary shares with a par value of P25
and fair value of P40 per share 800,000
2,400,000
Prior to use, installation cost of P50,000 was incurred. The machine has an
estimated residual value of P100,000.
What is the initial cost of the machine?

a. 2,000,000
b. 2,400,000
c. 2,050,000
d. 2,450,000
End of Topic 1
Topic 2: Government Grant
Introduction
This module focuses on the accounting and reporting of government
grants. It introduces the learner to the subject, guides the learner through the
official text, develops the learner’s understanding of the requirements through the
use of examples and indicates significant judgements that are required in
accounting for government grants. Furthermore, the module includes questions
designed to test the learner’s knowledge of the requirements and to develop the
learner’s ability to account for government grants.
Learning outcome:
 Understand the nature of a government grant
 Know the recognition and accounting of a government grant
Learning objectives:
 To know the proper accounting treatment of government grant
 To know the accounting treatment of repayment of government grant
 To understand government assistance in contradistinction with
government grant
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Topic outline:
2.1 Definition of Government grant 2.4 Accounting for Government
vs Government assistance grant
2.2 Recognition and Measurement 2.5 Repayment of Government grant
2.3 Classification of Government 2.6 Grant of interest-free loans
grant 2.7 Disclosures related to
Government grant.
Presentation of Topic
2.1 Definition of Government grant- PAS 20, paragraph 3, defines government

grant as assistance by government in the form of transfer of resources to an entity
in return for part or future compliance with certain conditions relating to the
operating activities of the entity. Government grant is sometimes called by other
names such as subsidy, subvention, or premium.
Definition of Government assistance- Government assistance is action by the
government designed to provide an economic benefit specific to an entity or range
of entities qualifying under certain criteria. The essence of government assistance
is that no value can reasonably be placed upon it. Examples are:
a) Free technical or marketing advice
b) Provision of guarantee
c) Government procurement policy that is responsible for a portion of the
entity’s sales.
2.2 Recognition and Measurement

Recognition: recognize when there is a reasonable assurance that; (a) the
grant will received; (b) entity will comply with the conditions attached to the
grant.
2.3 Classification of Government grant

a) Grant related to asset- This is government grant whose primary condition is
that an entity qualifying for the grant shall purchase, construct, or otherwise
acquire long-term asset.
b) Grant related to income- By residual definition, this is government grant other
than grant related to asset.
2.4 Accounting for Government grant

Two general approaches:
a. Capital approach
b. Income approach**
a. Recognize grants in profit or loss in the same periods that the
related expenses are recognize
b. If for acquisition of assets - on the same basis as the depreciation
on the assets
c. If related directly - to incurring specific expenditures on the same
basis as the expenditures
**Grants from government are not equity financing, they are non –
shareholder – related increases in net assets and therefore items of
income
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Presentation:
a. Grants Related to Assets:
1. Deferred income
2. As a reduction in the carrying amount of the related assets
e.g Company A receives a 25,000 Php grant toward the purchase of
new equipment that cost 100,000 Php; Equipment has a five year life
and is depreciated on a straight – line basis
Entry:
1) Cash 25,000
Deferred Income 25,000
2) Cash 25,000
Equipment 25,000
Entries as the asset is used:

a.) Depreciation Expense 20,000
Accumulated depreciation 20,000
Deferred Government Grant 5,000
Depreciation expense/grant income 5,000
b.) Depreciation Expense ((100,000-25,000)/5) 15,000

b. Grants Related to Income:

e.g. Company B receives a government grant equal to a 10% of the
payroll cost incurred. Payroll costs incurred are 100,000 Php
Entry: Grant Receivable 10,000
Wages expense/ grant income 10,000
Illustrations:
 Grant in recognition of specific expenses- An entity received a grant of
P15,000,000 from the national government for the purpose of defraying
safety and environmental expenses over the period of three years. The
safety and environmental expenses will be incurred by the entity as
follows:
First year P2,000,000
Second year 3,000,000
Third year 5,000,000
P10,000,000
Grant in recognition of specific expenses shall be recognized as income over the
period of the related expense. Accordingly, the grant of P15,000,000 is allocated
as income over three years in proportion to the costs incurred.
First year
1) Cash 15,000,000
Deferred grant income 15,000,000
2) Deferred grant income 3,000,000

Grant income(2/10x15,000,000) 3,000,000
3) Environmental expenses 2,000,000

Cash 2,000,000
First year (2/10x15,000,000) = 3,000,000

Second year (3/10x15,000,000) = 4,500,000
Third year (5/10x15,000,000) = 7,500,000
15,000,000
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 Grant related to depreciable asset- an entity received a grant of
P50,000,000 from the Australian government for the acquisition of a
chemical facility with an estimated cost of P80,000,000 and useful life of
5 years.
Grant related to depreciable asset shall be recognized as income over the periods
and in proportion to the depreciation of the related asset. Accordingly, the grant
of P50,000,000 is allocated as income over 5 years depending on the method of
depreciation. Assume the straight line method is used.
First year
1) Cash 50,000,000
2) Building 80,000,000
Cash 80,000,000
3) Depreciation 16,000,000
Accumulated depreciation* 16,000,000
*(80,000,000/5)

Grant income* 10,000,000
*(50,000,000/5)
 Grant related to nondepreciable asset- An entity is granted a large tract

of land in Mindanao by the national government. The fair value of the land
is P60,000,000. The grant requires that the entity shall construct a refinery
on the site. The cost of the refinery is estimated to be P100,000,000 and
the useful life is 20 years.
Grant related to nondepreciable asset requiring fulfillment of certain conditions
shall be recognized as income over the periods which bear the cost of meeting the
conditions. Accordingly, the grant of P60,000,000 is allocated over 20 years.
First year
1) Land 60,000,000
2) Refinery 100,000,000
Cash 100,000,000
3) Depreciation 5,000,000
Accumulated depreciation* 5,000,000
*(100,000,000/20)
Grant income* 3,000,000
*(60,000,000/20)
 Grant that becomes receivable as compensation- An entity received a

grant of P50,000,000 from the USA government to compensate for the
massive losses incurred because of a recent earthquake.
A government grant that becomes receivable as compensation for expenses or losses already
incurred or for the purpose of giving immediate financial support to the entity with no further
related costs shall be recognized as income of the period in which it becomes receivable.
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Accordingly, the grant of P50,000,000 is recognized as income immediately as
follows:
Cash 50,000,000
Grant income 50,000,000
2.5 Repayment of Government grant:
 If grant becomes repayable - treat as a change in estimate
 If related to an asset : cumulative amount of additional depreciation that
would have been recognized to dated is recognized in P&L
 If related to income: any necessary adjustments are made to current year
profit or loss

2.6 Grant of interest-free loan- A forgivable loan from government is treated as
a government grant when there is reasonable assurance that the entity will meet
the terms for forgiveness of the loan.
PAS 20, paragraph 10, provides that the benefit of a government loan with a NIL
or below-market rate of interest is treated as a government grant. Paragraph
10A further provides that the benefit is measured as the difference between the
face amount and the present value of the loan.
2.7 Disclosures related to Government grant

 Accounting policy for grants and their presentation
 Nature and extent of grants recognized, and information about other
forms of assistance that have been beneficial
 Information about contingencies or conditions not yet met related to
assistance recognized
APPLICATION
Answer all the individual questions below. Choose the letter of the best
answer
Question 1
Which of following statements in relation to a repayment of grant related to an
asset is true?
I. The repayment of grant related to an asset shall be recorded by increasing the
carrying amount of the asset.
II. The cumulative additional depreciation that would have been recognized to
date in the absence of the grant shall be recognized immediately as an expense.
a. I only b. II only c. Both I and II d. Neither I nor II
Question 2
Government grant excludes which of the following form of government
assistance?
I. Government assistance that cannot reasonably have a value placed upon it.
II. Transaction with government that cannot be distinguished from the normal
trading transaction of the entity.
Question 3
Government assistance includes all of the following, except
a. Free technical advice
b. Provision of guarantee
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c. Government procurement policy that is responsible for a portion of the entity's
sales.
d. Improved irrigation water system for the benefit of an entire local community
Question 4
In relation to a benefit included in the term "government assistance", which of the
following statements is true?
I. The provision of infrastructure in developing areas is a benefit.
II. The imposition of trading constraints on competitors is a benefit.
Question 5
A forgivable loan from a government or the benefit of a government loan at NIL
or below market interest rate is accounted for as
a. Government grant only
b. Government assistance only
c. Both government grant and government assistance
d. Neither government grant nor government assistance
FEEDBACK/ASSESSMENT:
Test your knowledge of the requirements for accounting and properly reporting
government grant by answering the questions below. Assume all amounts are
material.
Choose the most correct statement/answer
Question 1
Pola Company purchased a varnishing machine for P6,000,000 on January 1,
2016. The entity received a government grant of P540,000 in respect of this asset.
The accounting policy is to depreciate the asset over 4 years on a straight line
basis and to treat the grant as deferred income.
1. What is the carrying amount of the machine on December 31, 2017?

a. 3,000,000 b. 4,500,000 c. 3,270,000 d. 2,730,000
2. What amount should be reported as deferred grant income on December 31,

2017?
a. 540,000 b. 270,000 c. 405,000 d. 135,000
Question 2
Peachy Company purchased a machine for P7,000,000 on January 1, 2016 and
received a government grant of P1,000,000 toward the capital cost.
The machine is to be depreciated on a straight line basis over 5 years and
estimated to have a residual value of P500,000 at the end of this period. The
accounting policy is to treat the grant as a deferred income.
1. What is the carrying amount of the asset on December 31, 2017?
a. 4,200,000 b. 5,700,000 c. 4,400,000 d. 3,900,000
2. What is the deferred grant income on December 31, 2017?

a. 400,000 b. 800,000 c. 600,000 d. 0
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Question 3
Betsy Company purchased a jewel polishing machine for P3,600,000 on January
1, 2016 and received a government grant of P500,000 toward the capital cost.
The accounting policy is to treat the grant as a reduction in the cost of the asset.
The machine is to be depreciated on a straight line basis over 8 years and
estimated to have a residual value of P100,000 at the end of this period.
1. What is the depreciation of the machine for 2016?
a. 387,500 b. 500,000 c. 437,500 d. 375,000
2. What is the carrying amount of the asset on December 31, 2017?

a. 2,725,000 b. 2,350,000 c. 3,000,000 d. 2,250,000
Question 4
On January 1, 2016, Dawn Company purchased a plating machine for P5,400,000.
The entity received a government grant of P400,000 toward this capital cost. The
machine is to be depreciated on a 20% reducing balance basis over 10 years. The
estimated residual value is P200,000.
The accounting policy is to treat the government grant as a reduction in the cost of
the asset.
1. What is the accumulated depreciation on December 31, 2017?
a. 1,000,000 b. 1,944,000 c. 1,800,000 d. 2,000,000
2. What is the carrying amount of the machine on December 31, 2017?

a. 4,000,000 b. 4,040,000 c. 3,456,000 d. 3,200,000
Question 5
On January 1, 2016, East Company received a grant of P1,500,000 from the
government to subsidize tuition fees for a period of 5 years. On January 1, 2018,
the entity violated certain conditions attached to the grant, and therefore had to
repay fully such grant to the government.
1. What is the grant income for 2016?

a. 1,500,000 b. 600,000 c. 300,000 d. 0
2. What amount should be recognized as loss resulting from the repayment of the
grant in 2018?
a. 1,500,000 b. 900,000 c. 600,000 d. 0
Question 6
Government grant in recognition of specific costs is recognized as income
a. Over the same period as the relevant expense
b. Immediately
c. Over a maximum of 5 years using straight line
d. Over a maximum of 5 years using sum of digits
Question 7
Government grant related to depreciable asset is usually recognized as income
a. Immediately
b. Over the useful life of the asset using straight line
c. Over the useful life of the asset using sum of years' digits
d. Over the useful life of the asset and in proportion to the depreciation of the
asset.
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Question 8
Government grant related to nondepreciable asset that requires fulfillment of
certain conditions
a. Should not be recognized as income
b. Should be recognized as income immediately
c. Should be recognized as income over 40 years
d. Should be recognized as income over the periods which bear the cost of
meeting the conditions.
Question 9
A government grant that becomes receivable as compensation for expenses or
losses already incurred or for the purpose of giving immediate financial support to
the entity with no future related costs should be recognized as income
a. When received
b. Of the period in which it becomes receivable
c. Over a maximum of 5 years using straight line.
d. Over a maximum of 10 years using straight line.
Question 10
Repayment of grant related to income shall be
a. Recognized as component of other comprehensive income
b. Charged to retained earnings
c. Expensed immediately
d. Applied first against the deferred income balance and any excess shall be
recognized immediately as an expense.
End of Topic 2
Topic 3: Borrowing Costs
Introduction
This module focuses on the accounting and reporting of borrowing costs. It
introduces the learner to the subject, guides the learner through the official text,
develops the learner’s understanding of the requirements through the use of
examples and indicates significant judgments that are required in accounting for
borrowing costs. Furthermore, the module includes questions designed to test the
learner’s knowledge of the requirements and to develop the learner’s ability to
account for borrowing costs.
Learning outcome:
 Identify the items included in borrowing costs
 Know the concept of a qualifying asset for purposes of capitalization of
borrowing costs
 Understand the proper accounting treatment of borrowing costs
 Distinguish specific borrowing and general borrowing in relation to
capitalization of borrowing costs
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Learning objectives:
 to distinguish borrowing costs from other costs
 to disclose borrowing costs in financial statements
 to demonstrate an understanding of the significant judgments that are
required in accounting for borrowing costs.
Topic outline:
3.1 Definition of borrowing costs 3.6 Asset financed by specific and
3.2 Qualifying Asset general borrowing
3.3 Accounting/Recognition for 3.7 Specific borrowing for asset used
borrowing costs for general purposes
3.4 Asset financed by specific 3.8 Commencement of Capitalization
borrowing 3.9 Suspension/Cessation of
3.5 Asset financed by general capitalization
borrowing 3.10 Disclosures related to
borrowing costs
3.1 Definition of borrowing costs- This section specifies the accounting for
borrowing costs. Borrowing costs are interest and other costs that an entity incurs
in connection with the borrowing of funds. Borrowing costs include:
(a) interest expense calculated using the effective interest method
(b) finance charges in respect of finance leases
(c) exchange differences arising from foreign currency borrowings to the extent
that they are regarded as an adjustment to interest costs.
3.2 Qualifying asset- a qualifying asset is an asset that necessarily takes a

substantial period of time to get ready for the intended use or sale.
Definitions:
 Borrowing costs are interest and other costs incurred by an enterprise in
connection with the borrowing of funds.
 Qualifying asset is an asset that necessarily takes a substantial period of
time to get ready for its intended use or sale.
Borrowing Costs
 Interest and commiment  Finance charges of assets
charges on bank & other acquired under finace leases
short term borrowings or under other similar
 Amortization of discounts or arrangements
premiums relating to  Exchange differences arising
borrowings from foreign currency
 Amortization of ancillary borrowings to the extent that
costs incurred in connection they are regarded as an
with the arrangement of adjustment to interest costs
borrowings
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Qualifying Assets
Included
 Manufacturing Plants
 Power Generation facilities
 Inventories that require a substantial period of time to bring them to a
saleable condition
 Investment properties
Not Included
 Other Investments
 Inventories that are routinely manufactured or otherwise produced in large
quantities on repetitive basis over a short period of time
 Assets that are ready for their intended use or sale when acquired
3.3 Accounting/Recognition for borrowing costs

 Capitalize borrowing costs that are directly attributable to the acquisition,
construction or production of a qualifying asset
 Other borrowing costs to be expensed off
 Capitalize if it is probable that they will result in future economic benefits
to the enterprise and costs can be measured reliably
3.4 Asset Financed by specific borrowing
 Borrowing costs that would have been avoided if the expenditure on the
qualifying asset had not been made
 Actual borrowing costs incurred less any income on temporary investment
of those borrowing to be capitalized
Illustration. At the beginning of the current year, an entity obtained a loan of
P4,000,000 at an interest rate of 10%, specifically to finance the construction of a
new building. Availments from the loan were made quarterly in equal amounts.
Total borrowing cost incurred amounted to P250,000 for the current year. Prior to
their disbursement, the proceeds of the borrowing were temporarily invested and
earned interest income of P40,000. The building was completed at the current
year-end.
Actual borrowing cost P250,000

Interest income from investment of proceeds (40,000)
Capitalizable borrowing cost P210,000
3.5 Asset financed by general borrowing

 General Borrowings
o Determine borrowing costs by applying a capitalization rate
o Capitalization rate should be the weighted average of the
borrowing costs that are outstanding during the period
 Note: The amount of capitalizable borrowing cost is equal to the average
carrying amount of the asset during the period multiplied by a
capitalization rate or average interest rate. However, the capitalizable
borrowing cost shall not exceed the actual interest incurred.
The capitalization rate or average interest rate is equal to the total annual
borrowing cost divided by the total general borrowings outstanding during
the period. Accordingly, any investment income from general borrowing
is not deducted from capitalizable borrowing cost.
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Illustration. An entity had the following borrowings on January 1 of the current
year. The borrowings were made for general purposes and the proceeds were
partly used to finance the construction of a new building.
Principal Borrowing costs

10% bank loan P3,000,000 P300,000
12% short-term note 1,500,000 180,000
8% long-term loan 3,500,000 280,000
P8,000,000 P760,000
Capitalization rate= 760,000/8,000,000= 9.5%
The construction of the building was started on January 1 and was completed on
December 31 of the current year. Expenditures on the building were:
January 1 P 400,000
March 31 1,000,000
June 30 1,200,000
September 30 1,000,000
December 31 400,000
Total cost P4,000,000
Average carrying amount of the building
Date Expenditures Fraction (months Average
outstanding
January 1 400,000 12/12 400,000
March 31 1,000,000 9/12 750,000
June 30 1,200,000 6/12 600,000
September 30 1,000,000 3/12 250,000
December 31 400,000 - -
2,000,000
Capitalizable borrowing cost= 2,000,000x9.5%= P190,000

The amount of capitalizable borrowing cost is P190,000 because it is less than the
actual borrowing cost of P760,000. The excess of P760,000 over P190,000 or
P570,000 is charged to interest expense.
3.6 Asset financed both by specific and general borrowing

At the beginning of the current year, an entity borrowed P1,500,000 at an interest
of 10% specifically for the construction of a new building. The actual borrowing
cost on this loan is P150,000. The entity had also outstanding during the year a 5-
year 8% general borrowing of P7,000,000.
The construction of the building started on January 1 and was completed on

December 31 of the current year. Expenditures on the construction were:
January 1 500,000
April 1 1,000,000
May 1 1,500,000
September 1 1,500,000
December 31 500,000
Total cost P5,000,000
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Amount of Average Expenditures
Date Expenditures Fraction (months Average

outstanding)
January 1 500,000 12/12 500,000
April 1 1,000,000 9/12 750,000
May 1 1,500,000 8/12 1,000,000
September 1 1,500,000 4/12 500,000
December 31 500,000 - -
2,750,000
Capitalizable borrowing cost

Average expenditures P2,750,000
Specific borrowing (1500,000)
General borrowing P1,250,000
Specific borrowing (10%x1,500,000) 150,000

General borrowing (8%x1,250,000) 100,000
Total capitalizable borrowing cost P250,000
3.7 Specific borrowing for asset used for general purposes- if the asset is
financed by specific borrowing but a portion is used for working capital purposes,
the borrowing shall be treated as a general borrowing in determining capitalizable
borrowing cost.
3.8 Commencement of Capitalization

 Expenditure for the acquisition, construction or production of a qualifying
asset is being incurred
 Borrowing costs are being incurred
 Activities that are necessary to prepare the asset for its intended use or sale
are in progress
Note:
 Expenditure on qualifying asset includes only such expenditure:
o That has resulted in payment of cash
o Transfer of other assets
o Assumption of interest bearing liabilities
 Expenditure to be reduced by progress payments and grants
 Average carrying amount of the asset during a period including
borrowing costs previously capitalized is normally a reasonable
approximation of the expenditure to which capitalization rate is applied
in that period
 When the carrying amount or the expected ultimate cost of the
qualifying asset exceeds its recoverable amount or NRV, the carrying
amount is written down or written off in accordance with the
requirements of the accounting standards
 In certain circumstances such write down or write off may be written
back as per those other accounting standards
Sequence of Capitalization
1. Specific Borrowings
2. General Borrowings
3. Own Funds
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3.9 Suspension/Cessation of Capitalization
 Suspend during extended periods in which active development is
interrupted
 Capitalization should cease when substantially all activities necessary
to prepare the qualifying asset for its intended use or sale are complete
 In case of construction of a qualifying asset in parts and a completed
part is capable of being used while construction continues for the other
parts, capitalization of borrowing costs in relation to a part should cease
when substantially all the activities necessary to prepare that part for its
intended use or sale are compete
3.10 Disclosures related to borrowing costs
 The accounting policy adopted for borrowing costs
 The amount of borrowing costs capitalized during the period
*Additional disclosure: The capitalization rate used to determine
the amount of borrowing costs eligible for
capitalization.
APPLICATION:
Answer the following questions.
Question 1
Borrowing costs are:
a. interest and other costs that an entity incurs in connection with the borrowing of
funds.
b. interest expense calculated using the effective interest method only.
c. finance charges in respect of finance leases only.
d. none of the above.
Question 2
Borrowing costs do not include:
a. interest incurred on bank overdrafts.
b. incremental administrative fees incurred in connection with raising loans.
c. finance charges in respect of finance leases.
d. dividends declared to equity holders.
Question 3
An entity must:
a. recognize all borrowing costs as an expense in profit or loss in the period in
which they are incurred.
b. recognize all borrowing costs as an expense in profit or loss in the period in
which they are incurred, except to the extent that borrowing costs that are directly
attributable to the acquisition, construction or production of an asset that
necessarily takes a substantial period of time to get ready for its intended use or
sale are capitalized as part of the cost of that asset.
c. choose either (a) or (b) above as its accounting policy for borrowing costs and
apply the chosen policy consistently to all of its borrowing costs.
Question 4
Fun Company was constructing an asset that qualified for interest capitalization.
The entity had outstanding notes payable during the entire year of construction
comprising P6,000,000 8% interest and P9,000,000 9% interest. None of the
borrowings were specified for the construction of the qualified asset.
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What interest rate should be used to calculate capitalized interest on the
construction?
a. 9.00% b. 8.50% c. 8.00% d. 8.60%
Question 5
The third year of a construction project of Villain Company began with a
P3,000,000 balance in construction in progress. Included in that figure is
P600,000 of interest capitalized in the first two years. Construction expenditures
during the third year were P8,000,000 which were incurred evenly throughout the
entire year. The entity had P30,000,000 in interest-bearing debt outstanding in the
third year at an interest rate of 9%.
1. What amount of interest for the third year is capitalized?

a. 360,000 b. 630,000 c. 936,000 d. 990,000
2. What amount should be reported as interest expense for the third year?
a. 2,700,000 b. 2,070,000 c. 1,980,000 d. 1,350,000
FEEDBACK/ASSESSMENT
Test your knowledge of the requirements for accounting for borrowing
costs by answering the questions below. Choose the most correct
statement/answer.
Question 1
Jambeh Company started construction on a building at the beginning of current
year and completed construction at year-end. The entity had only two interest
notes outstanding during the year and both of these notes were outstanding for all
12 months of the year.
The following information is available:

Average accumulated expenditures
2,500,000
Ending balance in construction in progress before capitalization of interest
3,600,000
6% note incurred specifically for the project
1,500,000
9% long-term note
5,000,000
What is the cost of the building?

a. 3,780,000 b. 2,680,000 c. 3,750,000 d. 3,825,000
Question 2
During 2016, Josa Company constructed asset costing P5,000,000. The weighted
average expenditures totaled P3,000,000. To help pay for construction,
P2,200,000 was borrowed at 10% on January 1, 2016.
Funds not needed for construction were temporarily invested in short term
securities yielding P45,000 in interest revenue. Other than the construction funds
borrowed, the only other debt outstanding during the year was a P2,500,000, 10-
year, 9% note payable dated January 1, 2015.
1. What amount of interest should be capitalized during 2016?

a. 300,000 b. 150,000 c. 247,000 d. 472,000
2. What amount should be reported as interest expense for 2016?

a. 225,000 b. 178,000 c. 153,000 d. 0
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Question 3
During 2016, Elsa Company constructed a new facility at a cost of P30,000,000.
The expenditures for the building, which was finished late in 2016 were incurred
evenly during the year. The entity had the following loans outstanding on
December 31 2016:
• 10% note to finance specifically the construction, dated January 1, 2016,
P10,000,000. This note is unpaid on December 31, 2016. Investments were made
on the proceeds from this loan and income of P100,000 was realized in 2016.
• 12% 20-year bonds issued at face amount on April 30, 2015, P30,000,000.
• 8% 5-year note payable, dated March 1, 2015, P10,000,000.
What amount of interest is capitalized as cost of the new building?
a. 1,550,000 b. 1,450,000 c. 1,400,000 d. 1,500,000
Question 4
Which of the following is a disclosure requirement in relation to borrowing cost?
I. Amount of borrowing cost capitalized during the period.
II. Segregation of assets that are "qualifying assets" from other assets in
the statement of financial position or as a disclosure in the notes to
financial statements.
III. Capitalization rate used to determine the amount of borrowing cost
eligible for capitalization.
a. I, II and III b. I and II only c. I and III only d. I only
Question 5
An asset is being constructed for an entity's own use. The asset has been financed
with a specific new borrowing. The interest cost incurred during the construction
period as a result of expenditures for the asset is
a. Interest expense in the construction period

b. A prepaid asset to be written off over the estimated useful life of the asset
c. A part of the historical cost of acquiring the asset to be allocated over the
estimated useful life of the asset
d. A part of the historical cost of acquiring the asset to be allocated over the term
of the borrowing used to finance the construction of the asset
Question 6
When computing the amount of interest cost to be capitalized, the concept of
"avoidable interest” refers to
a. The total interest cost actually incurred.
b. A cost of capital.
c. That portion of total interest cost which would not have been incurred if
expenditures for asset construction had not been made.
d. That portion of average accumulated expenditures on which no interest cost
was incurred.
Question 7
Which of the following assets could be treated as qualifying asset for purposes of
capitalizing borrowing cost?
a. Investment property
b. Investment in financial instrument
c. Inventory that is manufactured or produced in large quantity on a repetitive
basis and takes a substantial period of time to get ready for use or sale
d. Biological asset
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Question 8
Which of the following statements about the capitalization of borrowing cost as
part of the cost of a qualifying asset is true?
a. If funds come from general borrowings, the amount to be capitalized is based
on the weighted average amount of expenditures.
b. Capitalization always continues until the asset is brought into use.
c. Capitalization always commences as soon as expenditure of the asset is
incurred.
d. Capitalization always commences as soon as interest on relevant borrowings is
being incurred.
Question 9
Which of the following is required for borrowing cost incurred that is directly
attributable to the construction of a qualifying asset?
I. Recognize as an expense in the period incurred.
II. Capitalize as part of the cost of the asset.
a. I only b. II only c. Either I or II d. Neither I nor II
Question 10
An entity is commencing a new construction project which is to be financed by
borrowing. The key dates for the current year are as follows:
May 15 Loan interest relating to the project starts to be incurred.

June 15 Technical site planning commences.
June 30 Expenditures on the project start to be incurred.
July 15 Construction work commences.
The entity can commence the capitalization of borrowing cost from what date?
a. May 15 b. June 15 c. June 30 d. July 15
End of Topic 3
Topic 4: Land and Building
Introduction
This module focuses on the accounting and reporting of land and building. It
introduces the learner to the subject, guides the learner through the official text,
develops the learner’s understanding of the requirements through the use of
examples and indicates significant judgments that are required in accounting for
land and building. Furthermore, the module includes questions designed to test
the learner’s knowledge of the requirements and to develop the learner’s ability to
account for land and building.
Learning Outcome:
 Understand the nature and characteristics of land and building
 Identify specific items of land and building
 Know the recognition of land and building
 Understand the initial and subsequent measurement of land and building
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 To know the proper statement classification of land.
 To identify the costs normally included in land account.
 To know the treatment of issues related to land, such as land
improvements, special assessments and real property taxes.
 To identify the costs normally charged to building when purchased and
when constructed.
 To know the treatment of issues related to building, such as sidewalks,
pavements, parking lot, driveways, ventilating system, lighting system and
elevator.
Topic outline:
4.1 Land-classification, costs, land improvements,
special assessment, real property taxes
4.2 Building- costs when purchased and constructed
4.3 Sidewalks, pavements, parking lot, driveways
4.4 Claims for damages
4.5 Building fixtures
4.6 Ventilating System, lighting system, elevator
4.7 PIC interpretation on land and building
4.1 Land Account- Statement classification
The classification of land in the statement of financial position depends on the
nature and purpose of the land.
Land used as a plant site shall be treated as property, plant and equipment.
Land held for a currently undetermined use is treated as an investment property.
However, if the land is held definitely as a future plant site, it is classified as
owner-occupied property and not an investment property and therefore shall be
included in property, plant and equipment.
This accounting treatment is in accordance with paragraph 9 of PAS 40.
Land held for long-term capital appreciation is treated as an investment property.
Land held for current sale by a real estate developer as in the case of subdivided
lots is treated as current asset as part of inventory.
Costs chargeable to land

a. Purchase price
b. Legal fees and other expenditures for establishing clean title
c. Broker or agent commission
d. Escrow fees
e. Fees for registration and transfer of title
f. Cost of relocation or reconstruction of property belonging to others in order to
acquire possession
g. Mortgages, encumbrances and interest on such mortgages assumed by buyer
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h. Unpaid taxes up to date of acquisition assumed by buyer
i. Cost of survey
j. Payments to tenants to induce them to vacate the land in order to prepare the
land for the intended use but not to make room for the construction of new
building
k. Cost of permanent improvements such as cost of clearing, cost of grading,
leveling and landfill
l. Cost of option to buy the acquired land. If the land is not acquired, the cost of
option is expensed outright.
Land improvements
Land improvements not subject to depreciation are charged to the land account.
Examples of these expenditures are cost of surveying, cost of clearing, cost of
grading, leveling and landfill, cost of subdividing and other cost of permanent
improvement. On the other hand, land improvements that are depreciable are
charged to a special account "land improvements.”
Examples of these improvements are fences, water systems, drainage systems,
sidewalks, pavements and cost of trees, shrubs and other landscaping.
Land improvements of this type should be depreciated over their useful life.
Special assessments
Special assessments are taxes paid by the landowner as a contribution to the cost
of public improvements. Special assessments are treated as part of the cost of the
land.
Special assessments are capitalized as cost of land because public improvements
increase definitely the value of the land.
Real property taxes
As a rule, real property taxes are treated as outright expense.
However, if unpaid real property taxes are assumed by the buyer in acquiring
land, the taxes are capitalized but only up to the date of acquisition.
4.2 Building Account
Costs of building when purchased

The following expenditures are normally charged to the building account when
building is acquired by purchase:
a. Purchase price e. Payments to tenants to induce
b. Legal fees and other expenses them to vacate the building
incurred in connection with the f. Any renovating or remodeling
purchase costs incurred to put a building
c. Unpaid taxes up to date of purchased in a condition suitable for
acquisition the intended use such as lighting
d. Interest, mortgage, liens and other installations, partitions and repairs
encumbrances on the building
assumed by the buyer
Costs of building when constructed

The following expenditures are normally charged to the building when acquired
by means of construction:
a. Materials used, labor employed and overhead incurred during the construction
b. Building permit or license
c. Architect fee
d. Superintendent fee
e. Cost of excavation
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f. Cost of temporary buildings used as construction offices and tools or materials
shed
g. Expenditures incurred during the construction period such as interest on
construction loans and insurance.
h. Expenditures for service equipment and fixtures made a permanent part of the
structure.
i. 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.
j. Safety inspection fee
4.3 Sidewalks, pavements, parking lot, driveways

A question often arises as to the treatment of expenditures for sidewalks,
pavements, parking lot, and driveways. The problem is whether such expenditures
should be charged to land improvements or building.
a. If such expenditures are part of the blueprint for the construction of a new
building, these are charged to the building account.
b. On the other hand, if the expenditures are occasionally made or incurred not in
connection with the construction of a new building, these are charged to land
improvements.
4.4 Claims for damages

Where insurance is taken during the construction of a building, the cost of
insurance is charged to the building because it is a necessary and a reasonable cost
of bringing the building into existence.
However, where insurance is not taken, an accounting problem arises when the
entity is required to pay claims for damages for injuries sustained during the
construction.
In this regard, it is believed that the payment for damages should be expensed
outright because the damages represent management failure or negligence in
procuring insurance and are not a reasonable and necessary cost of construction.
To charge the damages to the building would be tantamount to concealment of the
management failure or negligence.
4.5 Building fixtures

Expenditures for shelves, cabinets and partitions may be charged to the building
or furniture and fixtures depending upon the nature of the expenditures.
If such expenditures are immovable in the sense that these are attached to the
building in such a manner that the removal thereof may destroy the building, these
are charged to the building account.
On the other hand, if such expenditures are movable, these are charged to
furniture and fixtures and depreciated over their useful life.
4.6 Ventilating system, lighting system, elevator

a. If installed during construction, the ventilating
system, lighting system and elevator are charged
to the building account.
b. Otherwise, these are charged to building
improvements and depreciated over their useful
life or remaining life of the building, whichever is
shorter.
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4.7 PIC Interpretation on land and building
1. Land and an old building are purchased at a single cost:

a. If the old building is usable, the single cost is allocated to land and building
based on relative fair value.
b. If the old building is unusable, the single cost is allocated to land only.
2. The old building is demolished immediately to make room for construction of

a new building:
a. Any allocated carrying amount of new building whether the new
the usable old building is recognized building is accounted for as property,
as a loss if the new building is plant and equipment, investment
accounted for as property, plant and property or inventory.
equipment or investment property. d. Needless to say, the net demolition
b. Any allocated carrying amount of cost is capitalized as cost of the land
the usable old building is capitalized if the old building is demolished to
as cost of the new building if the prepare the land for the intended use
new building is accounted for as but not to make room for the
inventory. construction of new building.
c. The demolition cost minus salvage
value is capitalized as cost of the
3. A building is acquired and used in a prior period but demolished in the

current period to make room for construction of a new building:
a. The carrying amount of the old accounted for as property, plant and
building is recognized as a loss, equipment, investment property or
whether the new building is property, inventory.
plant and equipment, investment c. If the old building is subject to a
property or inventory. contract of lease, any payments to
b. The net demolition cost is tenants to induce them to vacate the
capitalized as cost of the new old building shall be charged to the
building whether the new building is cost of the new building.
End of Topic 4
Topic 5: Machinery
Introduction
This module focuses on the accounting and reporting
of machinery. It introduces the learner to the subject,
guides the learner through the official text, develops
the learner’s understanding of the requirements
through the use of examples and indicates significant
judgments that are required in accounting for
machinery. Furthermore, the module includes
questions designed to test the learner’s knowledge of
the requirements and to develop the learner’s ability to
account for machinery.
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Learning Outcome:
 Understand the nature and characteristics of machinery
 Identify specific items of machinery
 Know the recognition of machinery
 Understand the initial and subsequent measurement of machinery
 To identify the costs normally charged to machinery when purchased.
 To understand capital expenditure and revenue expenditure.
 To know the accounting treatment of capital expenditure and revenue
expenditure.
 To know the accounting treatment of costs subsequent to acquisition, such
as addition, improvements, replacements, repairs and rearrangement cost.
Topic Outline:
5.1 Cost of machinery acquired by purchase
5.2 Tools
5.3 Patterns and dies
5.4 Equipment- Delivery, Store and Office Equipment, Furniture and Fixtures
5.5 Returnable containers
5.6 Capital Expenditure and revenue expenditure
5.7 Recognition of subsequent cost
5.8 Additions, improvements or betterments, replacements, repairs, rearrangement
costs
5.9 Accounting for major replacement
5.1 Cost of machinery

When machinery is purchased, the cost normally includes the following:
a. Purchase price machinery and restoring the site on
b. Freight, handling, storage and which it is located, and for which the
other cost related to the acquisition entity has a present obligation.
c. Insurance while in transit g. Fee paid to consultants for advice
d. Installation cost, including site on the acquisition of the machinery.
preparation and assembling h. Cost of safety rail and platform
e. Cost of testing and trial run, and surrounding machine.
other cost necessary in preparing the i. Cost of water device to keep
machinery for its intended use. machine cool.
f. Initial estimate of cost of
dismantling and removing the
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If 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 value added tax or VAT on the purchase of machinery is not capitalizable but
charged to input tax to be offset against output tax.
However, any irrecoverable or nonrefundable purchase tax is capitalized as cost
of the machinery.
5.2 Tools
Tools are classified as machine tools and hand
tools. Machine tools include drills and punches.
Hand tools include hammer and saws. Tools should
be segregated from the machinery account.
5.3 Patterns and dies
Patterns and dies are used in designing or forging
out a particular product. Patterns and dies used for
the regular product are recorded as assets. Patterns
and dies are depreciated over the useful life.
However, patterns and dies used for
specially ordered product form part of
the cost of the special product.
5.4 Equipment
The term "equipment” includes delivery equipment, store equipment, office
equipment and furniture and fixtures.
The cost of such equipment includes the purchase price, freight and other
handling charges, insurance while in transit, installation costs and other costs
necessary in preparing them for the intended use.
Delivery equipment includes cars, trucks and other vehicles used in business
operations.
Motor vehicle registration fees should be expensed and not be included as part of
the cost of the delivery equipment.
Store and office equipment include computers, typewriters, adding machines,

cash register and calculator.
Assets identified with the selling function are classified as store equipment.
Otherwise, the assets are charged to office equipment.
Furniture and fixtures include showcases, counters, and shelves. Display

fixtures, cabinets, partitions, safes, desks and tables.
In a broad sense, furniture and fixtures may include store and office equipment.
5.5 Returnable containers

Returnable containers include bottles, boxes, tanks, drums and barrels which are
returned to the seller by the buyer when the contents are consumed or used.
Containers in big units or of great bulk as in the case of tanks. Drums and barrels
are classified as property, plant and equipment.
On the other hand, containers that are small and individually involve small
amount as in the case of bottles and boxes are classified as other noncurrent
assets.
Needless to say, containers that are not returnable are charged outright to expense.
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5.6 Capital expenditure and Revenue expenditure
An expenditure that benefits only the current period is a revenue expenditure and
therefore reported as an expense.
An expenditure that benefits the current period and future periods is a capital
expenditure and therefore reported as an asset.
5.7 Recognition of subsequent cost

The recognition of subsequent cost is subject to the same recognition criteria for
the initial cost of property, plant and equipment.
Accordingly, the subsequent cost incurred for property, plant and equipment shall
be recognized as an asset when:
a. It is probable that future economic benefits associated with the subsequent cost
will flow to the entity.
b. The subsequent cost can be measured reliably.
In other words, if the subsequent cost will increase the future service potential of
the asset, the cost should be capitalized.
If the subsequent cost merely maintains the existing level of standard
performance, the cost should be expensed when incurred.
Future economic benefit
In general, a subsequent cost on an item of property, plant and equipment will
benefit future periods or increase the future service potential of an asset when:
a. The expenditure extends the life of the property.
b. The expenditure increases the capacity of the property and quality of
output, for example, by upgrading machine parts.
c. The expenditure improves the efficiency and safety of the property, for
example, by adopting a new production process leading to large reduction
in operating cost.
5.8 Subsequent cost

Generally, the following expenditures
are incurred during ownership of
existing property, plant and equipment.
a. Additions
b. Improvements
or betterments
c. Replacements
d. Repairs
e. Rearrangement cost
Additions
Additions are modifications or alterations
which increase the physical size or capacity
of the asset. Such expenditures are of two
types, namely:
a. An entirely new unit
b. An expansion, enlargement or extension of the old asset
The construction of a new building is an addition of the first type but the addition
of a wing to a building or the construction of a third storey on a two-storey
building is an addition of the second type. In either case, the cost is capitalized in
the usual manner. The cost of an addition which is a new unit is depreciated over
the useful life. But the cost of an expansion should be depreciated over the useful
life of the expansion or remaining useful life of the asset of which it is part,
whichever is shorter.
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Improvements or betterments
Improvements or betterments are modifications or alternations which increase the
service life or the capacity of the asset.
Improvements may represent replacement of an asset or part thereof with one of a
better or superior quality. Such expenditures are normally capitalized.
The improvements that do not involve replacement of parts are simply added to
the cost of the existing asset.
Examples of improvements are:
a. A tile roof is substituted for wooden shingles
b. A shatter proof glass is substituted for ordinary glass
c. An old motor in a machine is replaced by a new and powerful one
d. Galvanized iron roofing is substituted for nipa roofing
e. Replacement of wooden floor by concrete flooring
Replacements
Replacements also involve substitution but the new asset is not better than the old
asset when acquired.
The basic difference between an improvement and replacement is that an
improvement is a substitution of a better or superior quality whereas a
replacement is a substitution of an equal or lesser quality.
Replacements may be classified into three:
a. Replacement of the old asset by a new one. This is the replacement
contemplated.
For example, an old truck is replaced by a new one. This replacement is surely
capitalizable as a new asset.
b. Replacement of major parts or extraordinary repairs
c. Replacement of minor parts or ordinary repairs
Repairs
Repairs are those expenditures used to restore assets to good operating condition
upon their breakdown or replacement of broken parts.
Repairs may be classified as extraordinary repairs and ordinary repairs.
Extraordinary repairs are material replacement of parts, involving large sums and
normally extend the useful life of the asset.
Extraordinary repairs are usually capitalized.
Ordinary repairs are minor replacement of parts, involving small sums and are
frequently encountered.
Ordinary repairs are normally charged to expense when incurred.
Accordingly, an entity does not include in the carrying amount of property, plant
and equipment the cost of day-to-day servicing of the property.
Rather, such cost of day-to-day servicing is recognized as expense when incurred.
Repair and maintenance

Repair is different from maintenance in that
repair restores the asset in good operating
condition while maintenance keeps the asset in
good condition.
Thus, repair is restorative or curative while
maintenance is preventive.
The theoretical distinction is difficult to maintain
in practice. Hence the combined in a single
account “repair and maintenance."
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Rearrangement cost
Rearrangement cost is the relocation or redeployment of an existing property,
plant and equipment.
PAS 16, paragraph 20, provides that recognition of costs in the carrying amount
of property, plant and equipment ceases when the asset is in the location and
condition for the intended use.
In other words, IFRS expressly mandates that the costs of relocating existing
property, plant and equipment or costs of reorganizing part or all of an entity's
operations are not capitalized but expensed as incurred.
The rearrangement merely maintains the existing level of standard performance of
the asset.
5.9 Accounting for major replacement

An important consideration in determining the appropriate accounting treatment
for a replacement is whether the original part of an existing asset is separately
identifiable.
If separate identification is practicable, the major replacement is debited to the
asset account.
The cost of the part eliminated and the related accumulated depreciation is
removed from the accounts and the remaining carrying amount of the old part is
treated as a loss.
If it is not practicable for an entity to determine the carrying amount of the
replaced part, it may use the cost of the replacement as an indication of the "likely
original cost" of the replaced part at the time it was acquired or constructed.
However, the current replacement cost shall be discounted.
Separate identification is practicable

For example, a building having a useful life of 20 years is constructed at a total
cost of P5,000,000.
After 10 years, the wooden roof is replaced with a concede roofing costing
P500,000.
A study of the original construction records reveals that P400,000 is an accurate
estimate of the original cost of the wooden roof.
Journal entries
1. To eliminate the original cost of the wooden roof:

Loss on retirement of building 200,000
Building 400,000
Note that the building is already 50% depreciated.

2. To record the replacement:
Building 500,000
Cash 500,000
3. To record subsequent annual depreciation:

Depreciation 280,000
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Building (5,000,000 - 400,000 + 500,000) = 5,100,000
Accumulated depreciation (2,500,000 - 200,000) = 2,300,000
Carrying amount 2,800,000
Annual depreciation (2,800,000/10 years remaining) = 280,000
Separate identification is not practicable

Assume the same data in the preceding illustration and it is not practicable to
identify the cost of the specific part replaced.
1. To eliminate the cost of the wooden roof replaced:
Loss on retirement of building 140,000
Building 280,000
If it is not practicable to identify the original cost of the replaced part, the entity
may use the replacement cost as an indication of the likely original cost.
However, this requires discounting of the replacement cost.
If the appropriate discount rate is 6%, the replacement cost of P500,000 is
discounted at 6% for 10 years. The present value of 1 at 6% for 10 periods is 0.56.
Thus, the likely original cost is equal to P500,000 multiplied by 0.56 or P280,000.
2. To record the replacement:

Building 500,000
Cash 500,000
3. To record the subsequent annual depreciation:

Depreciation
Building (5,000,000 - 280,000 + 500,000) = 5,220,000

Accumulated depreciation (2,500,000 - 140,000) = 2,360,000
Carrying amount 2,860,000
Annual depreciation (2,860,000 / 10 years remaining)= 286,000
APPLICATION
Choose the most correct statement/answer.
Question 1
During the current year, Bear Company had the following transactions pertaining
to a new office building:
Purchase price of land 600,000

Legal fees for contract to purchase land 20,000
Architect fee 80,000
Demolition of old building on site to make room
for construction of new building 50,000
Sale of scrap from old building 30,000
Construction cost of new building fully completed 3,500,000
1. What amount should be reported as cost of land?

a. 600,000 b. 620,000 c. 640,000 d. 650,000
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2. What amount should be reported as cost of building?
a. 3,520,000 b. 3,600,000 c. 3,500,000 d. 3,620,000
Question 2
At the beginning of current year, New Normal Company purchased a parcel of
land as a factory site for P1,000,000. An old building on the property was
demolished to pave the way for the construction of a new building which was
completed at year-end.
Demolition of old building 100,000

Legal fee for title investigation and purchase contract 25,000
Construction cost 5,450,000
1. What amount should be recorded as cost of land?

a. 1,125,000 b. 1,100,000 c. 1,000,000 d. 1,025,000
2. What amount should be recorded as cost of building?

a. 5,475,000 b. 5,750,000 c. 5,725,000 d. 5,450,000
Question 3
Martini Company incurred the following costs in purchasing a land as a factory
site:
Purchase price 2,400,000
Cost of tearing down old building 240,000
Legal fee for title investigation 15,000
Title insurance 10,000
Liability insurance during construction 25,000
Excavation cost 40,000
Payment to building contractor 8,800,000
Special assessment by city for public improvement 30,000
Interest cost during construction 300,000
1. What is the cost of the land?

a. 2,425,000 b. 2,455,000 c. 2,495,000 d. 2,695,000
2. What is the cost of the building?

a. 9,505,000 b. 9,490,000 c. 9,250,000 d. 9,530,000
Question 4
At the beginning of the current year, Leon Company purchased a parcel of land as
a factory site. An old building on the land was demolished and construction
started on a new building that was completed at the end of current year.
Purchase price of land 3,200,000

Legal fee-title investigation 50,000
Construction cost 8,500,000
Imputed interest on construction cost 140,000
Landfill for building site 190,000
Clearing of trees from building site 100,000
Timber sold 30,000
Temporary building used for construction activities 290,000
Land survey 40,000
Excavation for basement 110,000
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1. What is the cost of land?
a. 3,550,000 b. 3,750,000 c. 3,360,000 d. 3,660,000
2. What is the cost of new building?

a. 9,400,000 b. 9,200,000 c. 9,590,000 d. 9,290,000
Question 5
At the beginning of the current year, Rockz Company reported the following
balances:
Land 2,200,000
Building 6,500,000
During the current year, the following transactions occurred:

 A piece of land was acquired for P1,600,000. To be able to acquire the
land, P175,000 was paid to a real estate agent, and P50,000 was incurred
to clear the land. During the course of clearing the land, timber and gravel
were recovered and sold for P25,000.
 A second piece of land with a building was acquired for P4,500,000. The
appraiser valued the land at P2,000,000 and the building at P1,000,000.
Shortly after acquisition, the building was demolished at a cost of
P100,000. A new building was constructed at a cost of P5,000,000 plus
excavation fee P50,000, architect fee P80,000 and building permit
P70,000.
 A third piece of land was acquired for P2,000,000 and was held for
undetermined use.
1. What total cost of land should be reported in the statement of financial position
under property, plant and equipment?
a. 8,500,000 b. 7,000,000 c. 7,100,000 d. 8,600,000
a. 5,200,000 b. 5,300,000 c. 6,800,000 d. 6,700,000
Question 6
Rollin’ Company incurred the following expenditures related to land and
building.
Cash paid for land and dilapidated building

1,000,000
Removal of old building to make room for construction of new building
50,000
Payment to tenants for vacating old building
15,000
Architect fee for new building
200,000
Building permit for new construction
30,000
Fee for title search
10,000
Survey before construction of new building
20,000
Excavation before new construction
100,000
New building constructed
6,000,000
Assessment by city for drainage project
5,000
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Cost of grading, leveling and landfill
45,000
Driveway and walk to new building from street (part of building plan)
40,000
Temporary quarters for construction crew
80,000
Temporary building to house tools and materials
60,000
Cost of changes during construction to make new building more energy efficient
50,000
Cost of windows broken by vandals
25,000
1. What is the cost of land?

a. 1,145,000 b. 1,215,000 c. 1,130,000 d. 1,080,000

a. 6,625,000 b. 6,560,000 c. 6,650,000 d. 6,645,000
Question 7
Attitude Company purchased a plot of land for P2,000,000 as a plant site. There
was a small office building on the plot with fair value of P700,000 which the
entity will continue to use with some modification and renovation. The entity
decided to construct a factory building and incurred the following costs:
Materials and supplies 3,000,000
Excavation 100,000
Labor on construction 2,500,000
Cost remodeling office building 200,000
Legal cost of conveying land 10,000
Imputed interest on money used during construction 120,000
Cash discounts on materials purchased 60,000
Supervision by management 70,000
Compensation insurance premium for workers 20,000
Clerical and other expenses related to construction 30,000
Paving of streets and sidewalks 40,000
Plans and specifications 140,000
Payment for claim for injuries not covered by insurance 25,000
Legal cost of injury claim 15,000
Saving on construction 200,000
1. What is the initial cost of land?

a. 1,310,000 b. 1,300,000 c. 1,350,000 d. 1,410,000
2. What is the initial cost of office building?

a. 1,050,000 b. 900,000 c. 700,000 d. 850,000
3. What is the initial cost of factory building?

a. 5,720,000 b. 5,920,000 c. 5,800,000 d. 5,600,000
Question 8
Nitro Company acquired a new machinery.
Invoice price of the machinery
1,400,000
Cash discount available but not taken on purchase 20,000
Freight paid on the new machinery 40,000
Cost of removing the old machinery 15,000
Installation cost of the new machinery 50,000
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Testing cost before the machinery was put into regular operation
including P10,000 in wages of the regular machinery operator 30,000
Loss on premature retirement of the old machinery 5,000
Estimated cost of manufacturing similar machinery
including overhead 1,300,000
What amount should be capitalized as cost of the new machinery?

a. 1,500,000 b. 1,490,000 c. 1,515,000 d. 1,520,000
Question 9
Bass Company acquired a machine at the beginning of the current year.
Cash paid for machine, including VAT of P96,000 896,000
Cost of transporting machine 30,000
Labor cost of installation by expert fitter
50,000
Labor cost of testing machine
40,000
Insurance cost for the current year 15,000
Cost of training personnel who will use the machine 25,000
Cost of safety rails and platform surrounding machine
60,000
Cost of water device to keep machine cool 80,000
Cost of adjustment to machine to make it operate more efficiently 75,000
Estimated dismantling cost to be incurred as required by contract 65,000
What total amount should be capitalized as cost of the machine?

a. 1,135,000 b. 1,231,000 c. 1,200,000 d. 1,150,000
Question 10
Kamp Company acquired a new processing machine.
Invoice cost 1,600,000
Cost of transportation 50,000
Cost of installation 50,000
The terms of the acquisition include a 3% discount if payment is made in 10 days.

The entity paid beyond the discount period.
The entity's chief engineer spent two-thirds of his time during trial run of the new
machine. The monthly salary is P60,000.
The entity requested an allowance from the supplier because the machine proved
to be of less than standard performance capability. The supplier granted a cash
allowance of P100,000.
The cost of removing the old machine before the new machine was installed
amounted to P10,000.
The operator of the old machine who was laid off due to the acquisition of the
new machine was paid a gratuity of P30,000.
What is the initial cost of the new machine?

a. 1,592,000 b. 1,622,000 c. 1,640,000 d. 1,552,000
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FEEDBACK/ASSESSMENT
Test your knowledge of the requirements for accounting and properly reporting
land, building, and machinery by answering the questions below. Assume all
amounts are material. Choose the most correct statement/answer.
Question 1
Queen Company made the following expenditures:
Continuing and frequent repairs 400,000
Repainted the plant building 100,000
Major improvements to the electrical wiring system 300,000
Partial replacement of roof tiles 140,000
What amount should be charged to repair and maintenance expense?

a.960,000 b. 820,000 c. 640,000 d. 540,000
Question 2
Maxx Company made the following expenditures:
Renovation of a group of machines to secure significant
increase in production over the remaining five-year useful life 500,000
Continuing, frequent, and low cost repairs 350,000
Replacement of a broken gear on a machine 50,000
What amount should be charged to repair and maintenance expense?

a. 350,000 b. 400,000 c. 850,000 d. 900,000
Question 3
Rose Company provided the following charges to the “repair maintenance
account”.
Service contract on office equipment 100,000
Initial design fee for proposed extension of office building 150,000
New condenser for central air conditioning unit 10,000
Purchase of executive chairs and desks 200,000
Purchase of storm windows and screens and their
installation on all office windows 500,000
Sealing of roof leaks in production area 80,000
Replacement of door to production area 50,000
Installation of automatic door-opening system 200,000
Overhead crane for assembly department to speed
up production 350,000
Replacement of broken gear on machine 60,000
What total amount of expenditures should be capitalized?

a. 1,400,000 b. 1,200,000 c. 1,500,000 d. 1,410,000
Question 4
Cake Company purchased for P4,500,000 a tract of land as a factory site. An
existing building on the property was razed to pave the way for the construction
of a new factory building.
Cost of razing old building 300,000
Title insurance and legal fees to purchase land 200,000
New building construction cost 8,000,000
1. What is the cost of the land?

a. 4,700,000 b. 5,000,000 c. 4,500,000 d. 4,800,000
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2. What is the cost of factory building?
a. 9,250,000 b. 9,450,000 c. 8,000,000 d. 9,150,000
Question 5
When an entity purchases land with a building on it and immediately tears down
the building so that the land can be used for the construction of a plant, the cost
incurred to tear down the building shall be
a. Expensed as incurred
b. Added to the cost of the plant
c. Added to the cost of the land
d. Amortized over the estimated time period between the tearing down of the
building and the completion of the plant
Question 6
An entity purchased land to be used as the site for the construction of a plant.
Timber was cut from the building site so that construction of the plant could
begin. The proceeds from the sale of the timber shall be
a. Classified as other income
b. Netted against the cost to clear the land and expensed as incurred
c. Deducted from the cost of the plant
d. Deducted from the cost of land
Question 7
Land was purchased to be used as the site for the construction of plant. A building
on the property was sold and removed by the buyer so that construction on the
plant could begin. The proceeds from the sale of the building shall be
a. Netted against the cost to clear the land and expensed as incurred
b. Netted against the cost to clear the land and amortized over the life of the plant
c. Deducted from the cost of the land
d. Classified as other income
Question 8
If an entity purchases a lot and building and subsequently tears down the building
and uses the property as a parking lot, the proper accounting treatment of the cost
of the building would depend on
a. The significance of the cost allocated to the building in relation to the combined
cost of the lot and building
b. The length of time for which the building was held prior to its demolition
c. The contemplated future use of the parking lot
d. The intention of management for the property when the
building was acquired
Question 9
An entity's forest land was condemned for use as a national park. Compensation
for the condemnation exceeded the forest land's carrying amount. The entity
purchased similar, but larger, replacement forest land for an amount greater than
the condemnation award. As a result of the condemnation and replacement, what
is the net effect on the carrying amount of forest land reported in the entity's
statement of financial position?
a. The amount is increased by the excess of the replacement forest land's cost over
the condemned land's carrying amount
b. The amount is increased by the excess of the replacement forest land's cost over
the condemnation award
c. The amount is increased by the excess of the condemnation award over the
condemned forest land's
carrying amount
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d. No effect, because the condemned forest land's carrying amount is used as the
replacement forest land's carrying amount
Question 10
The term “betterment" refers to
a. An expenditure made for new facilities which increase "capacity".
b. An expenditure made to restore “capacity” after abandonment or retirement.
c. An expenditure made to improve existing facilities by increasing "capacity".
d. An expenditure made to help insure continuity of service capacity.
Question 11
Which type of expenditure occurs when an entity installs a higher capacity boiler
to heat its plant?
a. Rearrangement
b. Ordinary repair and maintenance
c. Addition
d. Betterment
Question 12
An improvement made to a machine which increased its fair value and its
production capacity without extending the machine's useful life should be
a. Expensed immediately
b. Debited to accumulated depreciation
c. Capitalized in the machine account
d. Allocated between accumulated depreciation and the machine account
Question 13
Which of the following would ordinarily be treated as a revenue expenditure
rather than a capital expenditure?
a. Cost of servicing and overhaul to restore or maintain the originally assessed
standard of performance. b. The replacement of a major component of building
c. An addition to an existing building
d. Cost of improvement that is expected to provide discernible future benefit
Question 14
A building suffered uninsured fire damage. The damaged portion of the building
was refurbished with higher quality materials. The cost and related accumulated
depreciation of the damaged portion are identifiable. What is the accounting for
these events?
a. Capitalize the cost of refurbishing and record a loss in the current period equal
to the carrying amount of the damaged portion of the building
b. Capitalize the cost of refurbishing by adding the cost to the carrying amount of
the building
c. Record a loss in the current period equal to the cost of refurbishing and
continue to depreciate the original cost of the building
d. Record a loss in the current period equal to the sum of the cost of refurbishing
and the carrying amount of the damaged portion of the building
Question 15
An entity incurred cost to modify its building and to rearrange its production line.
As a result, an overall reduction in production cost is expected. However, the
modification did not increase the building's fair value and the rearrangement did
not extend the production line's life. Should the building modification cost and the
production line rearrangement cost be capitalized?
a. Only the building modification cost should be capitalized.
b. Only the production line rearrangement cost should be capitalized.
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c. Both the building modification cost and production line rearrangement cost
should be capitalized.
d. The building modification cost and production line rearrangement cost should
be expensed.
Question 16
Which of the following costs should not be capitalized?
a. Replacement of a building's roof every 15 years
b. Cost of site preparation
c. Installation and assembly cost
d. Replacement of small spare parts annually
Question 17
The cost of building shall include all of the following, except
a. Any renovating or remodeling cost incurred to put the building purchased in a
condition for its intended use
b. Cost of excavation
c. Expenditure for service equipment and fixture made a permanent part of the
structure
d. Cost incurred to have existing building removed to make room for construction
of new building
Question 18
The cost of land shall include all of the following, except
a. Commission related to acquisition
b. Property tax after date of acquisition assumed by the purchaser
c. Property tax to date of acquisition assumed by the purchaser
d. Cost of survey
Question 19
Which of the following expenditures may properly be capitalized?
a. Expenditure for massive advertising campaign
b. Insurance on plant during construction
c. Research and development related to a long-term asset which is giving the
entity a competitive market advantage
d. Title search and other legal cost related to a piece of property which was not
acquired
Question 20
Blond Company purchased a P4,000,000 tract of land for a factory site. The entity
razed an old building on the property to make room for the construction of new
building and sold the materials salvaged from the demolition.
Legal fees for purchase contract and recording ownership 150,000
Title guarantee insurance 50,000
Proceeds from sale of salvaged materials 20,000
What is carrying amount of the land?

a. 4,200,000 b. 4,150,000 c. 4,050,000 d. 4,400,000
End Of Topic 4&5
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Topic 6: Depreciation
Introduction
This module focuses on the accounting procedures for depreciating fixed
assets. It introduces the learner to the subject, guides the learner through the
official text, develops the learner’s understanding of the requirements through the
use of examples and indicates significant judgements that are required in
accounting for depreciation. Furthermore, the module includes questions designed
to test the learner’s knowledge of the requirements and to develop the learner’s
ability to account for depreciation.
Learning Outcome:
 Understand the concept of depreciation
 Know the accounting and statement presentation for depreciation
 To identify the specific causes of depreciation
 To identify the factors involved in determining depreciation
 To be able to compute depreciation using straight line, service hours, and
production method
 To understand the rationale for straight line depreciation and variable
depreciation
Topic Outline:
6.1 Concept of depreciation depreciation: Inadequacy,
6.2 Depreciation in the financial supersession and obsolescence
statements 6.5 Factors of depreciation
6.3 Depreciation period 6.6 Methods of depreciation
6.4 Kinds of depreciation- Physical 6.7 Change in useful life and Change
depreciation, Functional in depreciation method
6.1 Concept of Depreciation

Depreciation is defined as the systematic allocation of the depreciable amount of
an asset over the useful life. Depreciation is a matter of cost allocation in
recognition of the exhaustion of the useful life of an item of property, plant, and
equipment.
The objective of depreciation is to have each period benefiting from the use of the
asset bear an equitable share of the asset cost.
6.2 Depreciation in the Financial Statements
Depreciation is an expense. It may be part of the cost of goods manufactured or an
operating expense. Except for non-exhaustible land, all property shall be
47 | P a g e
depreciated on a systematic basis over the useful life of the asset irrespective of
the earnings of the entity.
6.3 Depreciation Period

Depreciation of an asset begins when it is available for use, meaning, when the
asset is in the location and condition necessary for it to be capable of operating in
the manner intended by management.
Depreciation ceases when the asset is derecognized. Therefore, depreciation does
not cease when the asset becomes idle temporarily. However, PFRS 5, paragraph
25, provides that if the asset is classified as held for sale, depreciation shall be
discontinued.
6.4 Kinds of depreciation

There are two kinds of depreciation, namely physical and functional or economic
depreciation.
Physical depreciation is related to the depreciable asset's wear and tear and
deterioration over a period.
Physical depreciation may be caused by:

a. Wear and tear due to frequent use
b. Passage of time due to nonuse
c. Action of the elements such as wind, sunshine, rain or dust
d. Casualty or accident such as fire, flood, earthquake and other natural
disaster
e. Disease or decay - This physical cause is applicable to animals and
wooden buildings.
Accordingly, physical depreciation results to the ultimate retirement of the
property or termination of the service life of the asset.
Functional or economic depreciation arises from inadequacy, supersession and

obsolescence.
Inadequacy arises when the asset is no longer useful to the entity because of an
increase in the volume of operations. For example, adequate buildings acquired at
the inception of business may become inadequate or limited in their future service
potential when unexpected business growth or expansion requires larger facilities
for efficient operation.
Supersession arises when a new asset becomes available and the new asset can
perform the same function more efficiently and economically or for substantially
less cost.
Obsolescence is the catchall for economic or functional depreciation.
For example, obsolescence arises when there is no future demand for the product
which the asset produces. Obsolescence encompasses inadequacy and
supersession.
An asset becomes obsolete if it is inadequate or superseded.
6.5 Factors of depreciation

In order to properly compute the amount of depreciation, three factors are
necessary, namely depreciable amount, residual value and useful life.
Depreciation:
Is the systematic allocation of the depreciable amount of an asset over it’s
useful life
Residual value:
An asset is the estimated amount that an entity would currently obtain
from disposal of the asset, after deducting the estimated cost of disposal
48 | P a g e
Depreciable amount:
Is the amount is the cost of an asset or the amount that has replaced it, less
its residual value.
Depreciable amount- depreciable amount or depreciable cost is the cost of an

asset or other amount substituted for cost, less the residual value.
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.
For example, it may be appropriate to depreciate separately the airframe, engines,
fittings (seats and floor coverings) and tires of an aircraft.
The entity also depreciates separately the remainder of the item and the remainder
consists of the parts of the item that are individually not significant.
Residual value- residual value is the estimated net amount currently obtainable if
the asset is at the end of the useful life. The residual value of an asset shall be
reviewed at least at each financial year-end and if expectation differs from
previous estimate, the change shall be accounted for as a change in an accounting
estimate. In practice, the residual value of an asset is often insignificant and
therefore immaterial in the calculation of the depreciable amount. The residual
value of an asset may increase to an amount equal to or greater than the carrying
amount. If it does, the depreciation charge is zero unless and until the residual
value subsequently decreases to an amount below the carrying amount.
Depreciation is recognized even if the fair value of the asset exceeds the carrying
amount as long as the residual value does not exceed the carrying amount.
Useful life- useful life is either the period over which an asset is expected to be
available for use by the entity, or the number of production or similar units
expected to be obtained from the asset by the entity.
Accordingly, the useful life of an asset is expressed as:
a. Time periods as in years
b. Units of output or production
c. Service hours or working hours
Factors in determining useful life

a. Expected usage of the asset - Usage is assessed by reference to the asset's
expected capacity or physical output.
b. Expected physical wear and tear - This depends on the operational factors
such as the number of shifts the asset is used, the repair and maintenance
program, and the care and maintenance of the asset while idle.
c. Technical or commercial obsolescence - This arises from changes or
improvements in production, or change in the market demand for the
product output of the asset.
d. Legal limits for the use of the asset, such as the expiry date of the related
lease.
Incidentally, the service life of an asset should be distinguished from physical life.
Service life is the period of time an asset shall be used by an entity. The service
life is the equivalent of useful life. Physical life refers to how long the asset shall
last.
6.6 Depreciation method

The depreciation method shall reflect the pattern in which the future economic
benefits from the asset are expected to be consumed by the entity. The
depreciation method shall be reviewed at least at every year-end. The method
shall be changed if there is a significant change in the expected pattern of future
economic benefits. Such change in depreciation method shall be accounted for as
change in accounting estimate.
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Methods of depreciation
1. Equal or uniform charge methods 3. Decreasing charge or accelerated
a. Straight line or diminishing balance methods
b. Composite method a. Sum of years' digits
c. Group method b. Declining balance method
c. Double declining balance
2. Variable charge or use-factor or
activity methods 4. Other methods
a. Working hours or service hours a. Inventory or appraisal
b. Output or production method b. Retirement method
c. Replacement method
Straight line method

Assumes uniform consumption pattern of economic benefits
The depreciation expense:
Depreciation expense = Depreciable amount/Estimated useful life

*Depreciable amount = Cost – Salvage Value
Under the straight line method, the annual depreciation charge is calculated by
allocating the depreciable amount equally over the number of years of estimated
useful life. In other words, straight line depreciation is a constant charge over the
useful life of the asset.
The formula for the computation of the annual depreciation following the straight
line method is as follows:
Annual depreciation= Cost minus residual value/ Useful life in years
Cost minus residual value equals depreciable amount.
Straight line rate

Depreciable amount multiplied by the straight line rate of depreciation also gives
the amount of annual depreciation. The straight line rate is determined by dividing
100% by the life of the asset in years. For example, if the useful life of the asset is
5 years, the annual straight line rate is 20%, computed by dividing 100% by 5
years.
Rationale for straight line

The straight line method is adopted when the principal cause of depreciation is
passage of time. The straight line approach considers depreciation as a function of
time rather than as a function of usage.
Examples of assets which depreciate principally because of passage of time are
buildings, other structures such as radio and TV towers, dams, bridges, and office
equipment such as typewriters, adding machines, computers.
Although use and obsolescence contribute to the depreciation of such assets, such
causes are insignificant compared to the effects of time. The straight line method
is widely used in practice because of simplicity.
Illustration
The following data relate to an equipment acquired at the beginning of the first
year:
Equipment P105,000
Residual value 5,000
Useful life 5 years
Depreciable amount= 105,000 less 5,000= 100,000

Annual depreciation= 100,000/5 years= 20,000
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At the end of the useful life of the asset, the carrying amount should equal the
residual value. In this case, at the end of fifth year, the residual value of P5,000
will be the carrying amount of the asset.
Journal entry
Depreciation 20,000
The adjusting entry for depreciation is prepared at the end of every accounting
period.
Statement presentation
When a statement of financial position is prepared at the end of the first year, the
equipment account is classified as property, plant and equipment.
Equipment 105,000
Accumulated depreciation (20,000)
Carrying amount 85,000
The carrying amount is the amount at which an asset is recognized in the

statement of financial position after deducting any accumulated depreciation and
accumulated impairment loss.
Composite and group method

Large entities own various individual depreciable assets. For these entities,
making detailed depreciation computation for each individual asset referred to as
unit depreciation is time consuming and costly. Therefore, large entities find it
more practical to compute depreciation by treating many individual assets as
though they were a single asset.
The two methods of depreciating various individual assets as a single asset are
composite method and group method.
Under the composite method, assets that are dissimilar in nature or assets that
have different physical characteristics and vary widely in useful life, are grouped
and treated as a single unit.
Under the group method all assets that are similar in nature and in estimated
useful life are grouped and treated as a single unit.
The accounting procedure and the method of computation for the composite and
group method are essentially the same. In other words, the average useful life and
the composite or group rate are computed, and the assets in the group are
depreciated on that basis.
Accounting procedures
a. Depreciation is reported in a single accumulated depreciation account. Thus,
the accumulated depreciation account is not related to any specific asset account.
b. The composite or group rate is multiplied by the total cost of the assets in the
group to get the periodic depreciation.
c. When an asset in the group is retired, no gain or loss is reported. The asset
account is credited for the cost of the asset retired and the accumulated
depreciation account is debited for the cost minus salvage proceeds.
d. When the asset retired is replaced by a similar asset, the replacement is
recorded by debiting the asset account and crediting cash or other appropriate
account.
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Subsequently, the composite or group rate is multiplied by the balance of the asset
account to get the periodic depreciation.
Composite method
The following computation is necessary in determining the composite life and
composite rate:
Asset Cost Residua Depreciable Useful life in (a÷b)

l value amount years Annual
depreciation
Building 650,000 50,000 600,000 15 40,000
Machinery 220,000 20,000 200,000 8 25,000
Equipment 130,000 30,000 100,000 4 25,000
Total 1,000,000 100,000 900,000 90,000
The composite life is determined by dividing the total depreciable amount by

total annual depreciation. Thus, P900,000 divided by P90,000 equals 10 years.
The composite rate is determined by dividing the total annual depreciation by
the total cost. Thus, P90,000 divided by P1,000,000 equals 9% composite rate.
All of the assets in the group are acquired at the beginning of current year. The
annual depreciation for the current year is recorded as follows:
Depreciation 90,000
The accumulated depreciation account is not related to any specific asset account
in the group.
Thus, a statement of financial position prepared at the current year-end would
report the property, plant and equipment as follows:
Building 650,000
Machinery 220,000
Equipment 130,000
Total 1,000,000
Accumulated depreciation (90,000)
Carrying amount 910,000
Retirement of asset in the group

If the equipment is retired after four years and sold for P20,000, the journal entry
is:
Cash 20,000
Equipment 130,000
If there are no proceeds from the retirement of the equipment, the journal entry is:
Equipment 130,000
After the retirement of the equipment, the remaining cost of the assets in group is
P870,000 (P1,000,000 minus P130,000). Consequently, the annual depreciation is
no longer P90,000.
The annual depreciation starting the fifth year would be P78,300, computed by
multiplying the composite rate of 9% by the remaining cost of P870,000.
Retirement and replacement of asset

Upon the retirement of the equipment, the same is replaced by a similar asset
costing P160,000.
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Thus, the total cost of the assets in the group is now P1,030,000. Accordingly, the
annual depreciation starting the fifth year should be 9% times P1,030,000 or
P92,700.
Depreciation shall be discontinued when the same would result to a carrying

amount of the assets in the group which is below the residual value of the assets in
the group.
Variable charge or activity methods

The variable or activity methods assume that depreciation is more a function of
use rather than passage of time.
The useful life of the asset is considered in terms of the output it produces or the
number of hours it works. Thus, depreciation is related to the estimated
production capability of the asset and is expressed in a rate per unit of output or
per hour of use.
There are two variable methods, namely:
a. Working hours method
b. Output or production method
Rationale for variable depreciation

The variable methods are adopted if the principal cause of depreciation is usage.
The use of these methods is based on the following:
a. Assets depreciate more rapidly if they are used full time or overtime.
b. There is a direct relationship between utilization of assets and realization of
revenue.
If assets are used more intensively in production, greater revenue is expected. The
variable methods are found to be appropriate for assets such as machineries. The
major objection to these methods is that the units of output or service hours which
serve as the basis of depreciation may be difficult to estimate.
Illustration
Machinery, at cost 600,000
Residual value None
Estimated useful life:
Years 5 years
Service hours 60,000 hours
Output 150,000 units
Actual operations Service hours Output
First year 14,000 34,000
Second year 13,000 32,000
Third year 10,000 25,000
Fourth year 11,000 29,000
Fifth year 12,000 30,000
Total 60,000 150,000
Working hours method

Under this method, a depreciation rate per hour is computed by dividing the
depreciable amount by the estimated useful life in terms of service hours. Thus,
the rate per hour is P10, computed by dividing P600,000 by 60,000 hours. The
depreciation rate per hour is then multiplied by the actual hours worked in one
period to get the depreciation for that period.
Depreciation per year:

First year 14,000 X 10 = 140,000
Second year 13,000 x 10 = 130,000
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Third year 10,000 x 10 = 100,000
Fourth year 11,000 x 10 = 110,000
Fifth year 12,000 X 10 = 120,000
Output or production method

Units of production method measure the amount of depreciation dividing
the total estimated units by total estimated hours.
Here the total estimated hours is identified by subtracting salvage value
from cost multiplying specific working hours.
Depreciation charge = {(Cost - Salvage value) x Hours this year}/ Total
estimated hours
The output or production method results in a charge based on the expected use or
output.
Under this method, a depreciation rate per unit is computed by dividing the
depreciable amount by the estimated useful life in terms of units of output. Thus
the rate per unit is P4, computed by dividing P600,000 by 150,000 units. The
depreciation rate per unit is then multiplied by the yearly output to get the annual
depreciation.
Depreciation per year:

First year 34,000 X 4= 136,000
Second year 32,000 X 4= 128,000
Third year 25,000 X 4= 100,000
Fourth year 29,000 x 4= 116,000
Fifth year 30,000 X 4= 120,000
Decreasing charge or accelerated methods

The decreasing charge or accelerated methods provide higher depreciation in the
earlier years and lower depreciation in the later years of the useful life of the
asset. Thus, these methods result in a decreasing depreciation charge over the
useful life.
Rationale for accelerated depreciation

The accelerated depreciation is on the philosophy that new assets are generally
capable of producing more revenue in the earlier years than in the later years.
Another argument for the use of decreasing charge method is that the cost of
using an asset includes not only depreciation but also repairs on such assets. Such
repair cost should be allocated over the useful life of the asset on a systematic and
uniform basis. It has been observed that repairs tend to increase with the age of
the asset, hence repairs are small in the earlier years and large during the later
years.
Therefore, following the decreasing charge method, the overall effect would be a
uniform charge because the decreasing amount of depreciation and the increasing
repairs will tend to equalize each other.
There are three decreasing charge methods, namely:
a. Sum of years' digits
b. Declining balance
c. Double declining balance
Sum of the years' digits

Each fraction uses the sum of the years as a denominator (5+4+3+2+1 =
15). The numerator is the number of years of estimated life remaining as of the
beginning of the year.
*Alterative formula for calculating the denominator
54 | P a g e
(n(n+1))/2 where “n” is the useful; life of the asset
e.g. = (5(5+1))/2
= (5(6))/2
= (30)/2
= 15
The sum of years' digits method provides for depreciation that is computed by
multiplying the depreciable amount by a series of fractions whose numerator is
the digit in the useful life of the asset and whose denominator is the sum of the
digits in the useful life of the asset.
The fractions are developed by getting the sum of the digits in the useful life of
the asset. For example, if the useful life is 4 years, the sum of years’ digits is 1 + 2
+ 3 + 4 or 10.
Thus, the depreciation would be 4 / 10 for the first year, 3 / 10 for the second
year, 2 / 10 for the third year and 1 / 10 for the fourth and last year.
What happens if the useful life of the asset is 25 years? How then would the sum
of years' digits be computed?
Thankfully, the mathematicians have developed a formula which permits easy
calculation of the sum of years' digit (SYD) as follows:
SYD = Life x [(Life + 1) ÷ 2]
Applying the formula, the sum of the digits of 25 years is computed as follows.
SYD = 25 x [(25 + 1) ÷ 2]
SYD = 25 x [26 ÷ 2]
SYD= 25 x 13= 325
Sum of half years' digits

If the useful life of the asset is 2 1/2 years, the procedure is to multiply the useful
life by 2 in order to get the useful life of the asset in half years.
Thus, the useful life of the asset in half years would be 5 (2 1/2 years x 2). The
sum of half years' digits would then be 15 or 1 + 2 + 3 + 4 + 5.
First year Two fractions: 5/15 and 4/15 (each fraction pertaining to half year
or six months) Second year Two fractions: (3/15 and 2/15)
Third year One fraction: 1/15
Illustration - Sum of years' digits

Machinery 430,000
Depreciable amount 400,000
Estimated useful life 4 years
SYD = 4 x [(4+1) ÷ 2] = 10
Depreciation per year

First year 4/10 x 400,000= 160,000
Second year 3/10 X 400,000= 120,000
Third year 2/10 X 400,000= 80,000
Fourth year 1/10 x 400,000= 40,000
Fractional depreciation - sum of years' digits

Cost of asset 300,000
Residual value None
Date of acquisition April 1, 2019
SYD = 1 + 2 + 3 = 6
April 1, 2019
3 years
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Depreciation for each year of the useful life:
From April 1, 2019 to March 31, 2020 (3/6 x P300,000)= 150,000
300,000
Computation of depreciation - calendar period
Depreciation for 2019:
P150,000 x 9/12 (April 1, 2019 to December 31, 2019) 112,500

P150,000 x 3/12 (January 1 to March 31, 2020) 37,500
P100,000 x 9 / 12 (April 1 to December 31, 2020) 75,000
112,500
P 50,000 x 9/12 (April 1 to December 31, 2021) 37,500
62,500
Declining balance method

Under the declining balance method, a fixed or uniform rate is multiplied by the
declining carrying amount of the asset in order to arrive at the annual
depreciation. Because of the use of a fixed rate, this method is also known as
fixed rate on diminishing carrying amount method. The problem in this method is
the determination of the fixed rate to be applied against the carrying amount.
Formula for fixed rate
𝑛
Rate = 1- √𝑅𝑒𝑠𝑖𝑑𝑢𝑎𝑙 𝑣𝑎𝑙𝑢𝑒 ÷ 𝐶𝑜𝑠𝑡
The “n” in the formula is the useful life of the asset. Observe that the nature of the
method is such that the value of the asset cannot be reduced to zero and that the
formula cannot be used unless there is a residual value. Thus, a residual value
must always be assigned to the asset. In the absence of any residual value, a
nominal amount of P1 should be assumed.
Illustration
Computation of fixed rate

5
Rate= 1- √50,000 ÷ 500,000
5
= 1- √. 10
To solve the mathematical equation, a table of logarithms must be used to extract
the fifth root of .10. Accordingly, the fifth root of .10 is .632
Rate = 1-.632= .368 or 36.8%
Depreciation table - declining balance
Year Particular Depreciation Accumulated Carrying
depreciation amount
Acquisition Cost 500,000
1 36.8% x 500,000 184,000 184,000 316,000
2 36.8% x 316,000 116,288 300,288 199,712
3 36.8% x 199,712 73,494 373,782 126,218
4 36.8% x 126,218 46,448 420,230 79,770
5 36.8% x 79,770 29,770* 450,000 50,000
Total 450,000
56 | P a g e
* 36.8% times P79,770 equals P29,355. But the depreciation provided for the fifth
year is P29,770.
The difference of P415 is due to rounding of figures and the computation of the
fixed rate uses limited decimal places.
Note that the fixed rate of 36.8% is multiplied by the total cost of P500,000 in the
first year and not by the depreciable amount of P450,000. Meanwhile, the
residual value is ignored.
The declining balance method is not used extensively in practice because the
calculations are complex.
Double declining balance method

Double declining depreciation rate is fixed percentage which is equal to
double of the straight line rate.
If the straight line rate is 20% the twice of the straight line rate would be
40% that is double declining rate.
The common application of the declining balance method is the double declining
balance. The procedure for the double declining balance method is the same as the
declining balance method in that a fixed rate is multiplied by the declining
carrying amount of the asset to arrive at the annual
depreciation. Actually the double declining balance method is an approximation
of the declining balance method. The difference between the two lies in the
determination of the rate to be used.
Under the declining balance method, the fixed rate is determined following a
mathematical formula. But under the double declining balance method, the
straight line rate is simply doubled to get the fixed rate.
The term "double declining balance" came to its name because the straight line
rate is doubled.
Thus, this method is also known as "200% declining balance method".
Illustration
Date of acquisition January 1, 2019
Straight line rate (100%/5 years) 20%
Double declining rate (20% x 2) 40%
Year Particular Depreciation Accumulated Carrying
depreciation amount
Acquisition Cost 500,000
2019 40% x 500,000 200,000 200,000 300,000
2020 40% x 300,000 120,000 320,000 180,000
2021 40% x 180,000 72,000 392,000 108,000
2022 40% x 108,000 43,200 435,200 64,800
2023 64,800-50,000 14,800 450,000 50,000
Total 450,000
As in the declining balance method, the residual value is ignored in the first year
in the computation of depreciation. Thus, for 2019, the rate of 40% is multiplied
by the total cost of P500,000. However, in the last year 2023, the fixed rate of
40% is no longer multiplied by the carrying amount. The depreciation for 2023 is
simply the difference between the carrying amount of P64,800 and the residual
value of P50,000.
57 | P a g e
150% declining balance
In application and procedure, this method is the same as the double declining
balance. Under double declining balance, the fixed rate is twice or 200% of the
straight line rate. Under the 150% declining balance method, the fixed rate is
150% of the straight line rate.
Inventory method
The inventory method consists of merely estimating the value of the asset at the
end of the period. The difference between the balance of the asset account and the
value at the end of the year is then recognized as depreciation for the year. In
recording depreciation, no accumulated depreciation account is maintained. The
depreciation is credited directly to the asset account.
This depreciation approach is applied generally to assets which are small and
relatively inexpensive such as hand tools or utensils. The major objection to this
depreciation method is that it is not systematic. No set formula is involved and a
great deal of subjectivity is often encountered in the determination of the value of
the asset at the end of the year.
Illustration - inventory method

An entity uses the inventory method to account for numerous small tools. The
following transactions concerning small tools occurred during the current year.
Tools account, January 1 100,000
Acquisition, at cost 90,000
Sale of used tools, at residual value 2,000
Inventory of tools on December 31, at cost 125,000
Journal entries
1. To record the acquisition:
Tools 90,000
Cash 90,000
2. To record the sale of used tools at residual value
Cash 2,000
Tools 2,000
3. To record the depreciation of tools:
Depreciation 63,000
Tools 63,000
Balance of tools account (100,000+90,000-2,000) 188,000

Inventory of tools - December 31 (125,000)
Depreciation 63,000
Retirement and replacement method

Under the retirement method of depreciation, no depreciation is recorded until the
asset is retired.
The amount of depreciation is equal to the original cost of the asset retired minus
salvage proceeds.
Under the replacement method, no depreciation is recorded until the asset is

retired and replaced.
The amount of depreciation is equal to the replacement cost of asset retired, minus
salvage proceeds.
If the asset retired is not replaced, the original cost of the asset retired but not
replaced is recognized as depreciation.
58 | P a g e
The retirement and replacement method may be used in much the same situations
as the inventory method. Such methods are suitable when a large number of
similar items are employed by the entity and the items are constantly being retired
and replaced. These methods are frequently used by public utility entities which
have a large number of virtually identical items that are being installed, retired
and replaced such as poles, lines, meters and telephone receivers.
Illustration
The following data relate to the tools account for the current year.
Balance- January 1, 1,000 units at P50 per unit 50,000
Acquisition - 2,500 units at P70 per unit 175,000
Retirement of tools- 1,200 units
Proceeds from retirement of tools 5,000
Retirement method
1. To record the acquisition:
Tools 175,000
Cash 175,000
2. To record the retirement:
Cash 5,000
Depreciation 59,000
Tools 64,000
Cost of tools retired (FIFO):

1,000 units x 50 50,000
200 units x 70 14,000
1,200 units 64,000
Replacement method
1. To record the acquisition of tools in excess of the retirement (2,500 - 1,200
equals 1,300):
Tools (1,300 x 70) 91,000
Cash 91,000
2. To record the replacement of the tools retired:
Depreciation 79,000
Cash 79,000
Replacement cost of tools retired (1,200 x 70) 84,000

Proceeds from retirement (5,000)
Depreciation 79,000
6.7 Change in useful life and Change in depreciation method

Change in useful life
Unexpected physical deterioration or technological improvement may indicate
that the useful life of the asset is less than that originally estimated. On the other
hand, improved maintenance procedures or revision of operating procedures may
prolong the useful life of the asset beyond the original estimate.
The useful life of an item of property, plant and equipment shall be reviewed at
least at each financial year-end and if expectations are significantly different from
previous estimate, the change shall be accounted for as a change in accounting
estimate. Therefore, the depreciation charge for the current and future periods
shall be adjusted.
59 | P a g e
Illustration
A depreciable asset costing P500,000 is originally estimated to have a useful life
of 5 years. At the beginning of the third year, the original useful life is revised to
8 years. Thus, the asset has a remaining useful life of 6 years.
Past depreciation is not corrected. The procedure is simply to allocate the
remaining carrying amount of the asset over the remaining revised useful life in
order to get the subsequent annual depreciation.
Annual depreciation starting the third year

Cost 500,000
Accumulated depreciation (500,000/5 x 2) (200,000)
Carrying amount --beginning of third year 300,000
Annual depreciation starting the third year
= (300,000/6) 50,000
Change in depreciation method

Depreciation method used shall reflect the pattern in which the asset's economic
benefits are expected to be consumed by the entity. The depreciation method shall
be reviewed at least at each financial year-end and if there has been a significant
change in the expected pattern of economic benefits embodied in the asset, the
method shall be changed to reflect the new pattern. When such a change in
depreciation method is necessary, the change shall be accounted for as a change in
accounting estimate and the depreciation charge for the current and future periods
shall be adjusted.
Illustration
An entity decided to change from SYD to the straight line method of depreciation
on January 1, 2019.
The asset is acquired on January 1, 2017 at a cost of P1,000,000 and has an
estimated useful life of 4 years.
The carrying amount of the asset on January 1, 2019 is determined as follows:

Cost - January 1, 2017 1,000,000
Accumulated depreciation:
2017 (4/10 x 1,000,000) 400,000
2018 (3/10 x 1,000,000) 300,000 700,000
Carrying amount - January 1, 2019 300,000
The procedure is simply to allocate the remaining carrying amount of P300,000

over the remaining useful life of 2 years using the new depreciation method which
is the straight line.
Accordingly, the depreciation for 2019 is P150,000.
Depreciation (300,000/2) 150,000

60 | P a g e
APPLICATION
Choose the most correct statement/answer.
Question 1. The production method of depreciation results in

a. Constant charge over the life of the asset.
b. Decreasing charge over the life of the asset.
c. Increasing charge over the life of the asset.
d. Charge based on the expected use or output of the asset.
Question 2. Which of the following statements is incorrect concerning the

residual value of an item of property, plant and equipment?
a. The depreciable amount is determined after deducting the residual value of the
asset.
b. In practice, the residual value of an asset is often insignificant and therefore
immaterial in the calculation of the depreciable amount.
c. The residual value of an asset may increase to an amount equal to or greater
than the assets carrying amount
d. The residual value of an asset shall be reviewed at least at each financial year-
end and if expectation differs from previous estimate, the change shall be
accounted for as a change in an accounting policy.
Question 3. The useful life of an item of property, plant and equipment shall be
reviewed periodically and if expectations are significantly different from previous
estimates the depreciation charge for the
a. Current period only shall be adjusted
b. Future period only shall be adjusted
c. Prior periods shall be adjusted
d. Current and future periods shall be adjusted
Question 4. The depreciation method applied to property, plant and equipment

shall be reviewed periodically, and if there has been a significant change in the
expected pattern of consumption of economic benefits from those assets, the
change
a. Shall be accounted for as a change in accounting policy
b. Shall not be recognized
c. Shall be accounted for as a change in accounting estimate
d. Shall be accounted for as correction of a prior period error
Question 5. Technical obsolescence arises from

a. Expected usage of the asset
b. Expected physical wear and tear
c. Changes or improvements in production or change in the market demand for
the product output of the asset
d. Expiry date of related lease of the asset
Question 6. Gibi Company purchased an asset with a useful life of 10 years on

January 1, 2016 for P6,500,000. On December 31, 2016, the amount the entity
would receive from the disposal of the asset if it was already of the age and in the
condition expected at the end of the useful life was estimated at P700,000.
Inclusive of inflation, the actual amount expected to be received on disposal was
estimated at P900,000. What is the depreciation charge for 2016?
a. 580,000
b. 650,000
c. 560,000
d. 0
61 | P a g e
Question 7. On January 1, 2016, Diamond Company acquired for P1,000,000 a
new machinery with useful life of 10 years. The machine has a drum costing
P200,000 that must be replaced every five years. Continued operation of the
machine requires an inspection every four years after purchase and the inspection
cost is P80,000. The straight-line method of depreciation is used. What is the
depreciation for 2016?
a. 100,000
b. 108,000
c. 120,000
d. 140,000
Question 8. Later Company provided the following:

Total cost Residual value Estimated life
Machine A 5,500,000 500,000 20
Machine B 2,000,000 200,000 15
Machine C 400,000 5
The entity computed depreciation on the straight line method.

1. What is the composite life of the assets?
a. 13.3 b. 16.0 c. 18.0 d. 19.8
2. What is the composite rate of depreciation?
a. 6.25% b. 5.70% c. 2.50% d. 7.50%
Question 9. Tan Company purchased a boring machine on January 1, 2016 for

P8,100,000. The useful life of the machine is estimated at 3 years with a residual
value at the end of this period of P600,000. During the useful life, the expected
units of production are 12,000 units in 2016, 7,000 units in 2017, and 6,000 units
in 2018. What is the depreciation expense for 2017 using the most appropriate
depreciation method?
a. 2,100,000 b. 2.268,000 c. 3,600,000 d. 1,800,000
Question 10. Leon Company acquired a machine on July 1, 2016 and paid
P5,200,000 including freight P50,000 and installation P150,000. The estimated
life of the machine is 8 years or a total of 100,000 working hours with no residual
value. The operating hours of the machine totaled 5,000 hours in 2016 and 12,000
hours in 2017. The entity followed the working hours method of depreciation. On
December 31, 2017, what is the carrying amount of the machine?
a. 3,900,000 b. 4,299,000 c. 4,940,000 d. 4,316,000
FEEDBACK/ASSESSMENT
Test your knowledge of the different concepts and procedure of the different
depreciation methods by answering the questions below. Assume all amounts are
material.
Question 1. On January 1, 2014, Mogu-Mogu Company acquired equipment to

be used in the manufacturing operations. The equipment has an estimated useful
life of 10 years and an estimated residual value of P50,000. The depreciation
applicable to this equipment was P240,000 for 2016 computed under the sum of
years' digits method. What was the acquisition cost of the equipment?
a. 1,650,000 b. 1,700,000 c. 2,400,000 d. 2,450,000
Question 2. Bagel Company purchased factory equipment which was installed

and put into service January 1, 2016 at a total cost of P1,280,000. Residual value
62 | P a g e
was estimated at P80,000. The equipment is depreciated over eight years by the
double declining balance method. What amount of depreciation expense should
be recorded on the equipment for 2017?
a. 225,000 b. 240,000 c. 300,000 d. 320,000
Question 3. Rapplar Company purchased a machine on July 1, 2016 for

P6,000,000. The machine has an estimated useful life of five years and a residual
value of P800,000. The machine is being depreciated by the 150% declining
balance method. For the year ended December 31, 2017, what amount should be
recorded as depreciation expense on the machine?
a. 1,530,000 b. 1,326,000 c. 1,040,000 d. 1,800,000
Question 4. Wise Company used straight line depreciation for property, plant and
equipment which consisted of the following:
2017
2016
Land 250,000
250,000
Buildings 1,950,000
1,950,000
Machinery and equipment 6,950,000
6,500,000
Total 9,150,000
8,700,000
Less: Accumulated depreciation 4,000,000
3,700,000
5,150,000
5,000,000
The depreciation for 2017 and 2016 was P550,000 and P500,000, respectively.
What amount was debited to accumulated depreciation during 2017 because of
property, plant, and equipment retirement?
a. 400,000 b. 250,000 c. 200,000 d. 100,000
Question 5. Caramel Company provided the following information with respect

to a building.
* The building was acquired January 1, 2011 at a cost of P7,800,000 with an
estimated useful life of 40 years and residual value of P200,000. Yearly
depreciation was computed on the straight line method.
* The building was renovated on January 1, 2013 at a cost of P760,000. This was
considered as improvement. Residual value did not change.
* On January 1, 2016, the management decided to change the total life of the
building to 30 years.
What is the depreciation of the building for 2016?
a. 292,400 b. 266,000 c. 334,400 d. 294,000
Question 6. It is the systematic allocation of the depreciable amount of an item of

property, plant and equipment.
a. Depreciation b. Depletion c. Amortization d. Realization
Question 7. The useful life of an item of property, plant and equipment is

I. The period of time over which an asset is expected to be used by the entity.
II. The number of production or similar units expected to be obtained from the
asset by the entity.
63 | P a g e
Question 8. Carrying amount is
a. Cost of an asset or the amount substituted for cost in the financial statements,
less its residual value. b. Amount of cash or cash equivalent paid or the fair value
of the other consideration given to acquire an asset at the time of its acquisition or
construction.
c. Net amount which the entity expects to obtain for an asset at the end of its
useful life after deducting the expected costs of disposal.
d. Amount at which an asset is recognized in the statement of financial position
after deducting any accumulated depreciation and accumulated impairment loss.
Question 9. Which of the following statements is incorrect with respect to

depreciation?
a. The depreciable amount of item of property, plant and equipment shall be
allocated on a systematic basis over its useful life.
b. The depreciation method used shall not reflect the pattern in which the asset's
economic benefits are consumed by the entity.
c. The depreciation charge for each period shall be recognized as an expense
unless it is included in the carrying amount of another asset.
d. The estimation of the useful life of an item of property, plant and equipment is
a matter of judgment based on the experience of the entity with similar assets.
Question 10. All the following factors need to be considered in determining the
useful life of an asset, except
a. Expected usage of the asset
b. Expected physical wear and tear
c. Technical obsolescence
d. Residual value
End of Topic 6
References:
Intermediate Accounting Volume 1 (2019)
by: Conrado Valix, Jose F. Peralta and Christian Aris M. Valix
Intermediate Accounting 1 2019 edition
by: Zeus Vernon B. Millan
https://www.focusifrs.com
64 | P a g e

Module On Intermediate Accounting 2 Unit 1 Part 1

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UNIT 1

Topic 1: Property, Plant, and Equipment

 to distinguish items of property, plant and equipment from other assets of

1.1 Definition and Examples of 1.6 Derecognition of Property,

Examples- Items of Property, plant, and equipment:

1.2 Recognition of Property, Plant, and Equipment- An entity shall recognize

Note: Major spare parts and stand-by equipment qualify as property,

1.3 Measurement of Property, Plant, and Equipment- An entity shall measure

1.4 Elements of Cost

1.5 Acquisition of Property

2) To record the payment within discount period:

3) To record the payment beyond the discount period:

2) To record the payment within discount period:

3) To record the payment beyond the discount period:

Acquisition on installment basis- if an asset is offered at a cash price and at an

2) To record the first installment payment:

3) To amortize the discount on note payable:

Note Payable Fraction Interest expense

If there is no available cash price- The asset is recorded then at an

Illustration: A machinery is acquired at an installment price of P700,000. The

Note Payable 600,000

1) To record the acquisition:

2) To record the first installment payment:

3) To amortize the discount on note payable:

Acquisition by Issuance of share capital- Accordingly, where a property is

Exchange- with no commercial substance

- An entity shall recognize the gain or loss on the derecognition of an item

1.7 Fully depreciated property- a property is said to be fully depreciated when

(a) the measurement bases used for (aggregated with accumulated

This reconciliation need not be presented for prior periods.

(a) land; (h) office equipment: and

A condition of operating an aircraft is that it is inspected by the aviation

1. What amount should be recorded as initial cost of the machine?

2. What is the discount on note payable on December 31, 2016?

3. What is the interest expense for 2017?

4. What is the carrying amount of note payable on December 31, 2017?

2. What is the total cost of building?

a. Cost of opening a new facility

a. Cost incurred while an item capable of operating in a manner intended by

Down payment 400,000

What is the initial cost of the machine?

Topic 2: Government Grant

2.1 Definition of Government grant- PAS 20, paragraph 3, defines government

2.2 Recognition and Measurement

2.3 Classification of Government grant

2.4 Accounting for Government grant

Entries as the asset is used:

b.) Depreciation Expense ((100,000-25,000)/5) 15,000

b. Grants Related to Income:

2) Deferred grant income 3,000,000

3) Environmental expenses 2,000,000

First year (2/10x15,000,000) = 3,000,000

4) Deferred grant income 10,000,000

 Grant related to nondepreciable asset- An entity is granted a large tract

 Grant that becomes receivable as compensation- An entity received a

2.7 Disclosures related to Government grant

a. I only b. II only c. Both I and II d. Neither I nor II

a. I only b. II only c. Both I and II d. Neither I nor II