Learning Objectives

• Understand that investing activities create value for

businesses: risk, return considerations
AC1102 Accounting II • Identify the recognition and measurement issues
Seminar 3-5 Part 1: Property, Plant, and • Understand the importance of proper classification of
Equipment expenditures and evaluate its impact on the quality of
financial information
Asad Kausar • Compare the Cost model and the Revaluation model and
Assistant Professor determine the financial statement effects of the revaluation
Nanyang Business School model
• Understand the application of Highest and Best Use
concept for revaluation of non-financial assets such as PPE
• Account for the impairment of PPE under FRS 36
• Account for the depreciation and the disposal of PPE

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SIA AR 2016
2016 2015

Property, Plant and Equipment (PPE)

Firms engage in 3 main types of investing activities:

 Invest in property, plant & equipment (PPE)

 Invest in intangible assets S9 E-learning mode

(no class).
dealt with in
 Invest in other companies advanced accounting
courses.

Investing activities and value creation

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Property, Plant and Equipment (PPE)
PPE - Recognition Issue
What are PPE? PPE Recognition Criteria
PPE are tangible items that: Recognize PPE as an asset if and only if:

 are held for use in the production or supply of goods or It is probable that future economic benefits associated
services, for rental to others, or
 for administrative purposes; and
with the item will flow to the entity; and
 are expected to be used during more than one period.
the cost of the item can be measured reliably.
(FRS 16:6) (FRS 16:7)

an item of PPE that qualifies for recognition as an asset

shall be measured at its cost. (FRS 16:15)
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Property, plant and equipment – Life cycle

Initial Measurement

Mode of acquisition:

a) Purchase

b) Self-constructed assets

c) Exchange

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 Costs to be Capitalized When Purchase
Purchase PPE
Equipment Land
• Net purchase price • Purchase price
• Taxes • Real estate commissions
Issue – what is the acquisition cost? • Transportation costs • Attorney’s fees
• Installation costs • Title search
• Modification to building
(e.g., transportation, installation, legal necessary to install
• Title transfer fees
equipment • Title insurance premiums
expenses, foreign exchange gains/losses, • Testing and trial runs • Removing old buildings

Land Improvements Buildings

etc.) Separately identifiable costs of • Purchase price
• Driveways • Attorney’s fees
• Parking lots • Commissions
• Fencing • Reconditioning
• Landscaping
• Private roads
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Purchase PPE Self-Constructed Assets

The cost of a purchased item of PPE comprises:
Issues:
a) its purchase price, including import duties and non-refundable purchase
taxes, after deducting trade discounts and rebates. • Gain / Loss (FRS 16:22)?
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 • Borrowing costs (i.e., interest expense)?
by management.

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.
(FRS 16:16)
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Self-Constructed Assets Interest Capitalization

When self-constructing an asset, two accounting issues must be

addressed: Capitalization begins when:
 full-cost approach: any internal profits or abnormal costs • construction begins
incurred in self-constructing an asset is not included in the
cost of the asset.(FRS 16:22) • interest is incurred, and
 proper treatment of interest incurred during construction • qualifying expenses are incurred.
Capitalization ends when:
• the asset is substantially complete and
Under certain conditions, interest incurred on ready for its intended use, or
qualifying assets is capitalized.
• when interest costs no longer are being
Asset constructed: Interest that could have incurred.
been avoided if the asset
 For a company’s own use.
were not constructed and
 As a discrete project for the money used to retire
sale or lease. debt.
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Exchanges PPE
Exchanges PPE
General Valuation Principle (GVP): Cost of asset acquired is:
 What are the issues or concerns? • fair value of asset given up plus cash paid or minus cash
received or
 Cost of ‘new’ asset? Fair value of old asset or • fair value of asset acquired, if it is more clearly
evident
new asset?
 Gain / Loss on disposing of ‘old’ asset In the exchange of assets fair value is used except in
rare situations in which the fair value cannot be
determined or the exchange lacks commercial substance.
 What is the guiding principle? When fair value cannot be determined or the exchange lacks
 Commercial substance (paragraph 24) commercial substance, the asset(s) acquired are valued at
the book value of the asset(s) given up, plus (or minus)
any cash exchanged. No gain is recognized.
(FRS 16: 23-26)
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 Example – Exchange with / without
Exchange Lacks Commercial Substance
commercial substance
When exchanges are recorded at fair value, any gain
or loss is recognized for the difference between the Matrix exchanged new equipment and $10,000 cash for
fair value and book value of the asset(s) given-up. equipment owned by Float.
To preclude the possibility of companies engaging in Below is information about the asset exchanged by
exchanges of appreciated assets solely to be able to Matrix. Record the transaction assuming the
recognize gains, fair value can only be used in exchange has commercial substance.
legitimate exchanges that have commercial substance.
Accumulated Book Fair
A nonmonetary exchange is considered to have commercial
substance if the company:
Cost Depreciation Value Value
Matrix's
 expects a change in future cash flows as a result of the
Equipment $ 500,000 $ 300,000 $ 200,000 $ 205,000
exchange, and
 that expected change is significant relative to the fair
value of the assets exchanged. Gain = Fair Value – Book Value
Gain = $205,000 – $200,000 = $5,000
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Example – Exchange with / without

PPE – Subsequent Costs (Expense or Capitalize?)
commercial substance (cont.)
Management Incentives
$205,000 fair value + $10,000 cash
If subsequent If subsequent
Equipment ............................................... 215,000
expenditures are expenditures are
Accumulated depreciation………............. 300,000
Equipment ……………………… 500,000 expensed off capitalized
Cash ……………………………. 10,000
Gain on exchange …………….. 5,000
To record the exchange of equipment.
Effect on income
Expense higher Expense lower
Record the same transaction assuming the statement
net income lower net income higher
exchange lacks commercial substance.
$200,000 book value + $10,000 cash
Equipment ............................................... 210,000 Effect on balance Asset values Asset values
Accumulated depreciation………............. 300,000 sheet lower higher
Equipment ……………………… 500,000
Cash …………………………….. 10,000
To record the exchange of equipment. 19 20

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When to Capitalize Subsequent Costs Expenditures Subsequent to Acquisition
Type of
Expenditure Definition Usual Accounting Treatment
• Generally, subsequent expenditures that Repairs and Expenditures to maintain Expense in the period incurred
Maintenance a given level of benefits
result in one or more of the following may
be said to have “future economic benefits”: Additions The addition of a new major Capitalize and depreciate over the
component to an existing asset remaining useful life of the original
– Extension in the asset’s estimated useful life; asset, or over the useful life of the
addition, whichever is shorter
– Increase in capacity;
– Substantial improvement in the quality of Improvements The replacement of Capitalize and depreciate over the
output; and a major component useful life of the improved asset

– Substantial reductions in previously assessed Rearrangements Expenditures to restructure If expenditures are material and
operating costs. an asset without addition, clearly increase future benefits,
replacement, or improvement capitalize and depreciate over
the future periods benefited

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SIA AR 2016
Singapore Airlines’ PPE Depreciation
• Depreciation (expense in SPLOCI) is a systematic allocation of
the cost of an asset (e.g., PPE) over its useful life.

• The depreciation should begin when the asset is available for

use (FRS 16:55).

• The depreciation process matches the asset’s expense against

revenue to measure income, as the matching principle directs.

• The cumulative amount of depreciation charged since the initial

recognition and measurement of an asset is called accumulated
depreciation (contra asset in SFP).

DR Depreciation xxx
CR Accumulated depreciation xxx
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Cost Allocation – An Overview Depreciation Methods
The matching principle requires that part of the Sum-of-the Units-of-
acquisition cost of property, plant, and equipment Straight-line Double Reducing
years digits production
be expensed in periods when the future revenues are • An equal • An accelerated • Another type of • A fixed amount
earned. amount of depreciation reducing of depreciation
depreciation is method writes method is assigned to
assigned to off a larger each unit of
Depreciation is cost allocation processes each year / amount of the output / service
used to help meet the matching principle period of asset asset’s cost produced by
use near the start the asset
requirements. Dep. exp = Cost-RV of its useful life Dep. exp= (cost – RV) * N
Useful life in years Useful life in units
Dep. rate= 1 x2
Some of the cost is expensed each Useful life in years of production
N = units produced in a
period. given period

Dep. exp

Dep. exp

Dep. exp

Dep. exp
Acquisition
Expense
Cost
25 Year Year Year 26 Year
(Balance Sheet) (Income Statement)

Straight-Line Straight-Line Method

Results in the same

The most widely used amount of depreciation in
and most easily each year of the asset’s
understood method. service life.

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 Straight-Line Method
Straight-Line Depreciation Schedule

For year ended December 31 As of December 31

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SIA AR 2016 SIA AR 2016

Singapore Airlines’ PPE
Statement of Financial Position as at 31
March (S$ millions)
2016 2015
Page 105
Largest asset

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 SIA AR 2016

Declining-Balance (DB) Method

DB depreciation Stop depreciating
• Based on the straight-line rate when:
multiplied by an acceleration BV = Residual Value
Page 103
factor.
3rd largest
expense
• Computations initially ignore
residual value.

Double-Declining-Balance (DDB) depreciation

is computed as follows:
Book
DDB = × ( 2 × Straight-line Rate )
Value

33 Note that the Book Value will get lower each 34

year.

Double-Declining-Balance Method Double-Declining-Balance Method

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Units-of-Production Units-of-Production Method

Acquisition Residual Assume that 7,000 units were inspected

Depreciation – during 2011. Depreciation would be
Cost Value calculated as follows:
rate per unit =
of output Estimated Output in Units Step 1:
Depreciation = Cost - Residual Value $9,000
= = $0.25/unit
Per Unit Total Units of Production 36,000

Step 2:
Number of Units
Depreciation Depreciation = $0.25 × 7,000 = $1,750
Depreciation Units of × Produced
Expense = Per Unit
Depreciation = × in the Period
rate per unit output

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Comparing Depreciation Methods

Units-of-Production Depreciation Schedule Straight‐ Units of
Double‐
Declining‐
Period Line Production Balance In 2011, DDB gives the highest
2011 $   1,800 $      1,750 $    4,000 expense, which result in the lowest
2012      1,800         2,000       2,400 income, which will reduce
2013      1,800         2,250       1,440 profitability ratios such as profit
2014      1,800         1,750          864 margin which is net income divided
2015      1,800         1,250          296
by net sales.
Totals $   9,000 $      9,000 $    9,000

$4,000

$3,500

$3,000

$2,500

$2,000

$1,500

$1,000
Units produced and sold during the period.
$500

$-
39 2011 2012 2013 2014 40
2015

Straight-Line Units-of-Production Double-Declining-Balance

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Sum-of-the-years’-digits Partial-Year Depreciation
This method also result in more depreciation in the
early years of an asset’s useful life and less When an item of property, plant and equipment is
depreciation in later years of an asset’s useful acquired during the year, depreciation is calculated
life. for the fraction of the year the asset is owned.
Note that total depreciation over the asset’s Cost $           10,000 
Assume our machinery was purchased
useful Residual value 1,000 
on October 8, 2010. Let’s calculate
life is the same as the straight-line method. Depreciable cost $             9,000 
depreciation expense for 2010,
Useful life
Accounting periods 5 years  assuming we use straight-line
Units inspected 36,000 units  depreciation.
Sum-of-the-years’-digits (SYD) depreciation
Remaining Years
SYD Residual of Useful Life
= ( Cost – ) ×
Depreciation Value Sum-of-the-Years
41 Digits* 42

SIA AR 2016

Subsequent Measurement Singapore Airlines’ PPE

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 Subsequent Measurement at Historical Example: Straight-Line Depreciation
Cost Schedule

• After recognition as an asset, an item of property, plant and

equipment shall be carried at its cost less any accumulated
depreciation and any accumulated impairment losses.
(FRS 16:30)

• Under cost model, subsequent measurements can only

decrease the value of PPE.

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Subsequent Measurement at Revalued Subsequent Measurement at Revalued

Amount Amount – Highest and Best Use
After recognition as an asset, an item of PPE whose fair
value (see FRS 113:9) can be measured reliably shall be Highest and best use:
carried at a revalued amount, being its fair value at the date A fair value measurement of a non-financial asset takes into account a market
participant’s ability to generate economic benefits by using the asset in its highest
of revaluation less any subsequent accumulated
and best use or by selling it to another market participant that would use the asset
depreciation and subsequent impairment losses. in its highest and best use. (FRS 113: 27)
(FRS 16:31)

If PPE is revalued, the asset’s carrying amount can either

increase or decrease due to revaluation.
The highest and best use of a non-financial asset takes into account the use of the
asset that is physically possible, legally permissible and financially feasible…..
(FRS 113: 28)
Fair value: the price that would be received to sell an asset or paid to transfer a
liability in an orderly transaction between market participants at the measurement
date. (FRS 113: 9)

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 Subsequent Measurement at Revalued Revaluation Model (Freehold Land)
Amount
Example 1. Initial revaluation -> Increase
If freehold land’s carrying amount increases from $20m (cost) to $24
If an asset’s carrying amount is increased as a result of a as a result of an initial revaluation,
revaluation, the increase shall be recognized in other
comprehensive income and accumulated in equity under the Dr Freehold land 4m
heading of revaluation surplus. Cr Revaluation Reserve 4m

However, the increase shall be recognized in profit or loss to (FRS 16:39)

the extent that it reverses a revaluation decrease of the same
asset previously recognized in profit or loss.
FRS 16:39
* The increase is recognized in “other comprehensive income” and
accumulated in equity under the heading of “revaluation surplus/reserve”.

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AAA Ltd
Statement of Profit or Loss and other Comprehensive Income for the year ended 31 December 20x9
20x9 20x8
S’000 S’000 AAA Ltd
Statement of Changes in Equity
Revenue XXXX XXXX For the year ended 31 December 20x9
Cost of sales (xxx) (xxx) Share Retained Revaluation Fair Total
Capital earning Surplus value equity
Gross profit XXXX XXXX
reserve
Other income XXX XXX S’000 S’000 S’000 S’000 S’000
Distribution costs (XXX) (XXX)

Administrative expenses (XXX) (XXX) Balance at 1 January 20x8 XXXX XXXX - XXXX XXXX

Finance cost (XXX) (XXX) Changes in accounting policy - (XX) - - (XX)

Restated balance XXXX XXXX - XXX XXXX
Other expenses (XXX) (XXX)
Changes in equity for 20x8
Total expenses (XXX) (XXX)
Dividends - (XX) - - (XX)
Profit before tax XXXX XXXX
Total comprehensive income for the year
Tax expense (XXX) (XXX)
Balance at 31 December 20x8 XXXX XXXX XXX XXX XXXX
Profit for the year xxxx A xxxx
Changes in equity for 20x8
Other comprehensive income: Issue of share capital (xx) - - - (XX)
Item that will not be reclassified to profit or loss: Dividends - (XX) - - (XX)

Gain on revaluation xxx B XXX Year

Total comprehensive income for the year XXXX A xxx B XXX C XXXX D

FV Gain on investment in shares xxx C xxx Transfer to retained earnings - XX (XX) - -

Balance at 31 December 20x9 XXXX XXXX XXX XXX XXXX
Other comprehensive income for the year xxx xxx

Total comprehensive income for the year xxxx D xxxx

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Subsequent Measurement at Revalued Revaluation Model (Freehold Land)
Amount
Example 2. Initial revaluation -> Decrease
If an asset’s carrying amount is decreased as a result of a If freehold land’s carrying amount decreases from $20m (cost) to
revaluation, the decrease shall be recognized in profit or loss. $17m as a result of an initial revaluation (deficit on revaluation):

However, the decrease shall be recognized in other Dr Deficit on Revaluation 3m

comprehensive income to the extent of any credit balance
existing in the revaluation surplus in respect of that asset. The Cr Freehold Land 3m
decrease recognized in other comprehensive income reduces
the amount accumulated in equity under the heading of
revaluation surplus.
FRS 16:40

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Revaluation Model (Freehold Land)

Example 3. Subsequent revaluation - increase

Following from Example 2, if freehold land’s carrying amount
increases ** from $17m to $21m as result of a subsequent revaluation.

Dr Freehold Land 4m

Cr Reversal of Deficit on Revaluation 3m

Cr Revaluation Reserve 1m

** The increase shall be recognized in profit or loss to the extent

that it reverses a revaluation decrease ($3m) of the same asset
previously recognized in profit or loss. (FRS 16:39)

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