DR. FILEMON C.

AGUILAR MEMORIAL COLLEGE OF LAS

PINAS
Golden Gate Subdivision, Talon III, Las Piñas City
Tel Nos. 519-1960/4788671/4031985

Course Code and Title : ACED 6 - Intermediate Accounting 1

Lesson 10 : Initial Recognition of PPE

Topics : Property, plant and equipment; modes of acquisition;

cost of land, building, machine and land improvement.

This lesson identifies the recognition and measurement of property, plant and
equipment in accordance with Philippine Accounting Standards 16 (PAS 16). It also
shows the different methods of acquiring property, plant and equipment as well as the
various cost involve in acquiring the same.

Learning Objectives

At the end of this module, the learners are expected to:

COGNITIVE

1. Analyze the characteristics of a PPE subject to recognition.

PSYCHOMOTOR

2. Account and recognize an item of PPE using different modes of acquisition.

AFFECTIVE

3. Discuss the various cost involve and should be part of the measurement of various
items of property, plant and equipment.

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Page 1 of 120
DR. FILEMON C. AGUILAR MEMORIAL COLLEGE OF LAS
PINAS
Golden Gate Subdivision, Talon III, Las Piñas City
Tel Nos. 519-1960/4788671/4031985

Pre-Assessment

Exercise #1: Classification of costs

Melancholy Company reported the following property, plant and equipment on January 1,2014:

Land 3,500,000
Land improvements 900,000
Building 6,000,000
Machinery 1,500,000

Transactions during the current year

 A tract of land was acquired for PI,250,000 and intended definitely for use as future building
site.
 A plant facility consisting of land and building was acquired from another entity in exchange for
100,000 Melancholy Company's shares. On the acquisition date, the share had a closing market
price of P45 on a stock exchange.
 The plant facility was carried at P1,000,000 for land and P3,000,000 for the building at the
exchange date.
 Current appraised values for the land and building, respectively, are PI,200,000 and P2,400,000.
 Expenditures totaling P750,000 were made in January for new parking lot, street and sidewalk
at the entity's various plant locations. These expenditures had an estimated useful life of fifteen
years.
 Machinery was purchased at a cost of P3,000,000. Freight and unloading charge of P50,000, and
installation cost of P350,000 were incurred.
 A machine was sold for P175,000 on July 1,2014. Original cost of machine was P500,000 on
January 1,2012 and it was depreciated on the straight line basis over an estimated useful life of
five years and no residual value.

Requirements:
1. What is total cost of land at year-end?
2. What is the total cost of building at year-end?
3. What is the total cost of land improvements at year-end?
4. What is the total cost of machinery at year-end?

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DR. FILEMON C. AGUILAR MEMORIAL COLLEGE OF LAS
PINAS
Golden Gate Subdivision, Talon III, Las Piñas City
Tel Nos. 519-1960/4788671/4031985

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DR. FILEMON C. AGUILAR MEMORIAL COLLEGE OF LAS
PINAS
Golden Gate Subdivision, Talon III, Las Piñas City
Tel Nos. 519-1960/4788671/4031985

LESSON PRESENTATION

INTRODUCTION
Property, plant and equipment are also called fixed assets. It includes various tangible
assets that are expected to be used or utilized for more than 12 months. In this lesson
we will discuss the various ways of acquiring those assets as well as the cost
associated with their measurement.

Property, Plant and Equipment

Property, plant and equipment are "tangible assets which are held by an entity for use in
production or supply of goods and services, for rental to others, or for administrative
purposes, and are expected to be used during more than one period".

Characteristics
a. The property, plant and equipment are tangible assets, meaning with physical
substance.
b. The property, plant and equipment are used in business, meaning used in
production or supply of goods and services, for rental purposes and for
administrative purposes. Assets that are held for sale, including land, or held for
investment are not included in property, plant and equipment.
c. The property, plant and equipment are expected to be used over a period of more
than one year.

Examples of property, plant and equipment include land, building, machinery, ship,
aircraft, motor vehicle, furniture and fixtures, office equipment, patterns, molds and dies,
tools, leasehold improvement and book plates. The old term for property, plant and
equipment is "fixed assets".

PAS 16 on property, plant and equipment does not apply to:

a. Biological assets related to agricultural activity.

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DR. FILEMON C. AGUILAR MEMORIAL COLLEGE OF LAS
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Golden Gate Subdivision, Talon III, Las Piñas City
Tel Nos. 519-1960/4788671/4031985

b. Mineral rights and mineral reserves such as oil, natural gas and similar non-
regenerative resources.

Such assets are shown as separate line item on the face of the statement of financial
position. However, an entity is required to apply PAS 16 to property, plant and
equipment used to develop or maintain biological assets, and mineral rights and mineral
reserves.

Recognition Principles
An item of property, plant and equipment shall be recognized as an asset when:
a. It is probable that future economic benefits associated with the asset will flow to the
entity.
b. The cost of the asset to the entity can be measured reliably.

Elements of Cost of PPE

The cost of an item of property, plant and equipment comprises.

a. Purchase price, including import duties and nonrefundable purchase taxes, after
deducting trade discounts and rebates.

b. Cost 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.
Examples of directly attributable costs include:
a. Cost of employee benefits arising directly from the construction or acquisition of
the item of property, plant and equipment.
b. Cost of site preparation
c. Initial delivery and handling cost
d. Installation and assembly cost
e. Professional fees

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Golden Gate Subdivision, Talon III, Las Piñas City
Tel Nos. 519-1960/4788671/4031985

f. Cost of testing whether the asset is functioning properly, after deducting the net
proceeds from selling any items produced while bringing the asset to that location
and condition, such as samples produced when testing equipment.

c. Initial estimate of the cost 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.

Examples of costs that are expensed rather than recognized as element of cost of an
item of property, plant and equipment are:
a. Cost of opening a new facility
b. Cost of introducing a new product or service, including cost of advertising and
promotion
c. Cost of conducting business in a new location or with a new class of customer,
including cost of staff training
d. Administration and other general overhead cost
e. Cost incurred while an item capable of operating in the manner intended by
management has yet to be brought into use or is operated at less than full capacity
f. Initial operating loss
g. Cost of relocating or reorganizing part or all of an entity's operations.

Modes of Acquiring PPE

Cash Purchase
The cost of property acquired by direct cash purchase includes the cash paid plus all
directly attributable costs of bringing the asset to the location and condition for its
intended use, such as freight, installation and testing cost. When various assets are

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Golden Gate Subdivision, Talon III, Las Piñas City
Tel Nos. 519-1960/4788671/4031985

acquired for a lump sum price, the total cost is allocated to the individual assets based
on their relative fair value.

ILLUSTRATIVE EXAMPLE
On January 1, 20x1, X Co. purchased a machine for P2,500,000 cash.

Journal entry:
January 1, 20x1
Machine 2,500,000
Cash 2,500,000
To record the acquisition of machine by cash

ILLUSTRATIVE EXAMPLE
Amity Company purchased for P5,400,000 including appraiser's fee of P50,000, a building and
the land on which it is located. The current appraised value is P2,000,000 for the land and
P3,000,000 for the building. The seller's original cost is P1,400,000 for the land and P2,800,000
for the building. What is the initial measurement of the land?

Solution:
Allocation:
Fair Value Allocation Cost
Land 2,000,000 2/5 2,160,000
Building 3,000,000 3/5 3,240,000
Total 5,000,000 100% 5,400,000

Journal entry:
Land 2,160,000
Building 3,240,000
Cash 5,400,000

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DR. FILEMON C. AGUILAR MEMORIAL COLLEGE OF LAS
PINAS
Golden Gate Subdivision, Talon III, Las Piñas City
Tel Nos. 519-1960/4788671/4031985

On Account
The cost of property acquired on credit is equal to the invoice price minus the discount
regardless of whether the discount is taken or not.

If the discount is not taken, it is charged to purchase discount lost which is shown as
other expense.
Cash discounts and rebates are generally considered as reduction of cost and not as
income.

ILLUSTRATIVE EXAMPLE
Lax Company recently acquired two items of equipment. The transactions are described as
follows:
 Acquired a press at an invoice price of P3,000,000 subject to a 5% cash discount which was
taken. Costs of freight and insurance during shipment were P50,000 and installation cost
amounted to P200,000.
 Acquired a welding machine at an invoice price of P2,000,000 subject to a 10% cash
discount which was not taken. Additional welding supplies were acquired at a cost of
P100,000.
What is the total increase in the equipment account as a result of the transactions?

Solution:
Invoice price – press 3,000,000
Freight and insurance 50,000
Installation 200,000
Cash discount taken (3,000,000 x 5%) (150,000)
Cost of press 3,100,000

Invoice price – welding machine 2,000,000

Cash discount not taken (2,000,000 x 10%) (200,000)
Cost of welding machine 1,800,000

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DR. FILEMON C. AGUILAR MEMORIAL COLLEGE OF LAS
PINAS
Golden Gate Subdivision, Talon III, Las Piñas City
Tel Nos. 519-1960/4788671/4031985

Journal entry:
Equipment 4,900,000
Accounts payable 4,900,000

Deferred Payment Schemes

The cost of property acquired by installment is equal to the cash price equivalent. The
excess of the installment price over the cash price is recognized as interest expense
over the credit period. When there is no established cash price, the cost of the asset is
equal to the present value of all installment payments using the market rate of interest.

ILLUSTRATIVE EXAMPLE
On December 31, 2014, Bart 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, 2014, and the others are due annually on December 31.

Solution:
Annual installment 200,000
PV of annuity due 5.712
Present value of the notes 1,142,400

Journal entry:
Machine 1,142,400
Discount on notes 457,600
Notes payable 1,600,000

Issuance of Shares
Under Philippine GAAP, the Accounting Standards Council concludes that if shares are
issued for consideration other than actual cash, the proceeds shall be measured by the
fair value of the consideration received.

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DR. FILEMON C. AGUILAR MEMORIAL COLLEGE OF LAS
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Golden Gate Subdivision, Talon III, Las Piñas City
Tel Nos. 519-1960/4788671/4031985

Fair value is 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.

Moreover, PFRS 2 on share-based payment, paragraph 10, provides that for equity-
settled transactions, the entity shall measure the goods or services received and the
corresponding increase in equity at the fair value of the goods or services received.

If the entity cannot estimate reliably the fair value of the goods or services received, the
entity shall measure their value by reference to the fair value of the equity instruments
issued.

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 the order of priority:
a. Fair value of the property received
b. Fair value of the share capital
c. Par value or stated value of the share capital

ILLUSTRATIVE EXAMPLE
Beanery Company purchased land with a current market value of P2,400,000. The carrying
amount of the land was P1,305,000. In exchange for the land, the entity issued 20,000 ordinary
shares with par value of P100 and an estimated market value of P140 per share. The shares
are not traded in an established stock exchange.

Journal entry:
Land 2,400,000
Share capital (20,000 x 100) 2,000,000
Share premium 400,000

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DR. FILEMON C. AGUILAR MEMORIAL COLLEGE OF LAS
PINAS
Golden Gate Subdivision, Talon III, Las Piñas City
Tel Nos. 519-1960/4788671/4031985

ILLUSTRATIVE EXAMPLE
Beanery Company purchased land with a carrying amount of the land was P1,305,000. In
exchange for the land, the entity issued 20,000 ordinary shares with par value of P100 and an
estimated market value of P140 per share.

Journal entry:
Land (20,000 x 140) 2,800,000
Share capital (20,000 x 100) 2,000,000
Share premium 800,000

ILLUSTRATIVE EXAMPLE
Beanery Company purchased land with a carrying amount of the land was P1,305,000. In
exchange for the land, the entity issued 20,000 ordinary shares with par value of P100.

Journal entry:
Land (20,000 x 100) 2,000,000
Share capital (20,000 x 100) 2,000,000

Issuance of Bonds Payable

When an entity acquires an asset by issuing bonds payable, PFRS 9, paragraph 5.1.1,
provides that the entity shall measure the financial liability at fair value plus transaction
costs that are directly attributable to the issue of the financial liability.

Accordingly, the asset acquired by issuing bonds payable is measured in the following
order:
a. Fair value of bonds payable
b. Fair value of asset received
c. Face value of bonds payable

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DR. FILEMON C. AGUILAR MEMORIAL COLLEGE OF LAS
PINAS
Golden Gate Subdivision, Talon III, Las Piñas City
Tel Nos. 519-1960/4788671/4031985

ILLUSTRATIVE EXAMPLE
Figaro Company acquired land and paid in full by issuing P600,000 of its 10 percent bonds
payable. The bonds were trading at 102. The land had a fair value of P700,000.

Journal entry:
Land (600,000 x 102%) 612,000
Bonds payable 600,000
Premium on bonds 12,000

Acquisition by 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, unless the exchange transaction
lacks commercial substance or the fair value of neither the asset given up nor the asset
received is reliably measurable." Accordingly, any gain or loss on the exchange is fully
recognized.

Exchange with 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 by reason of the exchange.

An exchange has commercial substance when:

a. The cash flows of the asset received differ from the cash flows of the asset
transferred and the difference is significant relative to the fair value of the asset
exchanged.
b. The entity-specific value of the portion of the entity's operations affected by the
transaction changes as a result of the exchange and the change is significant
relative to the fair value of the asset exchanged. Entity-specific value is the present
value of the cash flows an entity expects to arise from the continuing use of an asset

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DR. FILEMON C. AGUILAR MEMORIAL COLLEGE OF LAS
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Golden Gate Subdivision, Talon III, Las Piñas City
Tel Nos. 519-1960/4788671/4031985

and from its disposal at the end of its useful life or expects to incur when settling a
liability.

Non-monetary Exchanges
If an entity is able to determine reliably the fair value of either the asset received or the
asset given, the fair value of the asset given is used to measure the cost of the asset
received unless the fair value of the asset received is more clearly evident. Accordingly,
if a property is acquired in an exchange and there is no cash involved, the cost is
measured at the following in the order of priority:
a. Fair value of property given
b. Fair value of property received
c. Carrying amount of property given

If the exchange transaction lacks commercial substance or if the fair value of neither the
asset given up nor the asset received is reliably measurable, the cost of the acquired
item is measured at the carrying amount of the asset given up plus cash payment, if
any. No gain or loss is recognized when the exchange lacks commercial substance.

If an asset is acquired in an exchange with commercial substance and there is a cash

involved or monetary consideration, the cost Of the asset is equal to the following:
a. Fair value of asset given plus cash payment - on the part of the payor.
b. Fair value of asset given minus the cash received - on the part of the recipient.

ILLUSTRATIVE EXAMPLE
During the current year, Kaye Company acquired a new equipment in exchange for an old
equipment acquired years ago. The old equipment was purchased for P700,000 and had a
carrying amount of P260,000. On the date of the exchange, the old equipment had a fair value
of P280,000. The new equipment had a fair value of P1,250,000.

CASE #1: The exchange has a commercial substance.

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DR. FILEMON C. AGUILAR MEMORIAL COLLEGE OF LAS
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Golden Gate Subdivision, Talon III, Las Piñas City
Tel Nos. 519-1960/4788671/4031985

Journal entry
Equipment - new 280,000
Accumulated depreciation (700,000 – 260,000) 440,000
Equipment – old 700,000
Gain on exchange 20,000

CASE #2: The exchange has a commercial substance. Kaye Company paid P900,000 cash.
Journal entry
Equipment – new (280,000 + 900,000) 1,180,000
Accumulated depreciation (700,000 – 260,000) 440,000
Equipment – old 700,000
Cash 900,000
Gain on exchange 20,000

CASE #3: The exchange has a commercial substance. Kaye Company received P50,000 cash.
Journal entry
Equipment – new (280,000 – 50,000) 230,000
Cash 50,000
Accumulated depreciation (700,000 – 260,000) 440,000
Equipment – old 700,000
Gain on exchange 20,000

CASE #4: The exchange has a no commercial substance.

Journal entry
Equipment - new 260,000
Accumulated depreciation (700,000 – 260,000) 440,000
Equipment – old 700,000

Acquisition by Donation

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Golden Gate Subdivision, Talon III, Las Piñas City
Tel Nos. 519-1960/4788671/4031985

At present, IFRS does not address donation or contribution. However, IFRS explicitly
addresses government grant. Philippine GAAP provides that "contributions, including
shares of an entity, received from shareholders shall be recorded at the fair value of the
items received, with the credit going to donated capital if significant".

Expenses incurred in connection with the donation, like payment of registration fees and
legal fees shall be charged to the donated capital account.
The reason is that such expenses do not increase or enhance the value of the asset.

However, directly attributable costs incurred, such as installation and testing cost
necessary to bring the donated asset to the location and condition for its intended use
shall be capitalized.

Philippine GAAP further provides that business entities sometimes receive from non-
shareholders gifts or grants of funds or other assets that are restricted for property and
equipment additions. Capital gifts or grants shall be recorded at their fair value when
they are received or receivable.

When such items are received by business entities, they are generally subsidies. In the
rare case when such items are not subsidies, the offsetting credit is a liability account
until the initial restrictions are met. At that time, they are transferred to income or less
desirably, to donated capital.

ILLUSTRATIVE EXAMPLE
X Co. received a donation of Land which has a book value of P1,200,000 and a fair market
value of P1,500,000. X Co. incurred P10,000 related to the registration of the donation and
P20,000 as direct attributable cost related to the land.

Solution:
Fair value of the land 1,500,000

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DR. FILEMON C. AGUILAR MEMORIAL COLLEGE OF LAS
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Golden Gate Subdivision, Talon III, Las Piñas City
Tel Nos. 519-1960/4788671/4031985

Direct attributable cost 20,000

Cost of land 1,520,000

CASE #1: If the donor of the land is a shareholder.

Journal entry:
and 1,520,000
Cash 30,000
Donated capital 1,490,000

CASE #2: If the donor of the land is a non-shareholder.

Journal entry:
Land 1,520,000
Cash 30,000
Income from donation 1,490,000

Land
Classification
1. Land used as a plant site is classified as property, plant and equipment.
2. Land held for 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 may be included
under property, plant and equipment. Such treatment is in accordance with PAS 40.
3. Land held for long-term capital appreciation is also treated as an investment
property.
4. 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.

Cost of Land
a. Purchase price
b. Attorney fees and other expenditures for establishing clean title

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c. Broker 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 the buyer
h. Unpaid taxes up to date of acquisition assumed by the buyer
i. Cost of survey
j. Cost of clearing, grading and demolishing unwanted old building, less proceeds from
salvage
k. Payments to tenants to induce them to vacate the premises
l. Cost of permanent improvements, cost of grading, leveling, and landfill.
m. Cost of option to buy the acquired land. If the land is not acquired, the cost of option
is expensed outright.

Land Improvements
If land improvements are additions to cost not subject to depreciation, they 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, if land improvements are depreciable, these are charged to a special
account "land improvements."
Land improvements of this type should be depreciated over the useful life.

Examples of these improvements are fences, water systems, drainage systems,

sidewalks, pavements and cost of trees, shrubs and other landscaping.

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Building
Acquired by purchase
a. Purchase price
b. Legal fees incurred in connection with the purchase
c. Unpaid taxes up to date of purchase assumed by the buyer
d. Interest, liens and other encumbrances assumed by the buyer
e. Payments to tenants to induce them to vacate the building
f. Any renovating or remodelling costs incurred to put the building purchased in a
condition suitable for the intended use.

Constructed
a. Material used, labor employed and overhead directly attributable to construction
b. Building permit or license
c. Architect fee
d. Superintendent fee
e. Cost of excavation
f. Cost of temporary building used as construction office and tools or materials shed
g. Expenditures incurred during the construction period such as borrowing cost 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

Expenditures for sidewalks, pavements, parking lots and driveways

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1. If the said expenditures are part of the blueprint for the construction of a new
building, they are charged to the building account.
2. If the expenditures are occasionally made or incurred not in connection with the
construction of a new building, they are charged to land improvements.

Expenditures for ventilating system, lighting system and elevator?

1. If installed during construction, the ventilating system, lighting system and elevator
should be charged to the building account.
2. Otherwise, the said expenditures are charged to building improvements to be
depreciated over their useful life or remaining life of the building whichever is shorter.

Expenditures for shelves, cabinets, and partitions

Expenditures for shelves, cabinets and partitions may be charged to the building or
furniture and fixtures. If such expenditures are immovable in the sense that tnese are
attached to the building in such a manner that the removal thereof may destroy the
building, the expenditures 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 the useful life.

Cost of Machine
a. Purchase price
b. Freight, handling, storage and other cost related to the acquisition
c. Insurance while in transit
d. Installation cost, including site preparation and assembling
e. Cost of testing and trial run, and other cost necessary in preparing the machinery for
use
f. Initial estimate of cost of dismantling and removing the machinery and restoring the
site on which it is located, for which the entity has a present obligation.
g. Fee paid to consultants for advice on the acquisition of the machinery.

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h. Cost of safety rail and platform surrounding machine.

i. Cost of water device to keep machine cool.

If a machinery is moved to a new location in order to increase the future service

potential of the asset, the undepreciated cost of the old installation cost is expensed and
the new installation cost is charged to the new asset.

If a 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 on the
theory that this is part of the service related to the retirement of the old machinery.

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
purchase tax is capitalized as cost of the asset.

COMPREHENSIVE ILLUSTRATION 1
Facetious Company incurred the following expenditures related to the construction of a new home office:
Cost of land, which included usable old apartment
building with fair value of P200,000 2,000,000
Legal fees, including fee for title search 10,000
Payment of land mortgage and related interest due
at time of sale 50,000
Payment of delinquent property taxes 20,000
Cost of razing the apartment building 30,000
Grading and drainage on land site 15,000
Architect fee on new building 200,000
Payment to building contractor 8,000,000
Interest cost on specific borrowing during construction 300,000
Payment of medical bills of employees accidentally
injured while inspecting building construction 10,000

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Golden Gate Subdivision, Talon III, Las Piñas City
Tel Nos. 519-1960/4788671/4031985

Cost of paving driveway and parking lot 40,000

Cost of trees, shrubs and other landscaping 55,000
Cost of installing light in parking lot 5,000
Premium for insurance on building during construction 25,000
Cost of open house party to celebrate opening of building 60,000

Solution:
Land Building Land imp.
Cost of land, which included usable old apartment
building with fair value of P200,000 1,800,000
Legal fees, including fee for title search 10,000
Payment of land mortgage and related interest due
at time of sale 50,000
Payment of delinquent property taxes 20,000
Cost of razing the apartment building 30,000
Grading and drainage on land site 15,000
Architect fee on new building 200,000
Payment to building contractor 8,000,000
Interest cost on specific borrowing during construction 300,000
Cost of paving driveway and parking lot 40,000
Cost of trees, shrubs and other landscaping 55,000
Cost of installing light in parking lot 5,000
Premium for insurance on building during construction 25,000
TOTAL COST 1,895,000 8,555,000 100,000

Expenses when incurred

Payment of medical bills of employees accidentally
injured while inspecting building construction 10,000
Cost of open house party to celebrate opening of building 60,000
Total 70,000

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 DR. FILEMON C. AGUILAR MEMORIAL COLLEGE OF LAS
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Golden Gate Subdivision, Talon III, Las Piñas City
Tel Nos. 519-1960/4788671/4031985

COMPREHENSIVE ILLUSTRATION 2
Paragon Company incurred the following costs during the current year in relation to property, plant and
equipment:
Cash paid for purchase of land 2,500,000
Mortgage assumed on the land purchased, including interest accrued 1,000,000
Realtor commission 300,000
Legal fees, realty taxes and documentation expenses 50,000
Amount paid to relocate persons squatting on the property 100,000
Cost of tearing down an old building on the land to make
room for construction of new building 200,000
Salvage value of the old building demolished 50,000
Cost of fencing the property 110,000
Amount paid to the contractor for the building constructed 5,000,000
Building permit fee 50,000
Excavation 50,000
Architect fee 200,000
Interest that would have been earned had the money used
during the period of construction been invested 150,000
Invoice cost of machine acquired 2,000,000
Freight, unloading and delivery charges 60,000
Custom duties and other charges 140,000
Allowances and hotel accommodation, paid to foreign
technicians during installation and test run of machine 400,000

Solutions:
Land Building Machine
Cash paid for purchase of land 2,500,000
Mortgage assumed on the land purchased,
including interest accrued 1,000,000
Realtor commission 300,000
Legal fees, realty taxes and documentation expenses 50,000
Amount paid to relocate persons squatting on the property 100,000

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Golden Gate Subdivision, Talon III, Las Piñas City
Tel Nos. 519-1960/4788671/4031985

Cost of tearing down an old building on the land to make

room for construction of new building 200,000
Salvage value of the old building demolished (50,000)
Cost of fencing the property 110,000
Amount paid to the contractor for the building constructed 5,000,000
Building permit fee 50,000
Excavation 50,000
Architect fee 200,000
Invoice cost of machine acquired 2,000,000
Freight, unloading and delivery charges 60,000
Custom duties and other charges 140,000
Allowances and hotel accommodation, paid to foreign
technicians during installation and test run of machine 400,000
TOTAL COST 3,950,000 5,450,000 2,600,000

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DR. FILEMON C. AGUILAR MEMORIAL COLLEGE OF LAS
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Golden Gate Subdivision, Talon III, Las Piñas City
Tel Nos. 519-1960/4788671/4031985

ACTIVITY EVALUATION

Student Name: Date Taken:

Course, Year and Section: Time Frame:

Multiple Choice
Choose the correct answer from the choices provided. Write your answer beside the
number. USE CAPITAL LETTERS. ERASURES ARE NOT ALLOWED.

1. 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 site preparation
B. Installation and assembly cost
C. Initial delivery and handling cost
D. Cost of employee benefit not arising directly from the construction and acquisition of
property, plant and equipment.

2. An entity purchased a plant asset under a deferred payment contract. The agreement was
to pay P10,000 per year for five years. The plant asset shall be measured at
A. P50,000
B. P50,000 plus imputed interest
C. Present value of P10,000 annuity for five years at an imputed interest
D. Present value of a P10,000 annuity for five years discounted at the bank prime interest
rate

3. A donated plant asset for which the fair value has been determined, and for which directly
attributable costs were incurred, shall be recorded at an amount equal to
A. Carrying amount.
B. Directly attributable costs incurred.
C. Fair value and directly attributable costs incurred.
D. Carrying amount and directly attributable costs incurred.

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4. The cost of an item of property, plant and equipment that is acquired in exchange for
combination of monetary and nonmonetary asset is measured at the
A. Fair value of the asset given up plus cash payment.
B. Fair value of the asset received plus cash payment.
C. Carrying amount of the asset given up plus cash payment.
D. Carrying amount of the asset received plus the cash payment.

5. In an exchange of assets, an entity received equipment with a fair value equal to the
carrying amount of equipment given up. The entity also contributed cash. As a result of the
exchange, the entity shall recognize
A. Neither gain nor loss
B. A loss equal to the cash given up
C. A gain determined by the proportion of cash paid to the total transaction value
D. A loss determined by the proportion of cash paid to the total transaction value

6. If an entity purchased a lot and an old building and immediately demolished the old building
and used the property as a parking lot, the proper accounting treatment of the carrying
amount of the old building would depend on
A. The contemplated future use of the parking lot.
B. The length of time for which the building was held prior to demolition.
C. The intention of management for the property when the building was acquired.
D. The significance of the cost allocated to the building in relation to the combined cost of
the lot and building.

7. An entity purchased land to be used as an investment property. Timber was cut from the
site so development of the land could begin. The proceeds from the sale of the timber
should be
A. Classified as other income
B. Credited to retained earnings
C. Deducted from the cost of the land
D. Classified as deferred income and amortized over five years

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Tel Nos. 519-1960/4788671/4031985

8. The cost of building usually includes all, except

A. Cost of excavation
B. Expenditure for movable equipment and fixture
C. Any renovating cost incurred to put the building purchased in a condition for the
intended use
D. Cost incurred to have existing building removed to make room for construction of new
building

9. An item, of property, plant and equipment shall be recognized as an asset when

A. The cost is material.
B. The cost of the asset can be measured reliably.
C. It is probable that future economic benefits will flow to the entity.
D. It is probable that future economic benefits will flow to the entity and the cost of the
asset can be measured reliably.

10. 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 and
expected to be used during more than one reporting period.
D. 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.

11. Defensible Company acquired several fixtures for a new building, including display cases,
shelves and hanging racks. The invoice price of the fixtures was P700,000. The entity
received a 2% cash discount by paying within the discount period.
Freight and insurance during shipment totaled P3,000. Costs of assembling and installing
fixtures were P5,000. While installing a display case, a new employee carelessly broke a
glass top. This top was replaced at a cost of P2,000.
What total amount should be recorded as cost of the fixtures?

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Tel Nos. 519-1960/4788671/4031985

A. 694,000
B. 696,000
C. 708,000
D. 710,000

12. Anxious Company acquired two items of machinery as follows:

On December 31, 2014, Anxious Company purchased a machine in exchange for a
noninterest bearing note requiring ten payments of P500,000. The first payment was
made on December 31, 2015, and the others are due annually on December 31. The
prevailing rate of interest for this type of note at date of issuance was 12%. The present
value of an ordinary annuity of 1 at 12% is 5.33 for nine periods and 5.65 for ten
periods.
On December 31, 2014, Anxious Company acquired used machinery by issuing the seller a
two-year, noninterest-bearing note for P3,000,000. In recent borrowing, the entity has
paid a 12%o interest for this type of note. The present value of 1 at 12%o for 2 years
is .80 and the present value of an ordinary annuity of 1 at 12% for 2 years is 1.69.
What is the total cost of the machinery?
A. 5,065,000
B. 5,225,000
C. 5,565,000
D. 8,235,000

13. Dawson Company has received a donation of land from a rich shareholder. The land
originally had a cost of P1,000,000. On the date of the donation, the land had a market
value of P1,500,000 and an assessed value of P1,200,000. What amount of income should
be recognized from the donation?
A. 0
B. 1,000,000
C. 1,200,000
D. 1,500,000

14. Kirk Company purchased equipment by making a down payment of P400,000 and issuing a

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Tel Nos. 519-1960/4788671/4031985

note payable for P1,800,000. A payment of P600,000 is to be made at the end of each year
for three years. The applicable rate of interest is 8%. The present value of an ordinary
annuity of 1 for three years at 8% is 2.58, and the present value for the future amount of a
single sum for three years at 8% is .735. Shipping charges for the equipment of P200,000
and installation charges of P350,000 were incurred. What is the capitalized cost of the
equipment?
A. 1,948,000
B. 2,148,000
C. 2,498,000
D. 2,750,000

15. Precious Company had the following property acquisitions during the current year:
Acquired a tract of land in exchange for 50,000 shares of Precious Company with P100 par
value that had a market price of P120 per share on the date of acquisition. The last
property tax bill indicated assessed value of P2,400,000 for the land.
Received land from a major shareholder as an inducement to locate a plant in the city. No
payment was required but the entity paid P50,000 for legal expenses for land transfer.
The land is fairly valued at P1,200,000.
What is the total increase in land as a result of the acquisitions?
A. 6,000,000
B. 6,100,000
C. 7,050,000
D. 7,200,000

16. Figaro Company acquired land and paid in full by issuing P600,000 of its 10 percent bonds
payable and 40,000 ordinary shares with par value of P10. The share was selling at P19
and the bonds were trading at 102. What amount should be recorded as cost of the land?
A. 988,000
B. 1,000,000
C. 1,372,000
D. 1,387,200

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Tel Nos. 519-1960/4788671/4031985

17. At the beginning of the current year, Winn Company traded in an old machine having a
carrying amount of P1,680,000 and paid a cash difference of P600,000 for a new machine
having a cash price of P2,050,000. What amount of loss should be recognized on the
exchange?
A. 0
B. 230,000
C. 370,000
D. 600,000

18. Caine Company exchanged a car from its inventory for a computer to be used as a long-
term asset. The following information relates to this exchange:
Carrying amount of the car - P600,000;
List selling price of the car - P900,000;
Fair value of the computer - P860,000;
Cash difference paid by Caine - P100,000.
What amount of gain should be recognized on the exchange?
A. 0
B. 160,000
C. 200,000
D. 260,000

19. Isabela Company incurred the following costs during the current year:
Option fee for land acquired - P10,000;
Option fee for land not acquired - P10,000;
Taxes in arrears on land - P50,000;
Payment for land - P1,000,000;
Architect fee - P230,000;
Payment to city hall for approval of building construction - P120,000;
Contract price for factory building - P5,000,000;
Safety fence around construction site - P35,000;
Safety inspection on building - P30,000;
Removal of safety fence after completion of building - P20,000;

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Tel Nos. 519-1960/4788671/4031985

New fence surrounding the factory - P80,000;

Driveway, parking bay and safety lighting - P550,000.
What is the cost of land and building, respectively?
A. 1,050,000 and 5,435,000
B. 1,060,000 and 5,350,000
C. 1,060,000 and 5,435,000
D. 1,145,000 and 5,350,000

20. Negros Company acquired a new machinery.

List price of the machinery - P1,400,000;
Cash discount available but not taken on purchase - P20,000;
Freight paid on the new machinery - P40,000;
Cost of removing the old machinery - P15,000;
Installation cost of the new machinery - P50,000;
Testing cost before the machinery was put into regular operation
(including P10,000 in wages of the regular machinery operator) - P30,000;
Loss on premature retirement of the old machinery - P5,000;
Estimated cost of manufacturing similar machinery including overhead - P1,300,000.
What amount should be capitalized as cost of the new machinery?
A. 1,490,000
B. 1,500,000
C. 1,515,000
D. 1,520,000

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DR. FILEMON C. AGUILAR MEMORIAL COLLEGE OF LAS
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Golden Gate Subdivision, Talon III, Las Piñas City
Tel Nos. 519-1960/4788671/4031985

REINFORCEMENT
ASSIGNMENT
DIRECTION: Use the problem to answer the requirements

Prince Company and Albert Company agreed to exchange tractor trailers. Information relating to
these assets is as follows:

Prince Albert
Original acquisition cost 1,500,000 800,000
Accumulated depreciation 700,000 720,000
Fair value on date of exchange 900,000 150,000

In accordance with the agreement, Albert will pay P750,000 in cash to Prince which is the
difference in fair value.

Requirements:
1. What amount should Prince Company record as cost of the asset received in exchange?
2. What amount should Albert Company record as cost of the asset received in exchange?
3. Assuming the exchange lack commercial substance, what amount should Prince Company
record as cost of the asset received in exchange?
4. Assuming the exchange lack commercial substance, what amount should Albert Company
record as cost of the asset received in exchange?

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DR. FILEMON C. AGUILAR MEMORIAL COLLEGE OF LAS
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Tel Nos. 519-1960/4788671/4031985

Course Code and Title : ACED 6 - Intermediate Accounting 1

Lesson 11 : Subsequent Measurement of PPE

Topics : Depreciation methods, revaluation method,

expenditures after initial recognition

This lesson identifies the methods of depreciation and concept of revaluation as part of
the measurement of property, plant and equipment in accordance with Philippine
Accounting Standards 16 (PAS 16).

Learning Objectives

At the end of this module, the learners are expected to:

COGNITIVE

1. Identify the factors of depreciation and the expenditures after the initial recognition of
PPE.

PSYCHOMOTOR

2. Compute for the depreciation expense, carrying amount of the PPE and the
revaluation to be recognized for the period.

AFFECTIVE

3. Discuss how revaluation affects the measurement of the PPE.

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Tel Nos. 519-1960/4788671/4031985

Pre-Assessment

Exercise #1: Revaluation

Seaside Company applied revaluation accounting to plant asset with carrying amount of P4,000,000
on January 1, 2014, useful life of 4 years, and no residual value. Depreciation is calculated on the
straight line basis. On December 31, 2014, independent appraisers determined that the asset has a
fair value of P3,750,000.

Requirements:
5. Prepare all necessary journal entries.

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DR. FILEMON C. AGUILAR MEMORIAL COLLEGE OF LAS
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Tel Nos. 519-1960/4788671/4031985

LESSON PRESENTATION

INTRODUCTION
After the initial recognition, an item of PPE will be subject to wear and tear. It will also
losses its value over time or through continuing use. These factors affect the carrying
value of a PPE.

Capital Expenditure
A capital expenditure is an expenditure that benefits not only the current period but also
future periods. A capital expenditure is reported as an asset. A revenue expenditure is
an expenditure that benefits only the current period and therefore is reported as outright
expense.

Costs after initial recognition

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 performance, the cost should be expensed when incurred.

In general, a subsequent cost on an item of property, plant and equipment will benefit
future periods or the subsequent cost will increase the service potential of the asset
when:

a. The expenditure extends the life of the asset.

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b. The expenditure increases the capacity of the asset and quality of output, for
example, by upgrading machine parts.
c. The expenditure improves the efficiency and safety of the asset, for example, by
adopting a new production process leading to large reduction in operating cost.

Additions
Additions represent major expenditures for new assets or an expansion, enlargement or
extension of the old asset. Additions are capitalized in the usual manner.

Betterments or improvement
Improvements or betterments are modifications or alterations which increase the service
life or the capacity of the asset. Improvements may represent replacement of an asset
or part of an asset with one of a better or superior quality.

Such expenditures are normally capitalized and the cost and accumulated depreciation
of the old part are derecognized. The improvements that do not involve replacement of
parts are simply added to the cost of the existing asset.

Replacement
Replacements also involve substitution but the new asset is not better than the old
asset when acquired. Thus, 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 a replacement of an old asset by a new one, replacement of major parts and
replacement of minor parts.

An important consideration in determining the appropriate accounting treatment for a

replacement is whether the original part of an existing asset is separately identifiable.

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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 are
removed from the accounts and the carrying amount of the old part is treated as 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.

ILLUSTRATIVE EXAMPLE
During the current year, Printable Company incurred the following costs for a printing press:

Purchase of collating and stapling attachment 840,000

Installation of attachment 360,000
Replacement parts for overhaul of press 260,000
Labor and overhead in connection with overhaul 140,000

The overhaul resulted in a significant increase in production. Neither the attachment nor the
overhaul increased the estimated useful life of the press. What total amount should be
capitalized?

Solution:
Purchase of collating and stapling attachment 840,000
Installation of attachment 360,000
Replacement parts for overhaul of press 260,000
Labor and overhead in connection with overhaul 140,000
Capitalizable cost 1,600,000

Repairs

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Extraordinary repairs are replacement of major parts of an asset involving large sum
and will normally extend the useful life of the asset. Extraordinary repairs are usually
capitalized.

Ordinary repairs are replacement of minor parts involving small sums and are frequently
encountered. Thus, ordinary repairs are expensed outright.

ILLUSTRATIVE EXAMPLE
During the current year, Quean Company made the following expenditures relating to the plant
building:

Continuing and frequent repairs 400,000

Repainting of the plant building 100,000
Major improvements to the electrical wiring system 30,000
Partial replacement of roof tiles 150,000

What total amount should be charged to repair and maintenance expense in the current year?

Solution:
Continuing and frequent repairs 400,000
Repainting of the plant building 100,000
Partial replacement of roof tiles 150,000
Total 650,000

Rearrangement cost
Rearrangement cost is the relocation or reinstallation of an asset which proves to be
less efficient in its original location. The rearrangement normally increases the future
service potential of the asset and therefore the rearrangement cost should be
capitalized. For example, the rearrangement of a group of machines increases the
future service potential of the machines because the rearrangement facilitates future

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production, secures greater efficiency or achieves substantial reduction in previously

assessed operating costs. However, if the rearrangement merely maintains the existing
level of performance of the asset, the rearrangement cost should be expensed
immediately.

ILLUSTRATIVE EXAMPLE
Yvo Company installed a production assembly line to manufacture furniture. In the
current year, the entity purchased a new machine and rearranged the assembly line to
install this machine. The rearrangement did not increase the estimated useful life of the
assembly line, but it did result in significantly more efficient production. The following
expenditures were incurred in connection with this project:

Machine 750,000
Labor to install machine 140,000
Parts added in rearranging the assembly line 400,000
Labor and overhead to rearrange the assembly line 180,000

What total amount of the expenditures should be capitalized?

Solution:
Machine 750,000
Labor to install machine 140,000
Parts added in rearranging the assembly line 400,000
Labor and overhead to rearrange the assembly line 180,000
Capitalizable Cost 1,470,000

Subsequent Measurement

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Tel Nos. 519-1960/4788671/4031985

An item of property, plant and equipment that qualifies for recognition as an asset shall
be measured initially at cost. Cost is the amount of cash or cash equivalent paid and
the fair value of the other consideration given to acquire an asset at the time of
acquisition or construction.

After recognition, an entity shall choose either the cost model or the revaluation model
as its accounting policy and shall apply that policy to an entire class of property, plant
and equipment. The cost model means that property, plant and equipment are carried
at cost less any accumulated depreciation and any accumulated impairment loss. The
revaluation model means that property, plant and equipment are carried at revalued
amount, being the fair value at the date of revaluation less any subsequent accumulated
depreciation and subsequent accumulated impairment loss.

Cost Model
Depreciation is the systematic allocation of the depreciable amount of the property,
plant and equipment over the useful life.

Depreciation is not so much a matter of valuation as it is a matter of cost allocation in

recognition of the exhaustion of the life of an item of property, plant and equipment used
in business operations.

The objective of depreciation is to have each period benefiting from the use of the asset
bear an equitable share of the asset cost.

Depreciation is the systematic allocation of the depreciable amount of the property,

plant and equipment over the useful life.

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Depreciation is not so much a matter of valuation as it is a matter of cost allocation in

recognition of the exhaustion of the life of an item of property, plant and equipment used
in business operations.

The objective of depreciation is to have each period benefiting from the use of the asset
bear an equitable share of the asset cost.

Kinds of Depreciation
1. Physical depreciation is related to the depreciable asset's wear and tear and
deterioration over a period.
cease - is applicable to animals and wooden buildings.

2. Functional or economic depreciation arises from technical obsolescence or

inadequacy of the asset to perform efficiently.

Obsolescence may arise from the following:

a. When there is no future demand for the product that the asset produces.
b. When a new asset becomes available and the new asset can perform the same
function for substantially less cost.

Inadequacy arises when an asset is no longer useful to the ifrm 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.

Depreciable Amount

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DR. FILEMON C. AGUILAR MEMORIAL COLLEGE OF LAS
PINAS
Golden Gate Subdivision, Talon III, Las Piñas City
Tel Nos. 519-1960/4788671/4031985

Depreciable amount is the cost of an asset or other amount substituted for cost less its
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.

To the extent that an entity depreciates separately some significant parts of an item of
property, plant and equipment, it also depreciates separately the remainder of the item.

The remainder consists of the parts of the item that are individually not significant.

Residual Value
Residual value of an asset is the estimated amount that an entity would currently obtain
from disposal of the asset, after deducting the estimated cost of disposal, if the asset
were already of the age and condition expected at the end of its useful life.

Simply stated, residual value is the estimated net amount currently obtainable if the
asset is at the end of its 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.

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DR. FILEMON C. AGUILAR MEMORIAL COLLEGE OF LAS
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Golden Gate Subdivision, Talon III, Las Piñas City
Tel Nos. 519-1960/4788671/4031985

The residual value of an asset may increase to an amount equal to or greater than the
asset's carrying amount.

If it does, the asset's depreciation charge is zero unless and until the residual value
subsequently decreases to an amount below the asset's carrying amount.

Useful life
Useful life or service life is either the period of time over which an asset is expected to
be used by the entity or the number of production or similar units expected to be
obtained from the asset by the entity.

As distinguished from useful life, physical life refers to how long the asset would last.
The useful life of an asset may be expressed in years, units of output and service hours.

Factors in determining useful life

a. Expected usage of the asset. The expected usage of the asset is assessed by
reference to the expected capacity or physical output.
b. Expected physical wear and tear. The expected physical wear and tear of an asset
depend 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 obsolescence. Technical obsolescence 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.

Methods of Depreciation
1. Equal or uniform charge methods - straight fine, composite method and group
method

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Tel Nos. 519-1960/4788671/4031985

2. Variable charge or use-factor methods - service hours and output or production

method
3. Decreasing charge or accelerated or diminishing balance methods - sum of years'
digits, declining balance and double declining balance
4. Other methods - inventory, retirement and replacement method

Straight-line Depreciation
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.
Depreciable amount multiplied by the annual 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.

ILLUSTRATIVE EXAMPLE
On January 1, 2014 Lem Company bought machinery under a contact that required a down
payment of P100,000, plus 24 monthly payments of P50,000 each, for total cash payments of
P1,300,000. The cash price of the machinery was P1,100,000. The machinery has a useful life
of 10 years and residual value of P50,000. The entity used straight line depreciation. What
amount should be reported as depreciation for 2014?

Solution:
Cost of machine 1,100,000
Residual value (50,000)
Depreciable amount 1,050,000
Annual depreciation (1,050,000/10) 105,000

Composite or Group Depreciation

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DR. FILEMON C. AGUILAR MEMORIAL COLLEGE OF LAS
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Golden Gate Subdivision, Talon III, Las Piñas City
Tel Nos. 519-1960/4788671/4031985

The composite method and group method are a variation of the straight line method of
depreciation. 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 life and the composite or
group rate are computed, and the assets in the group are depreciated on that basis.
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 recognized. The asset is
credited for the cost of the asset retired and the accumulated depreciation 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 and crediting cash or other appropriate account.

Subsequently, the composite or group rate is multiplied by the balance of the asset
account to-get the periodic depreciation.

ILLUSTRATIVE EXAMPLE
Lester Company provided the following:
Total cost Residual value Useful life
Machine A 5.5M .5M 20
Machine B 2M .2M 15
Machine C .4M 5

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DR. FILEMON C. AGUILAR MEMORIAL COLLEGE OF LAS
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Golden Gate Subdivision, Talon III, Las Piñas City
Tel Nos. 519-1960/4788671/4031985

How much is the composite rate and the composite life?

Solution:
A B C Total
Cost 5.5M 2M 400K 7.9M
Less RV 500K 200K 0 700K
Depr’ble amount 5M 1.8M 400K 7.2M

A B C Total
Depr’ble amount 5M 1.8M 400K 7.2M
Divide by 20 15 5
Dep’n expense 250K 120K 80K 450K

Composite rate = depreciation expense divide by total cost.

Composite rate = 450K/7.9M
Composite rate = 5.7%
(rounded-off)

Composite life = depreciable amount divided by depreciation expense

Composite life = 7.2M/450K
Composite life = 16 years

Depreciation expense = 7.9M x 5.7% = 450K

Alternatively;
Depreciation expense = 7.2M / 16 years = 450K

Variable Methods
The variable methods assume that depreciation is more a function of use rather than
passage of time. The life of the asset is considered in terms of the output it produces or

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Tel Nos. 519-1960/4788671/4031985

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.

The variable methods are working hours method and output or production method.

Such 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.

Under working hours method, a depreciation rate per hour is computed by dividing the
depreciable amount by the estimated life in terms of service hours. The depreciation
rate per hour is then multiplied by the actual hours worked in one period to get the
depreciation for that period.

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 life in terms of units of output. The depreciation
rate per unit is then multiplied by the yearly output to get the annual depreciation.

ILLUSTRATIVE EXAMPLE
Tania Company purchased a boring machine on January 1, 2014 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 2014,
7,000 units in 2015, and 6,000 units in 2016. What is the depreciation expense for 2015 using
the most appropriate depreciation method?

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DR. FILEMON C. AGUILAR MEMORIAL COLLEGE OF LAS
PINAS
Golden Gate Subdivision, Talon III, Las Piñas City
Tel Nos. 519-1960/4788671/4031985

Solutions:
Cost 8,100,000
Residual value (600,000)
Depreciable amount 7,500,000

Depreciation expense:
Year Output Allocation Depreciation
2014 12,000 12/25 3,600,000
2015 7,000 7/25 2,100,000
2016 6,000 6/25 1,800,000
Total 25,000 7,500,000

Journal entries:
Machine 8,100,000
Cash 8,100,000
To record the acquisition of machine

December 31, 2014

Depreciation expense 3,600,000
Accumulated depreciation 3,600,000

December 31, 2015

Depreciation expense 2,100,000
Accumulated depreciation 2,100,000

December 31, 2016

Depreciation expense 1,800,000
Accumulated depreciation 1,800,000

Accelerated Methods

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DR. FILEMON C. AGUILAR MEMORIAL COLLEGE OF LAS
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Golden Gate Subdivision, Talon III, Las Piñas City
Tel Nos. 519-1960/4788671/4031985

The decreasing charge or accelerated methods provide higher depreciation in the

earlier years and lower depreciation in the later years of the life of the asset. Thus,
these methods result in a decreasing depreciation charge over the useful life. This is on
the philosophy that new assets are generally capable of producing more revenue in the
earlier years than in the later years.

The decreasing charge methods are as follows:

a. Sum of years' digits
b. Declining balance
c. Double declining balance .

Under the sum of years' digits method, the depreciation is computed by multiplying the
depreciable amount by a series of fractions whose numerator is the digit in the life of the
asset and whose denominator is the sum of the digits in the life of the asset.

ILLUSTRATIVE EXAMPLE
On January 1, 2014 Lem Company bought machinery under a contact that required a down
payment of P100,000, plus 24 monthly payments of P50,000 each, for total cash payments of
P1,300,000. The cash price of the machinery was P1,100,000. The machinery has a useful life
of 10 years and residual value of P50,000. The entity used sum-of-the-years digits. What
amount should be reported as depreciation for 2014?

Solution:
Cost of machine 1,100,000
Residual value (50,000)
Depreciable amount 1,050,000

SYD = 1 +2 +3 + 4+ 5+ 6 + 7 + 8 + 9 + 10 = 55

Journal entries:

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DR. FILEMON C. AGUILAR MEMORIAL COLLEGE OF LAS
PINAS
Golden Gate Subdivision, Talon III, Las Piñas City
Tel Nos. 519-1960/4788671/4031985

December 31, 2014

Depreciation expense (1,050,000 x 10/55) 190,909
Accumulated depreciation 190,909

December 31, 2015

Depreciation expense (1,050,000 x 9/55) 171,818
Accumulated depreciation 171,818

December 31, 2016

Depreciation expense (1,050,000 x 8/55) 152,727
Accumulated depreciation 152,727

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 or
percentage on diminishing carrying amount method. The problem in this method is the
determination of the fixed rate to be applied against the carrying amount

The double declining balance is the same as the declining balance method in that a
fixed rate is also multiplied by the declining carrying amount of the asset to arrive at the
annual depreciation. However, under double declining balance, the straight line rate is
simply "doubled" to get the fixed rate.

ILLUSTRATIVE EXAMPLE
On January 1, 2014 Lem Company bought machinery under a contact that required a
down payment of P100,000, plus 24 monthly payments of P50,000 each, for total cash
payments of P1,300,000. The cash price of the machinery was P1,100,000. The
machinery has a useful life of 10 years and residual value of P50,000. The entity used

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Page 49 of 120
DR. FILEMON C. AGUILAR MEMORIAL COLLEGE OF LAS
PINAS
Golden Gate Subdivision, Talon III, Las Piñas City
Tel Nos. 519-1960/4788671/4031985

200% double declining balance. What amount should be reported as depreciation for
2014?

Solutions:
Depreciation rate = 100% divided by 10 years = 10% x 2 = 20%

YearCarrying amount Rate Depreciation expense

2014 1,100,000 20% 220,000
2015 880,000 20% 176,000
2016 704,000 20% 140,800
2017 563,200 20% 112,640
2018 450,560 20% 90,112
2019 360,448 20% 72,090
2020 288,358 20% 57,672
2021 230,687 20% 46,137
2022 184,549 20% 36,910
2023 147,640 20% 50,000*

The last year depreciation is rounded to equalize the residual value.

Inventory Methods
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 charged off 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. It is
defended on practical grounds.

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DR. FILEMON C. AGUILAR MEMORIAL COLLEGE OF LAS
PINAS
Golden Gate Subdivision, Talon III, Las Piñas City
Tel Nos. 519-1960/4788671/4031985

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 the asset retired, minus salvage proceeds.

If the asset retired is not replaced, the original cost of the asset retired but not replaced
is charged off as depreciation. The retirement and replacement method may be used in
much the same situations as the inventory method. They are suitable when a large
number of similar items are employed by the entity and the items are constantly being
retired and replaced.

ILLUSTRATIVE EXAMPLE
X Co. had tools with a total cost of 1M. During the year, tools costing P100K was retired at a
retirement price of P50K.
Journal entry to record the retirement was:
Cash 50K
Depreciation expense 50K
Tools 100K

Revaluation Model
Initially, an item of property, plant and equipment that qualifies for recognition shall be
measured at cost. After initial recognition, an entity shall choose either the cost model
or the revaluation model as its accounting policy and shall apply that policy to an entire
class of property, plant and equipment.

Frequency

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Golden Gate Subdivision, Talon III, Las Piñas City
Tel Nos. 519-1960/4788671/4031985

The frequency of revaluation depends upon the movements in the fair value of the items
of property, plant and equipment being revalued. When a fair value of a revalued asset
differs materially from its carrying amount, a further revaluation is necessary.

Some items of property, plant and equipment may experience significant and volatile
movements in fair value thus necessitating annual revaluation. Such frequent or annual
revaluations are unnecessary for items of property, plant and equipment with only
insignificant movements in fair value. Instead, revaluation every three to five years may
be sufficient.

When an item of property, plant and equipment is revalued, the entire class of property,
plant and equipment to which that asset belongs should be revalued.

A class of property, plant and equipment is a grouping of assets of a similar nature and
use in an enterprise's operations.

Examples of separate classes are land, land and buildings, machinery, ships, aircrafts,
motor vehicles, furniture and fixtures, and office equipment.

The items within a class of property, plant and equipment are revalued simultaneously
in order to avoid selective revaluation of assets and the reporting of amounts which are
a mixture of costs and values at different dates.

However, a class of assets may be revalued on a rolling basis provided revaluation of

the class of assets is completed within a short period of time and provided the
revaluations are kept up to date.

Basis of Revaluation

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Tel Nos. 519-1960/4788671/4031985

The revalued amount of an item of property, plant and equipment is based on the
following:
a. Fair value - The fair value is determined by appraisal normally undertaken by
professional qualified valuers.
b. Depreciated replacement cost - Where fair value is not available, depreciated
replacement cost shall be used.

1. Revalued amount is the fair value or depreciated replacement cost of the item of
property, plant and equipment.
2. Fair value is 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.
3. Depreciated replacement cost is the replacement cost of the property, plant and
equipment minus the corresponding accumulated depreciation. This amount is
actually the sound value of the asset. Replacement cost is the current "purchase
price" of the property, plant and equipment.
4. Carrying amount is equal to historical cost minus the corresponding accumulated
depreciation.
5. Revaluation surplus is equal to the fair value or depreciated replacement cost (sound
value) minus the carrying amount of the property, plant and equipment. This amount
is also known as revaluation increment.
6. Appreciation or revaluation increase is the excess of the revalued amount over the
historical cost.

Appreciation minus the corresponding accumulated depreciation equals the net

appreciation or revaluation surplus.

Approaches in Recording Revaluation

There are two approaches in recording the revaluation, namely:

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DR. FILEMON C. AGUILAR MEMORIAL COLLEGE OF LAS
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Tel Nos. 519-1960/4788671/4031985

1. The accumulated depreciation at the date of revaluation is restated proportionately

with the change in the gross carrying amount of the asset so that the carrying
amount of the asset after revaluation equals the revalued amount. Simply
described, this is the "proportional approach".
2. The accumulated depreciation is eliminated against the gross carrying amount of the
asset and the net amount restated to the revalued amount of the asset. This
procedure may be called the "elimination approach".

Revaluation Surplus
When an asset's carrying amount is increased as a result of the revaluation, the
increase shall be credited to revaluation surplus as a component of other
comprehensive income.

The revaluation surplus may be transferred directly to retained earnings when the
surplus is realized. The whole surplus may be realized on the retirement or disposal of
the asset.
However, if the revalued asset is being depreciated, part of the surplus is being realized
as the asset is used.

The revaluation surplus is allocated or realized over the remaining life of the asset in
order to get the piecemeal realization.

When an asset's carrying amount is decreased as a result of revaluation, the decrease

shall be recognized as an expense. However, a revaluation decrease shall be charged
directly against any revaluation surplus to the extent that the decrease is a reversal of a
previous revaluation and the balance is charged to expense.

When an asset's carrying amount is increased as a result of revaluation, the increase

shall be credited to revaluation surplus. However, a revaluation increase shall be

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recognized as income to the extent that it reverses a revaluation decrease of the same
asset previously recognized as an expense.

ILLUSTRATIVE EXAMPLE
On January 1, 20x1, Cool Company owned an equipment costing P5,200,000 with original
residual value of P400,000. The life of the asset is 10 years and was depreciated using the
straight-line method.

On December 31, 20x4, the equipment has a replacement cost of P8,000,000. The entity
decided to carry the equipment at revalued amount. The residual value and remaining life would
not change.

Solutions:
The carrying amount of the asset as of December 31, 20x4 using cost method would be:
Cost 5,200,000
Residual value (400,000)
Depreciable amount 4,800,000
Annual depreciation (4,800,000/10) 480,000

Initial recognition 5,200,000

Accumulated depreciation (480,000 x 4) (1,920,000)
Carrying amount 3,280,000

The replacement cost shall be analyze as follows:

Replacement cost 8,000,000
Residual value (400,000)
Depreciable amount 7,600,000
Annual depreciation (7,600,000/10) 760,000

Replacement cost 8,000,000

Accumulated depreciation (760,000 x 4) (3,040,000)
Carrying amount 4,960,000

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DR. FILEMON C. AGUILAR MEMORIAL COLLEGE OF LAS
PINAS
Golden Gate Subdivision, Talon III, Las Piñas City
Tel Nos. 519-1960/4788671/4031985

Original cost Replacement cost Change

Cost 5,200,000 8,000,000 2,800,000
Accumulated depreciation 1,920,000 3,040,000 1,120,000
Carrying amount 3,280,000 4,960,000 1,680,000

Journal entry:
Equipment 2,800,000
Accumulated depreciation 1,120,000
Revaluation Surplus 1,680,000

On December 31, 20x5, the equipment will be depreciated on the revalued amount as follows:
Journal entries:
Depreciation expense 760,000
Accumulated depreciation 760,000

Revaluation surplus (1,680,000/6) 280,000

Retained earnings 280,000

ILLUSTRATIVE EXAMPLE
On December 31, 2014, Louisiana Company reported the following information:

Equipment at cost 5,000,000

Accumulated depreciation 1,500,000

The equipment was measured using the cost model and depreciated on a straight line basis
over a 10-year period. On December 31, 2014, the management decided to change the basis of
measuring the equipment from the cost model to the revaluation model.
The equipment was recorded at fair value of P4,550,000 with remaining useful life of 5 years.

Solution:

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DR. FILEMON C. AGUILAR MEMORIAL COLLEGE OF LAS
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Golden Gate Subdivision, Talon III, Las Piñas City
Tel Nos. 519-1960/4788671/4031985

Carrying amount (5,000,000 – 1,500,000) 3,500,000

Fair value 4,550,000
Revaluation surplus 1,050,000

Journal entry:
Accumulated depreciation 1,050,000
Revaluation surplus 1,050,000

Derecognition
Derecognition means that the cost of the property, plant and equipment together with
the related accumulated depreciation shall be removed from the accounts.

PAS 16, paragraph 67, provides that the carrying amount of an item of property, plant
and equipment shall be derecognized on disposal or when no future economic benefits
are expected from its use or disposal.

The gain or loss arising from the derecognition of an item of property, plant and
equipment shall be determined as the difference between the net disposal proceeds
and the carrying amount of the item.

Fully depreciated asset

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. However, it is not uncommon for an entity to continue to
use an asset after it has been fully depreciated.

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Tel Nos. 519-1960/4788671/4031985

The cost of fully depreciated asset remaining in service and the related accumulated
depreciation ordinarily shall not be removed from the accounts. However, entities are
encouraged but not required to disclose fully depreciated property.

ILLUSTRATIVE EXAMPLE
Poe Company disclosed that the depreciation policy on machinery is as follows:

• A full year depreciation is taken in the year of acquisition.

• No depreciation is taken in the year of disposition.
• The estimated useful life is five years.
• The straight line method is used.

On June 30, 2015, the entity sold for P2,300,000 a machine acquired in 2012 for P4,200,000.
The residual value was P600,000. What amount of gain on the disposal should be recorded in
2015?

Solution:
Sale price 2,300,000
Carrying amount of machine:
Cost 2012 4,200,000
Accum. deprn. -12/31/2014 (4,200,000-600,000 /5 x 3) 2,160,000 2,040,000
Gain on disposal 260,000

No depreciation is recognized from January 1 to June 30, 2014 because the depreciation policy
is that no depreciation is taken in the year of disposition.

Journal entry:
Cash 2,300,000
Accumulated depreciation 2,040,000
Machinery 4,200,000

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DR. FILEMON C. AGUILAR MEMORIAL COLLEGE OF LAS
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Golden Gate Subdivision, Talon III, Las Piñas City
Tel Nos. 519-1960/4788671/4031985

Gain on Sale 260,000

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DR. FILEMON C. AGUILAR MEMORIAL COLLEGE OF LAS
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Golden Gate Subdivision, Talon III, Las Piñas City
Tel Nos. 519-1960/4788671/4031985

ACTIVITY EVALUATION

Student Name: Date Taken:

Course, Year and Section: Time Frame:

Multiple Choice
Choose the correct answer from the choices provided. Write your answer beside the
number. USE CAPITAL LETTERS. ERASURES ARE NOT ALLOWED.

1. Reverend Company acquired a new processing machine at the beginning of current year.

Invoice cost-terms 5/10, n/30 1,600,000

Cost of transportation to the entity's factory 50,000
Cost of installation (labor and materials) 50,000
Payment for strengthening the floor to support the
weight of the new machine 150,000

The chief engineer spent two-thirds of his time during trial run of the new machine. The
monthly salary is P60,000. During the year, the entity was granted a cash allowance of
P100,000 by the supplier because the machine proved to be of less than standard
performance capability. 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 amount should be
capitalized cost of the new machine?
A. 1,560,000
B. 1,590,000
C. 1,640,000
D. 1,710,000

2. Taylor Company incurred the following expenditures:

Painting partitions in a large room recently divided into four sections 50,000
Labor cost of tearing down a wall to permit extension of an assembly line 200,000

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Major replacement of the motor of the machine. This replacement was

anticipated when the machine was purchased. 500,000
Cost of grading land prior to construction 600,000
Dust filters in the interior of the factory were replaced. The new
filters are expected to reduce employee health hazards and
thus reduce wage and fringe benefit costs. 800,000

What total amount of the expenditures should be capitalized?

A. 1,400,000
B. 1,900,000
C. 1,950,000
D. 2,150,000

3. On July 1, 2014, Rudd Company had a delivery van which was destroyed in an accident.
On that date, the van's carrying amount wasP500,000. On July 15,2014, the entity received
and recorded a P140,000 invoice for a new engine installed in the van in May, and another
P100,000 invoice for various repairs. In August, the entity received P700,000 under an
insurance policy on the van, which it plans to use to replace the van. What amount should
be reported as gain on disposal of the van in the income statement?

A. 0
B. 60,000
C. 200,000
D. 700,000

4. Cool Company owned an equipment costing P5,200,000 with original residual value of
P400,000. The life of the asset is 10 years and was depreciated using the straight-line
method. The equipment has a replacement cost of P8,000,000 with residual value of
P200,000. The age of the asset is 4 years. The appraisal of the equipment showed a total
revised useful life of 12 years and the entity decided to carry the equipment at revalued
amount.
Ignoring income tax, what amount should be initially reported as revaluation surplus?

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A. 1,600,000
B. 1,680,000
C. 2,600,000
D. 6,680,000

London Company owned a building on January 1,2014 with historical cost ofP40,000,000. The
property is depreciated over 40 years on a straight line basis with no residual value. The entity
adopted a policy of revaluation of property. The building has so far been revalued twice at fair
value as follows:
January 1,2015 - P46,800,000; and
January 1,2017 - P55,500,000.

5. What is the revaluation surplus to be reported in the statement of changes in equity for the
year ended December 31,2017?
A. 18,000,000
B. 18,200,000
C. 18,500,000
D. 18,900,000

6. The revaluation surplus resulting from initial revaluation of property, plant and equipment is
A. Credited to retained earnings.
B. Deducted from current assets and added to property, plant and equipment.
C. Debited to the class of property, plant and equipment revalued and credited to
revaluation surplus.
D. Released to the income statement an amount equal to the difference between the
depreciation calculated on historical cost vis-a-vis revalued amount.

7. If a depreciable property is revalued at the middle of the current year, how is the
depreciation expense for the year determined when the entity has a calendar year-end?
A. Depreciation for the entire year is based on cost.
B. Depreciation for the entire year is based on revalued amount.
C. Depreciation for the year is based on the average of the depreciation based on cost

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and on revalued amount.

D. Depreciation for the first half of the year is based on cost and for the second half on
revalued amount.

8. An improvement made to a machine which increased the fair value and production capacity
without extending the useful life of the machine should be
A. Expensed
B. Capitalized in the machine account
C. Debited to accumulated depreciation
D. Allocated between accumulated depreciation and the machine account

9. Which of the following subsequent expenditures should be expensed immediately?

A. Expenditure made to add new asset
B. Expenditure made to extend the useful life of an existing asset
C. Expenditure made to maintain an existing asset in operating condition
D. Expenditure made to increase the efficiency or effectiveness of an existing asset

10. The carrying amount of property, plant and equipment shall be derecognized
A. On disposal
B. On acquisition
C. When no future economic benefits are expected from the use of the asset.
D. On disposal and when no future economic benefits are expected from the use of the
asset.

11. On September 20,2014, Klaudine Company purchased machinery for P7,600,000.

Residual value was estimated at P400,000. The machinery is depreciated over eight years
using the sum of years' digits method. Depreciation is computed on the basis of the nearest
full month. What amount should be recorded as depreciation for 2015?
A. 1,400,000
B. 1,550,000
C. 1,553,800
D. 1,636,120

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12. On July 1, 2014, Mundo Company purchased an equipment for P5,000,000. Residual value
was estimated at P200,000. The equipment is depreciated over ten years using the double
declining balance method. What is the depreciation expense for 2015?
A. 768,000
B. 900,000
C. 960,000
D. 1,000,000

13. Spiderman Company owned a machine that was bought on January 1, 2011 for
P3,760,000. The machine was estimated to have a useful life of five years and a residual
value of P240,000. The entity used the sum of years' digits method of depreciation. On
January 1, 2014, the entity determined that the total useful life of the machine should have
been four years and the residual value is P352,000. What amount should be recorded as
depreciation expense on the machine for 2014?
A. 192,000
B. 444,000
C. 592,000
D. 704,000

14. Turtle Company purchased equipment on January 1, 2012 for P5,000,000. The equipment
had an estimated 5-year service life. The depreciation policy for 5-year assets is to use the
200% double declining balance method for the first two years and then switch to the
straight line depreciation method. In the December 31,2014 statement of financial position,
what amount should be reported as accumulated depreciation for the equipment?
A. 3,000,000
B. 3,800,000
C. 3,920,000
D. 4,200,000

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15. On January 1, 2010, Lane Company acquired equipment for P1,000,000 with a 10-year
useful life and P100,000 residual value. The straight line method of depreciation is used.
During 2014, after the 2013 financial statements had been issued, the entity determined
that this equipment's remaining useful life was only four more years and the residual value
would be P40,000. What is the carrying amount of the equipment on December 31,2014?
A. 390,000
B. 415,000
C. 490,000
D. 515,000

16. 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 not be recognized
B. Shall be accounted for as a change in accounting policy
C. Shall be accounted for as correction of a prior period error
D. Shall be accounted for as a change in accounting estimate

17. In which of the following depreciation methods is residual value not a factor in determining
depreciation charge in the early years of the asset's life?
A. Declining balance
B. Productive output
C. Service hours
D. Straight line

18. The composite depreciation method

A. Is an accelerated method of depreciation
B. Is applied to a group of homogeneous assets
C. Excludes residual value from the base of the depreciation calculation
D. Does not recognize gain or loss on the retirement of single asset in the group

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19. In which of the following situations is the production method of depreciation most
appropriate?
A. An asset is subject to rapid obsolescence
B. An asset's service potential declines with use
C. An asset's service potential declines with the passage of time
D. An asset incurs increasing repairs and maintenance with use

20. Which 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. The residual value of an asset may increase to an amount equal to or greater than the
asset's carrying amount.
C. In practice, the residual value of an asset is often insignificant and therefore immaterial
in the calculation of the depreciable amount.
D. The residual value of an asset shall be reviewed at least at each financial year-end and
if expectations differ from previous estimate, the change shall be accounted for as a
change in accounting policy.

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REINFORCEMENT
ASSIGNMENT
DIRECTION: Use the problem to answer the requirements

Jade Company acquired a new milling machine on April 1,2008. The machine has a special
component that required replacement before the end of the useful life. The asset was originally
recorded in two accounts, one representing the main unit and the other for the special component.
Depreciation is recorded by the straight-line method and residual value is disregarded. On April
1,2014, the special component is scrapped and is replaced with a similar component. This new
component is expected to have a residual value of approximately 20% of cost at the end of the
useful life of the main unit, and because of materiality, the residual value will be considered in
calculating depreciation.

Main milling machine:

Purchase price in 2008 7,500,000
Residual value 100,000
Estimated useful life 10 years
First special component:
Purchase price 1,200,000
Residual value 60,000
Estimated useful life 6 years
Second special component:
Purchase price 2,000,000
Residual value (20% x 2,000,000) 400,000
What is the total depreciation for 2014?

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Course Code and Title : ACED 6 - Intermediate Accounting 1

Lesson 12 : Depletion of Mineral Resources

Topics : Wasting assets, depletion, depreciation,

This lesson identifies the recognition the measurement of a mineral resource through
exploration and evaluation of natural resources in accordance with Philippine Financial
Reporting Standards 6 (PFRS 6)

Learning Objectives

At the end of this module, the learners are expected to:

COGNITIVE

1. Classify the different cost of exploration and evaluation of mineral resources.

PSYCHOMOTOR

2. Compute for the depletion, depreciation of PPE used and account for subsequent
changes in estimates.

AFFECTIVE

3. Analyze the effects of exploitation of natural resources by a wasting assets

corporation.

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Pre-Assessment

Exercise #1: Depletion

On January 1, 2013, Samar Company paid P5,400,000 for property containing natural resource of
2,000,000 tons of ore. The present value of the estimated cost of restoring the land after the
resource is extracted is P450,000 and the land will have a value of P650,000 after it is restored for
suitable use.

Tunnels, bunk houses and other fixed installations are constructed at a cost of P8,000,000 and such
expenditures are charged to mine improvements.

Operations began on January 1,2014 and resources removed totaled 600,000 tons. During 2015, a
discovery was made indicating that available resource after 2015 will total 1,875,000 tons.

At the beginning of 2015, additional bunk houses were constructed in the amount of P770,000. In
2015, only 400,000 tons were mined because of a strike.

Requirements:
1. What amount should be recorded as depletion for 2014?
2. What amount should be recorded as depletion for 2015?
3. What amount should be recorded as depreciation for 2014?
4. What amount should be recorded as depreciation for 2015?

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LESSON PRESENTATION

INTRODUCTION
Depletion is a process of recognizing a resource extracted from a natural resource. This
is normally practiced by a wasting assets corporation. Through exploration, a wasting
assets corporation are able to locate and discover a resource that may be extracted
such as oil and precious stones.

Exploration & Evaluation of Mineral Resources & Depletion

Mineral resources include minerals, oil, natural gas and similar nonregenerative
resources. The term "exploration and evaluation of mineral resources" is defined as the
search for mineral resources after the entity has obtained legal rights to explore in a
specific area as well as the determination of the technical feasibility and commercial
viability of extracting the mineral resources.

The expenditures incurred by an entity in connection with the exploration and evaluation
of mineral resources before the technical feasibility and commercial viability of
extracting a mineral resource are known as exploration and evaluation expenditures.

Examples:
1. Acquisition of rights to explore
2. Topographical, geological, geochemical and geophysical studies
3. Exploratory drilling
4. Trenching
5. Sampling
6. Activities in relation to evaluating the technical feasibility and commercial viability of
extracting a mineral resource.
7. General and administrative costs directly attributable to exploration and evaluation
activities.

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Expenditures related to development of mineral resources, for example, preparation for

commercial production, such as building roads and tunnels, cannot be recognized as
exploration and evaluation expenditures.

The exploration and evaluation expenditures may qualify as exploration and evaluation
asset.
Under PFRS 6, an entity must develop its own accounting policy for the recognition of
such asset. An entity is permitted to continue to apply its previous accounting policy
provided that the resulting information is relevant and reliable. An exploration and
evaluation asset shall be measured initially at cost. After initial recognition, an entity
shall apply either the cost model or the revaluation model. Exploration and evaluation
asset is classified either as tangible asset or an intangible asset.

Impairment of exploration and evaluation assets

PFRS 6, paragraph 18, provides that exploration and evaluation asset shall be
assessed for impairment when facts and circumstances suggest that the carrying
amount may exceed recoverable amount. The facts and circumstances that may
indicate impairment include:
a. The period for which the entity has the right to explore in a specific area has expired
and is not expected to be renewed.
b. Substantive expenditure for exploration and evaluation is neither budgeted nor
planned.
c. The exploration and evaluation activities have not led to the discovery of
commercially viable quantity of mineral resource and the entity has decided to
discontinue such activities.
d. Sufficient data indicate that the carrying amount of the exploration and evaluation
asset is unlikely to be recovered in full from successful development or by sale.

ILLUSTRATGIVE EXAMPLE

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Sanguine Company is involved in the exploration for mineral resource. The accounting policy is
to recognize and measure exploration asset initially at cost. At the end of the current year, the
following amounts were extracted from the financial statements:

Trenching and sampling expenditure 1,000,000

Drilling rigs used for exploration, carrying amount 2,000,000
Drilling rigs used for exploration, depreciation expense 300,000

What amount of intangible exploration asset should be recognized in the statement of financial
position?

Solution:
Trenching and sampling expenditure 1,000,000
Depreciation of drilling rigs used for exploration 300,000
Total intangible exploration assets 1,300,000

Wasting Assets
Wasting assets are material objects of economic value and utility to man produced by
nature. Wasting assets are actually natural resources. Natural resources usually
include coal, oil, ore, precious metals like gold and silver, and timber. Wasting assets
are so called because these are physically consumed and once consumed, the wasting
assets cannot be replaced anymore.
If ever, the wasting assets can be replaced only by the process of nature. Natural
resources cannot be produced by man. Wasting assets are physically consumed and
irreplaceable.

Entities follow a wide variety of practices in accounting for an extractive industry. At

present, IFRS does not address wasting assets. There is no comprehensive standard
that is applicable to the extractive or mining industry. In general, the cost of wasting
asset or a natural resource can be divided into four categories, namely:

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a. Acquisition cost - Acquisition cost is the price paid to obtain the property containing
the natural resource. Unquestionably, this is the initial cost of the wasting asset.
Generally, the acquisition cost is charged to any descriptive natural resource
account. If there is a residual land value after the extraction of the natural resource,
the portion of the acquisition cost applicable to the land may be included in the
natural resource account or may be set up in a separate account and the remaining
cost should be charged to the natural resource account. Actually, the land value is
the residual value of a wasting asset for purposes of computing depletion. Thus, the
land value should be deducted from the total cost to get the depletable amount.

b. Exploration cost - Under PFRS 6, exploration cost is the expenditure incurred before
the technical feasibility and commercial viability of extracting a mineral resource are
demonstrated. Simply stated, exploration cost is the cost incurred in an attempt to
locate the natural resource that can economically be extracted or exploited.

The exploration cost may be accounted for following:

Under the "successful effort" method, only the exploration cost directly related to the
discovery of commercially producible natural resource is capitalized as cost of the
resource property.
The exploration cost related to "dry holes" or unsuccessful discovery is expensed in
the period incurred.

Under the "full cost" method, all exploration costs, whether successful or
unsuccessful, are capitalized as cost of the successful resource discovery. This is
on the theory that any exploration cost is a "wild goose chase" and therefore
necessary before any commercially producible and profitable resource can be found.
The cost of drilling dry holes is part of the cost of locating productive holes.

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Both methods are used in practice. Most large and successful oil entities follow the
successful effort method. The full cost method is popular among small oil entities.

ILLUSTRATIVE EXAMPLE
Delicate Company is an oil and gas exploration firm. During the current year, the entity
engaged in five different exploration projects. The costs associated with these projects are
as follows:

Project 1 3,250,000
Project 2 1,780,000
Project 3 4,230,000
Project 4 2,400,000
Project 5. 960,000

Only Projects 2 and 5 were successful. As of the end of the current year, production had not
yet started at either of these two sites.

CASE #1: Under the successful effort method, what amount should be recognized as
exploration expense in the current year?

Solutions:
Project 1 3,250,000
Project 3 4,230,000
Project 4 2,400,000
Total exploration expense 9,880,000

CASE #2: Under the full cost method, what amount should be recognized as exploration
expense in the current year?

Solutions:
Project 1 3,250,000
Project 2 1,780,000

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Project 3 4,230,000
Project 4 2,400,000
Project 5. 960,000
Total exploration expense 12,620,000

c. Development cost - Development cost is the cost incurred to exploit or extract the
natural resource that has been located through successful exploration.
Development cost may be in the form of tangible equipment and intangible
development cost.
Tangible equipment includes transportation equipment, heavy machinery, tunnels,
bunker and mine shaft. The cost of such tangible equipment is not capitalized as
cost of the wasting asset but set up in a separate account and depreciated in
accordance with normal depreciation policies. Intangible development cost is
capitalized as cost of the wasting asset. Such cost includes drilling cost, sinking
mine shaft and construction of wells.

d. Estimated restoration cost- Estimated restoration cost is the cost to be incurred in

order to bring the property to its original condition. PAS 16, paragraph 16, provides
that the estimated cost of restoring the property to the original condition is capitalized
only when the entity incurs the obligation when the asset is acquired. In other
words, the estimated restoration cost must be an existing present obligation required
by law or contract. The estimated restoration cost must be "discounted".

Depletion
Depletion is the removal, extraction or exhaustion of a natural resource or wasting
asset. Depletion, as an accounting procedure, is the systematic allocation of the
depletable amount of a wasting asset over the periods the natural resource is extracted
or produced.

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In essence, however, depletion is recognized as the cost of the material used in

production and thus becomes the finished product of the extractive entity since the
wasting asset is the total cost of the materials available for production.

Normally, depletion is computed using the output or production method. The depletable
amount of the wasting asset is divided by tk units estimated to be extracted to obtain
depletion rate per unit. The depletion rate per unit is then multiplied by the units
extracted during the year to arrive at the depletion for the period. Depletable amount
equals cost of wasting asset minus residual value. The residual value of wasting asset
is represented only by t value of the land after extraction underneath the resource isj
found.

ILLUSTRATIVE EXAMPLE
Bastion Company acquired a tract of land containing an extractable natural resource. The entity
is required by the purchase contract to restore the land to a condition suitable for recreational
use after it has extracted the natural resource. Geological survey indicated that the recoverable
reserves will be 4,000,000 tons, and that the land will have a value of P1,000,000 after
restoration.

Land at acquisition cost 9,000,000

Estimated restoration cost at present value 1,200,000

If the entity maintains no inventories of extracted material, what should be the charge to
depletion expense per ton of extracted material?

Solutions:
Land 9,000,000
Restoration cost 1,200,000
Exploration and evaluation asset 10,200,000
Residual value of land (1,000,000)

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Depletable amount 9,200,000

Divide by recoverable reserve 4,000,000
Depletion rate per unit 2.30

ILLUSTRATIVE EXAMPLE
Burlesque Company purchased in 2014 a property that contained certain mineral deposits for
P9,000,000. Estimated recovery was 2,000,000 tons of deposits. Development costs of
P300,000 were also incurred in the same year. The mining property was expected to be worth
P1,200,000 after the mineral deposits had all been removed. During 2014, the entity extracted
and sold 200,000 metric tons of minerals. Further development costs of P 135,000 were
incurred in 2015 and the estimate of total recoverable deposit including the deposits extracted in
2014 was revised to 1,850,000 metric tons. During 2015, the entity recovered and sold 300,000
tons.

Solution:
Purchase price 9,000,000
Development costs in 2014 300,000
Total cost 9,300,000
Residual value 1,200,000
Depletable amount 8,100,000
Divide by estimated deposits 2,000,000
Depletion rate for 2014 4.05

Journal entry:
2014
Exploration and evaluation assets 9,300,000
Cash 9,300,000

Inventory – Mineral deposit (200,000 x 4.05) 810,000

Accumulated depletion 810,000

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Cost of goods sold 810,000

Inventory – Mineral deposit 810,000

Presentation:
Exploration and evaluation assets 9,300,000
Accumulated depletion (810,000)
Carrying amount 8,490,000

2015
Depletable amount 8,100,000
Depletion in 2014 (810,000)
Balance to be depleted 7,290,000
Development costs in 2015 135,000
Depletable amounts in 2015 7,425,000
Divided by new estimated deposits 1,650,000
Depletion rate, 2015 4.50

Journal entry:
Exploration and evaluation assets 135,000
Cash 135,000

Inventory – Mineral deposit (300,000 x 4.5) 1,350,000

Accumulated depletion 1,350,000

Cost of goods sold 1,350,000

Inventory – Mineral deposit 1,350,000

Presentation:
Exploration and evaluation assets 9,435,000
Accumulated depletion (810,000 + 1,350,000) (2,160,000)
Carrying amount 7,275,000

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Depreciation of Tangible assets used in Depletion

Generally, the depreciation of tangible equipment used in mining operations is based on
the life of the mining equipment or the life of the wasting asset, whichever is shorter. If
the life of the mining equipment is shorter, the straight line method of depreciation is
normally used. But if the life of the wasting asset is shorter, the output method of
depreciation is frequently used. However, if the mining equipment is movable and can
be used in future extractive project, the equipment is depreciated over its useful life
using the straight line method.

ILLUSTRATIVE EXAMPLE
In 2011, Sunflower Company acquired a silver mine in Eastern Mindanao. Because the mine is
located deep in the Mindanao frontier, the entity was able to acquire the mine for the low price
of P50,000.

Journal entry:
Exploration and evaluation asset 50,000
Cash 50,000

In 2012, the entity constructed a road to the silver mine costing P5,000,000. Improvements and
other development costs made in 2012 cost P750,000. Because of the improvements to the
mine and to the surrounding land, it is estimated that the mine can be sold for P600,000 when
mining activities are complete.

Journal entry:
Exploration and evaluation asset 5,750,000
Cash 5,750,000

During 2013, five buildings were constructed near the mine site to house the mine workers and
their families. The total cost of the five buildings was P2,000,000. Estimated residual value is
P200,000. Geologists estimated that 4,000,000 tons of silver ore could be removed from the

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mine for refining.

Journal entry:
Building 2,000,000
Cash 2,000,000

During 2014, the first year of operations, only 500,000 tons of silver ore were removed from the
mine. However, in 2015, workers mined 1,000,000 tons of silver. During that same year,
geologists discovered that the mine contained 3,000,000 tons of silver ore in addition to the
original 4,000,000 tons.

Solution:
Purchase price 50,000
Road construction 5,000,000
Improvements and other development costs 750,000
Total cost 5,800,000
Residual value (600,000)
Depletable amount 5,200,000
Depletion rate per unit (5,200,000/4,000,000) 1.30
Depletion for 2014 (500,000 x 1.30) 650,000

Journal entry:
Inventory – silver ore 650,000
Accumulated depletion 650,000

Solution for depreciation of the building

Cost of buildings 2,000,000
Residual value (200,000)
Depreciable amount 1,800,000
Depreciation rate per unit (1,800,000/4,000,000) .45
Depreciation for 2014 (500,000 x .45) 225,000

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Journal entry:
Depreciation expense 225,000
Accumulated depreciation 225,000

Development costs of P1,300,000 were made to the mine early in 2015 to facilitate the removal
of the additional silver. Early in 2015, an additional building was constructed at a cost of
P375,000 to house the additional workers needed to excavate the added silver. This building is
not expected to have any residual value.

For the year 2015:

Solutions:
Depletable amount 5,200,000
Depletion in 2014 (650,000)
Remaining depletable amount 4,550,000
Development costs in 2015 1,300,000
Total depletable amount - January 1, 2015 5,850,000

Original estimate 4,000,000

Additional estimate in 2015 3,000,000
Total estimated deposits 7,000,000
Less: extracted in 2014 (500,000)
Remaining deposits 6,500,000

Depletion rate (5,850,000/6,500,000) 90

Depletion for 2015 (1,000,000 x .90) 900,000

Journal entry:
Exploration and evaluation assets 1,300,000
Cash 1,300,000

Inventory – silver ore 900,000

Accumulated depletion 900,000

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Solution for depreciation for 2015:

Depreciable amount 1,800,000
Depreciation for 2014 (225,000)
Remaining depreciable amount 1,575,000
Additional building in 2015 375,000
Total depreciable amount - January 1, 2015 1,950,000
New depreciation rate per unit (1,950,000/6,500,000) .30
Depreciation for 2015 (1,000,000 x .30) 300,000

Journal entry:
Depreciation expense 300,000
Accumulated depreciation 300,000

Trust Fund Doctrine

Under the trust fund doctrine, the share capital of a corporation is conceived as a trust
fund for the protection of creditors. However, the corporation can pay dividends to
shareholders but limited only to the balance of retained earnings. Accordingly, the
corporation cannot pay dividends if it has a deficit because this would be tantamount to
a return of capital to shareholders.

Wasting Assets Doctrine

Under the wasting asset doctrine, a wasting asset corporation or an entity engaged in
the extraction of a natural resource, can legally return capital to shareholders during the
lifetime of the corporation. Accordingly, a wasting asset corporation can pay dividend
not only to the extent of retained earnings but also to the extent of accumulated
depletion. The amount paid in excess of retained earnings is accounted for as a
liquidating dividend or return of capital. The wasting asset doctrine is therefore an
exception to the trust fund doctrine.

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The formula in determining the maximum dividend that can be declared by a wasting
asset corporation is as follows:
Retained earnings xx
Add: Accumulated depletion xx
Total xx
Less: Capital liquidated in prior years xx
Unrealized depletion in ending inventory xx xx
Maximum dividend xx

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ACTIVITY EVALUATION

Student Name: Date Taken:

Course, Year and Section: Time Frame:

Multiple Choice
Choose the correct answer from the choices provided. Write your answer beside the
number. USE CAPITAL LETTERS. ERASURES ARE NOT ALLOWED.

1. In 2006, Jannine Company purchased a tract of land as a possible future plant site. In
January 2014, valuable sulphur deposits were discovered on adjoining property and the
entity immediately began exploration on the property. In December 2014, after incurring
P2,000,000 in exploration costs, which were accumulated in an expense account, the entity
discovered sulphur deposits appraised at PI 2,000,000 more than the value of the land.
What is the journal entry to record the discovery of the sulphur deposits?
A. Make no entry
B. Debit P2,000,000 to an asset account
C. Debit P12,000,000 to an asset account
D. Debit P14,000,000 to an asset account

2. In January 2014, Huff Mining Company purchased a mineral mine for P36,000,000 with
removable ore estimated by geological survey at 2,160,000 tons. The property has an
estimated value of P3,600,000 after the ore has been extracted. The entity incurred
P10,800,000 of development cost preparing the property for the extraction of ore. During
2014, 270,000 tons were removed and 240,000 tons were sold. For the year ended
December 31, 2014, what amount of depletion should be included in cost of goods sold?
A. 3,600,000
B. 4,050,000
C. 4,800,000
D. 5,400,000

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3. Toledo Mining Company constructed a building costing P2,800,000 on the mine property.
The estimated residual value will not benefit the entity and will be ignored for purposes of
computing depreciation. The building has an estimated life of 10 years. The total estimated
recoverable output from the mine is 500,000 tons. The production of the first four years of
operations was:
First year - 100,000 tons;
Second year - 100,000 tons;
Third year - Shut down, no output; and
Fourth year - 100,000 tons.
What is the depreciation for the fourth year?
A. 210,000
B. 336,000
C. 490,000
D. 560,000

4. At the beginning of the current year, Vorst Company purchased a mineral mine for
P26,400,000 with removable ore estimated at 1,200,000 tons. After it has extracted all the
ore, the entity will be required by law to restore the land to its original condition at an
estimated cost of P2,100,000. The present value of the estimated restoration cost is
P1,800,000. The entity believed that it will be able to sell the property afterwards for
P3,000,000. During the current year, the entity incurred P3,600,000 of development cost
preparing the mine for production, removed 80,000 tons of ore and sold 60,000 tons. What
total amount of depletion should be recorded for the current year?
A. 1,440,000
B. 1,455,000
C. 1,920,000
D. 1,940,000

5. Josephine Company acquired a tract of land containing an extractable natural resource.

The entity is required by the purchase contract to restore the land to a condition suitable for
recreational use after it has extracted the natural resource. Geological survey indicated that
the recoverable reserves will be 2,500,000 tons and that the extraction will be completed in

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five years. Relevant cost information follows:

Land 9,000,000
Exploration and development cost 1,000,000
Expected cash flow for restoration cost 1,500,000
Credit-adjusted risk free interest rate 10%
PV of 1 at 10% for 5 periods 0.62
What is the depletion charge per ton of extracted material?
A. 3.60
B. 3.97
C. 4.00
D. 4.37

6. Harsh Company is involved in the exploration for mineral resource. The accounting policy is
to recognize and measure exploration asset initially at cost. During the current year, the
entity incurred the following expenditures:
Exploratory drilling for minerals on site and related activities2,000,000
Roads and infrastructure to access exploration site 3,500,000
Expenditures relating to the subsequent development of the resources 3,400,000
At what amount should exploration asset be initially recognized in the statement of financial
position?
A. 2,000,000
B. 5,400,000
C. 5,500,000
D. 8,900,000

7. Seacrest Company started business at the beginning of the current year. During the year,
the entity had oil and gas exploration costs of P5,000,000. Of these costs, PI,000,000 was
associated with successful wells and P4,000,000 with so called dry holes. All of the costs
were incurred during the year. The entity used the successful effort method. What is the oil
and gas exploration expense to be reported for the year?
A. 0
B. 1,000,000

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C. 4,000,000
D. 5,000,000

Canyon Company purchased in 2014 a property that contained certain mineral deposits for
P9,000,000. Estimated recovery was 1,000,000 tons of deposits. Development cost of
P300,000 was also incurred in the same year. The mining property was expected to be worth
P1,200,000 after the mineral deposits had all been removed.
During 2014, the entity extracted and sold 200,000 metric tons of minerals. Further
development cost of P945,000 was incurred in 2015 and the estimate of total recoverable
deposit including the amount extracted in 2014 was revised to 1,850,000 metric tons. During
2015, the entity recovered and sold 300,000 tons.

8. What amount should be recorded as depletion for 2014?

A. 1,560,000
B. 1,620,000
C. 1,800,000
D. 1,860,000

9. What amount should be recorded as depletion for 2015?

A. 1,179,000
B. 1,203,000
C. 1,350,000
D. 2,430,000

10. Depletion expense

A. Is usually part of cost of goods sold.
B. Excludes restoration cost from the depletable amount.
C. Includes tangible equipment cost in the depletable amount.
D. Excludes intangible development cost from the depletable amount.

11. The most common method of computing depletion is

A. Decreasing charge method

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B. Percentage depletion method

C. Production method
D. Straight line

12. Which of the following is not part of depletable amount?

A. Exploration cost
B. Acquisition cost of the mineral resource deposit
C. Intangible development cost such as drilling, tunnel and shaft
D. Tangible development cost associated with equipment used to extract the mineral
resource

13. Information needed to compute a depletion charge per unit includes the
A. Cumulative amount of resources removed.
B. Amount of resources sold during the period.
C. Amount of resources removed during the period.
D. Estimated total amount of resources available for removal.

14. Which of the following most accurately describes the generally accepted accounting
principle regarding the accounting for the costs of drilling dry holes in the oil and gas
industry?
a. Only the successful effort method may be used.
b. Only the full cost method may be used.
c. Both the successful effort and full cost methods may be used.
d. Neither the successful effort method nor the full cost method may be used pending the
promulgation by the Securities and Exchange Commission of the approach in
accounting for the costs of drilling dry holes.

15. Exploration and evaluation expenditures are incurred

A. When a specific area is being developed and preparations for commercial extraction are
being made.
B. In extracting mineral resource and processing the resource to make it marketable or
transportable.

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C. When searching for an area that may warrant detailed exploration even though the
entity has not yet obtained the legal rights to explore a specific area.
D. When the legal rights to explore a specific area have been obtained but the technical
feasibility and commercial viability of extracting a mineral resource are not yet
demonstrable.

16. When is an entity required to recognize exploration and evaluation expenditure as an

asset?
A. Such expenditure is always expensed as incurred.
B. When such expenditure is recoverable in future periods.
C. When required by the entity's accounting policy for recognizing exploration and
evaluation asset.
D. When the technical feasibility and commercial, viability of extracting the associated
mineral resource have been demonstrated.

17. Which type of expenditure is included in the term "exploration and evaluation" of mineral
resources.
I. The extraction and processing of mineral resources for transport to market.
II. The commercial review of possible areas for mineral extraction before bidding for the
legal rights to explore a specific area.
A. I only
B. II only
C. Either I or II
D. Neither I nor II

18. Which type of expenditure is included in the term "exploration and evaluation" of mineral
resources.
A. The extraction and processing of mineral resource for transport to market.
B. The commercial review of possible areas for mineral extraction before bidding for the
legal right to explore a specific area.
C. The expenditure incurred after the technical feasibility and commercial viability of
extracting a mineral resource are demonstrable.

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D. None of these should be included in exploration and evaluation expenditures.

19. Which of the following expenditures would never qualify as an exploration and evaluation
asset?
A. Expenditure for exploratory drilling
B. Expenditure for acquisition of rights to explore
C. Expenditures related to the development of mineral resource
D. Expenditures for activities in relation to evaluating the technical feasibility and
commercial viability of extracting a mineral resource

20. Does PFRS 6 require an entity to recognize exploration and evaluation expenditure as an
asset?
A. No, such expenditure is always expensed as incurred.
B. Yes, but only to the extent such expenditure is recoverable in future periods.
C. Yes, but only to the extent required by the entity's accounting policy for recognizing
exploration and evaluation asset.
D. Yes, but only to the extent the technical feasibility and commercial viability of extracting
the associated mineral resource have been demonstrated.

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REINFORCEMENT
ASSIGNMENT
DIRECTION: Use the problem to answer the requirements

On July 1, 2014, Lethargic Company, a calendar year entity, purchased the rights to a mine. The total
purchase price was P14,000,000, of which P2,000,000 was allocable to the land. Estimated reserves
were 1,500,000 tons. The entity expects to extract and sell 25,000 tons per month.

The entity purchased new equipment on July 1, 2014. The equipment was purchased for
P8,000,000 and had a useful life of 8 years. However, after all the resource is removed, the
equipment will be of no use and will be sold for P500,000.

Requirements:
1. What is the depletion for 2014?
2. What is the depreciation of the equipment for 2014?

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Course Code and Title : ACED 6 - Intermediate Accounting 1

Lesson 13 : Borrowing Cost and Government Grants

Topics : Types of borrowing costs; accounting for borrowing

cost; government grants; government assistance

This lesson identifies the recognition the measurement of borrowing cost in accordance
with Philippine Accounting Standards 23 (PAS 23) and government grants in
accordance with Philippine Accounting Standards 20 (PAS 20). It will also show the
process of capitalizing a borrowing cost and the types of government grants.

Learning Objectives

At the end of this module, the learners are expected to:

COGNITIVE

1. Identify the recognition principle of a qualifying asset and a government grant.

PSYCHOMOTOR

2. Apply the recognition principle in recognizing government grant and compute for the
borrowing cost to be capitalized as well as the cost of the qualifying asset.

AFFECTIVE

3. Analyze the effects ceasing the capitalization of borrowing costs and the repayment
of a government grant.

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Pre-Assessment

Exercise #1:Borrowing Cost

The Calvin Company self-constructed an asset for its own use. Construction started on January 1, 2016
and the asset was completed on December 31, 2016. Costs incurred during the year were as follows;
January 1 P400,000 August 1 P480,000
April 1 P500,000 December 1 P180,000

Required:
1. What is the average accumulated expenditures for the self-constructed asset?
2. If the company had a two-year, 18% loan of P500,000, specifically obtained to finance the asset
construction, what is the capitalized interest added to the cost of the self-constructed asset?
3. Assuming that in addition to the specific borrowing, prior to the construction, the company had a
general borrowing amounting to P600,000 with interest of 20% and a five-year term that used in part
in the self construction, what is the total cost of the self-constructed asset?
4. Assuming that the total construction costs of P1,560,000 were incurred evenly I during the
construction period, and the company has the following outstanding obligations prior to the start of
the construction:
Specific borrowing - P700,000,16%, due January 1,2018
General borrowing - P500,000,18%, due January 1, 2017

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LESSON PRESENTATION

INTRODUCTION
Borrowing are technically interest expense that is the cost of borrowing money.
According to the standards, it may be capitalized as a cost of asset in accordance with
the guidelines prescribe by the standards. Government grants are resources provided
by the government to a private business that may be dependent on a condition or not.
Such grant shall also be recognized in accordance with the provision of its standards.

Borrowing Cost
PAS 23, paragraph 5, defines borrowing costs as "interest and other costs that an entity
incurs in connection with borrowing of funds". This definition encompasses interest on
all types of borrowing, including finance leases and ancillary costs incurred in
connection with the arrangement of borrowing.

Paragraph 6 provides that borrowing costs specifically include:

a. Interest expense calculated using the effective interest method.
b. Finance charge with respect to a finance lease.
c. Exchange difference arising from foreign currency borrowing to the extent that it is
regarded as an adjustment to interest cost.

Qualifying Asset
PAS 23, paragraph 5, defines a qualifying asset as an asset that necessarily takes a
substantial period of time to get ready for the intended use or sale.

Qualifying assets include:

1. Manufacturing plants
2. Power generation facilities
3. Intangible assets
4. Investment properties

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Qualifying assets for purposes of borrowing cost capitalization do not include the
following:
1. Assets measured at fair value, such as biological assets.
2. Inventories that are manufactured or produced in large quantities on a repetitive
basis, such as maturing whisky, even if they take a substantial period of time to get
ready for sale. This is in accordance with Basis for Conclusions 6 on PAS
3. Assets that are ready for the intended use or sale when acquired.

Accounting for Borrowing Costs

PAS 23, paragraph 8, mandates the following rules on borrowing cost:
1. If the borrowing is directly attributable to the acquisition, construction or production of
a qualifying asset, the borrowing cost is required to be capitalized as cost of the
asset. In other words, the capitalization of borrowing cost is mandatory for a
qualifying asset. The borrowing costs that are directly attributable to the acquisition,
construction or production of a qualifying asset are those borrowing costs that would
have been avoided if the expenditure on the qualifying asset had not been made.
2. All other borrowing costs shall be expensed as incurred. In other words, if the
borrowing is not directly attributable to a qualifying asset, the borrowing cost is
expensed immediately.

Capitalization of Interest
PAS 23, paragraph 12, provides that if the asset is financed by specific borrowing, the
capitalizable borrowing cost is equal to the actual borrowing cost incurred during the
construction period minus any investment income from the temporary investment of the
specific borrowing. Note that any investment income or interest income from specific
borrowing is deducted from the capitalizable borrowing cost.

ILLUSTRATIVE EXAMPLE

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On January 1, 2014, Hamlet Company borrowed P6,000,000 at an annual interest rate of 10%
to finance specifically the cost of building an electricity generating plant. Construction
commenced on January 1, 2014 with a cost P6,000,000. Not all the cash borrowed was used
immediately, so interest income of P80,000 was generated by temporarily investing some of the
borrowed funds prior to use. The project was completed on November 30, 2014. What is the
initial carrying amount of the plant?

Solutions:
Interest (6,000,000 x 10% x 11 /12) 550,000
Interest income (80,000)
Capitalizable borrowing cost 470,000

Journal entries:
January 1, 2014
Cash 6,000,000
Notes payable 6,000,000
To record the loan acquired for the construction of the building

November 30,2014
Building 6,000,000
Various accounts 6,000,000
To record the completion of the building

Building 470,000
Interest receivable 80,000
Interest payable 550,000
To record the borrowing cost

December 31, 2014

Interest expense 50,000
Interest payable 50,000
To record the accrued interest

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Presentation:
Construction cost 6,000,000
Borrowing cost 470,000
Total cost of building 6,470,000

PAS 23, paragraph 14, provides that if the asset is financed by general borrowing, the
capitalizable borrowing cost is equal to the average expenditures of the asset during the
period multiplied by a capitalization 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.

No specific guidance is provided for general borrowing with respect to investment

income.

Accordingly, any investment income from general borrowing, is not deducted from
capitalizable borrowing cost.

ILLUSTRATIVE EXAMPLE
ABC Company had the following general borrowings during 2014 which were used to finance
the construction of the entity's new building.

Principal Borrowing cost

10% bank loan 2,800,000 280,000
10% short-term note 1,600,000 160,000
12% .long-term loan 2,000,000 240,000
6,400,000 680,000

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The construction began on January 1, 2014 and the building was completed on December 31,
2014. In the first phase of the construction, there were idle funds which the entity invested and
earned interest income of P100,000. Expenditures on the building were made as follows:

January 1 400,000
March 31 1,000,000
June 30 1,200,000
September 30 1,000,000
December 31 400,000

What is the amount of capitalizable borrowing cost?

Solutions:
Computation of average expenditure:
(a) (b) (a x b)
Date Expenditure Fractional months Average
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 0/12 0
4,000,000 2,000,000

Computation of average borrowing rate (interest rate)

Principal Borrowing cost
10% bank loan 2,800,000 280,000
10% short-term note 1,600,000 160,000
12% .long-term loan 2,000,000 240,000
6,400,000 680,000
Average rate (680,000/6,400,000) 10.625%

Borrowing cost is equal to:

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Average expenditure 2,000,000

Average rate (680,000/6,400,000) 10.625%
Capitalizable borrowing cost 212,500

Journal entries:
January 1, 2014
Building 400,000
Cash 400,000

March 31, 2014

Building 1,000,000
Cash 1,000,000

June 30, 2014

Building 1,200,000
Cash 1,200,000

September 30, 2014

Building 1,000,000
Cash 1,000,000

December 31, 2014

Building 400,000
Cash 400,000

Building 212,500
Interest payable 212,500
To record the borrowing cost

Interest expense (680,000 – 212,500) 467,500

Interest payable 467,500
To record the accrual of interest

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Interest receivable 100,000

Interest income 100,000
To record the income from reinvestment of idle funds

If the asset is financed by both specific and general borrowing, the capitalizable
borrowing cost is equal to the sum of the following:
a. Actual borrowing cost on specific borrowing minus any investment income from the
temporary investment of the proceeds from borrowing.
b. Average expenditures of the asset minus the specific borrowing equals amount
related to general borrowing multiplied by the capitalization rate equals capitalizable
borrowing cost.

ILLUSTRATIVE EXAMPLE
During 2014, Elysee Company constructed a new facility at a cost of P30,000,000. The
expenditures for the building, which was finished late in 2014, were incurred evenly during the
year. The entity had the following loans outstanding on December 31, 2014:

• 10% note to finance specifically the construction, dated January 1, 2014, P10,000,000.
This note is unpaid on December 31, 2014. Investments were made on the proceeds
from this loan and income of P100,000 was realized in 2014.
• 12% 20-year bonds issued at face value on April 30, 2013, P30,000,000.
• 8% 5-year note payable, dated March 1, 2013, PI0,000,000.

What amount of interest is capitalized as cost of the new building?

Solutions:
Since the construction cost are incurred evenly, the average expenditure is computed by
dividing the total amount by 2, that is, 30,000,000/2 = 15,000,000.

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Average expenditures (30,000,000/2) 15,000,000

Applicable to specific borrowing (10,000,000)
Applicable to general borrowing 5,000,000

Computation of average general borrowing rate:

Principal Interest
12% 20-year bonds payable 30,000,000 3,600,000
8% 5-year note payable 10,000,000 800,000
Total general borrowing 40,000,000 4,400,000
Average capitalization rate (4,400,000/40,000,000) 11%

Computation of borrowing costs:

Interest on specific borrowing (10% x 10,000,000) 1,000,000
Interest income related to specific borrowing ( 100,000)
Interest on general borrowing (11 % x 5,000,000) 550,000
Total capitalizable interest 1,450,000

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. Thus, the capitalizable borrowing cost is equal to the
average expenditures on the asset multiplied by the average interest rate.

Commencement of Capitalization of Interest

PAS 23, paragraph 17, provides that the capitalization of borrowing cost as part of the
cost of a qualifying asset shall commence when all of the following three conditions are
present:
a. When the entity incurs expenditures for the asset.
b. When the entity incurs borrowing cost.
c. When the entity undertakes activities that are necessary to prepare the asset for the
intended use or sale.

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• The activities necessary to prepare the asset for the intended use or sale
encompass more than the physical construction of the asset.
• These include technical and administrative work prior to the commencement of
physical construction, such as drawing up plans and obtaining permit for a
building.
• However, merely holding assets for use or development without any associated
development activity does not qualify for capitalization.
• For example, borrowing cost incurred while land is under development is
capitalized during the period in which development activities are being
undertaken.
• But borrowing cost incurred while land acquired for building purposes is held
without any associated development activity does not qualify for capitalization.

Suspension of Capitalization
PAS 23, paragraph 20, provides that capitalization of borrowing cost shall be
suspended during extended period in which active development is interrupted.

However, capitalization of borrowing cost is not normally suspended during a period

when substantial technical and administrative work is being carried out.

Capitalization of borrowing cost is not also suspended when a temporary delay is a

necessary part of the process of getting an asset ready for its intended use or sale.

For example, capitalization continues during the extended period that high water levels
delay the construction of a bridge, if such high water levels are common during the
construction period in the geographical region involved.

Cessation of Capitalization

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PAS 23, paragraph 22, provides that capitalization of borrowing cost shall cease when
substantially all the activities necessary to prepare the qualifying asset for its intended
use or sale are complete.

An asset is normally ready for its intended use or sale when the physical construction of
the asset is complete even though routine administrative work might still continue.

When the construction of a qualifying asset is completed in parts and each part is
capable of being used while construction continues on other parts, capitalization of
borrowing cost shall cease when substantially all activities necessary to prepare that
part for its intended use or sale are complete.

Government Grants
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 subsidy, subvention or premium.

Technically, to qualify as a government grant, it is a prerequisite that the grant shall be

provided by the government to an entity in return for past or future compliance with
conditions relating to the operating activities of the entity.

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.

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Recognition Principle of a Government Grant

Government grant, including nonmonetary grant at fair value, shall be recognized when
there is reasonable assurance that:
a. The entity will comply with the conditions attaching to the grant.
b. The grant will be received.

Receipt of a grant does not of itself provide conclusive evidence that the conditions
attaching to the grant have been or will be fulfilled. Government grant shall not be
recognized on a cash basis as this is not consistent with generally accepted accounting
practice.

Recognition of Grant as Income

1. Grant in recognition of specific expenses shall be recognized as income over the
period of the related expense.
2. Grant related to depreciable asset shall be recognized as income over the periods
and in proportion to the depreciation of the related asset.
3. 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.
4. 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.

Classification of Government Grants

1. Grant related to asset. This is government grant whose primary condition is that an
entity qualifying for the grant should purchase, construct or otherwise acquire long-
term asset. Subsidiary conditions may also be attached restricting the type or
location of the asset or the period during which the asset is to be acquired or held.

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2. Grant related to income. By residual definition, this is government grant other than
grant related to asset.

ILLUSTRATIVE EXAMPLE
On January 1, 2014, Sagada Company received a grant of P25,000,000 from the American
government in order to defray safety and environmental costs within the area where the entity is
located. The safety and environmental costs are expected to be incurred ever four years,
respectively, P2,000,000, P4,000,000, P6,000,000 and P8,000,000. What amount of grant
income should be recognized in 2014?

Solutions:
Computation of Grant income
Year Costs Fraction Income
2014 2,000,000 2/20 2,500,000
2015 4,000,000 4/20 5,000,000
2016 6,000,000 6/20 7,500,000
2017 8,000,000 8/20 10,000,000
20,000,000 25,000,000

Journal entries:
January 1, 2014
Cash 25,000,000
Deferred grant income 25,000,000
To record the receipt of grant

December 31, 2014

Safety and environmental expense 2,000,000
Cash 2,000,000

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Deferred grant income 2,500,000

Grant income 2,500,000

ILLUSTRATIVE EXAMPLE
Betty Company purchased a jewel polishing machine for P3,600,000 on January 1, 2014 and
received a government grant of P500,000. 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.
What is the depreciation of the machine for 2014?

CASE #1: The grant is treated as a deferred income

Journal entries:
January 1, 2014
Machine 3,600,000
Cash 3,600,000

Cash 500,000
Deferred grant income 500,000

December 31, 2014

Depreciation expense (3,600,000 – 100,000)/8 437,500
Accumulated depreciation 437,500

Deferred grant income (500,000/8) 62,500

Grant income 62,500

Machine 3,600,000
Accumulated depreciation (437,500)
Carrying amount 3,162,500

CASE #2: The grant is treated as a reduction of asset

Journal entries:

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Tel Nos. 519-1960/4788671/4031985

January 1, 2014
Machine 3,600,000
Cash 3,600,000

Cash 500,000
Machine 500,000

December 31, 2014

Depreciation expense (3,100,000 – 100,000)/8 375,000
Accumulated depreciation 375,000

Machine 3,100,000
Accumulated depreciation (375,000)
Carrying amount 2,725,000

Non-monetary Grant
A government grant may take the form of a transfer of nonmonetary asset, such as land
or other resources for the use of the entity. In such a case, it is usual to assess the fair
value of the nonmonetary asset and to account for both grant and asset at fair value.
An alternative approach that is sometimes followed is to record both asset and grant at
a nominal amount.

Presentation
Government grant related to asset, including nonmonetary grant at fair value, shall be
presented in the statement of financial position in either of two ways:
a. By setting the grant as deferred income.
b. By deducting the grant in arriving at the carrying amount of the asset.
The first approach means that the grant is recognized as deferred income initially and
systematically and rationally recognized as income over the useful life of the asset. The
second approach means that the grant is "netted" against the initial carrying amount of

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the asset. This netting approach will have the effect of equally recognizing the grant in
profit or loss over the useful life of the asset by way of a reduced depreciation charge.

Government grant related to income may simply be defined as one not related to an
asset. Such grant shall be recognized as income when the conditions attached to the
recognition have been satisfied:
Government grant related to income is presented as follows:
a. The grant is presented in the income statement, either separately or under the
general heading "other income".
b. Alternatively, the grant is deducted from the related expense.

Repayment of Grant
A government grant that becomes repayable because conditions of receipt have not
been met shall be accounted for as a change in accounting estimate.
1. Repayment of a grant related to income shall be applied first against any
unamortized deferred income and any excess shall be recognized immediately as an
expense.
2. Repayment of a grant related to an asset shall be recorded by increasing the
carrying amount of the asset.
The cumulative additional depreciation that would have been recognized to date in the
absence of the grant shall be recognized immediately as an expense.

ILLUSTRATIVE EXAMPLE
On January 1, 2014, Easy Company received a grant of P1,500,000 from the government to
subsidize tuition fees for a period of 5 years. On January 1, 2016, the entity violated certain
conditions attached to the grant, and therefore had to repay fully such grant to the government.
What amount should be recognized as loss resulting from the repayment of the grant in 2016?

Journal entries
January 1, 2014

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Tel Nos. 519-1960/4788671/4031985

Cash 1,500,000
Deferred grant income 1,500,000

December 31, 2014

Deferred grant income (1,500,000/5) 300,000
Grant income 300,000

December 31, 2015

Deferred grant income (1,500,000/5) 300,000
Grant income 300,000

January 1, 2016
Deferred grant income 900,000
Loss on repayment of grant 600,000
Cash 1,500,000

Disclosures for Government Grant

a. The accounting policy adopted for government grant, including the method of
presentation adopted in the financial statements.
b. The nature and extent of government grant recognized in the financial statements
and an indication of other forms of government assistance from which the entity has
directly benefited.
c. Unfulfilled conditions and other contingencies attaching to government assistance
that has been recognized.
It is not required to disclose the name of the government agency that gave the grant
along with the date of sanction of the grant by such government agency and the date
when cash was received in case of monetary grant.

Government Assistance

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Government assistance is action by 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 of government assistance 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.

Government assistance does not include the following indirect benefits:

a. Infrastructure in development areas such as improvement to the general transport
and communication network.
b. Imposition of trading constraints on competitors.
c. Improved facilities such as irrigation for the benefit of an entire local community.

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ACTIVITY EVALUATION

Student Name: Date Taken:

Course, Year and Section: Time Frame:

Multiple Choice
Choose the correct answer from the choices provided. Write your answer beside the
number. USE CAPITAL LETTERS. ERASURES ARE NOT ALLOWED.

1. Which of the following should not be considered a qualifying asset?

A. An expensive jet that can be purchased from a vendor.
B. A ship that normally takes one to two years to complete.
C. A toll bridge that usually takes more than a year to build.
D. A power generation plant that normally takes two years to construct.

2. Which of the following is a disclosure requirement in relation to borrowing costs?

A. Borrowing cost capitalized during the period.
B. Segregation of qualifying asset from other assets.
C. Capitahzation rate used to determine borrowing cost to be capitalized.
D. Borrowing cost capitalized during the period and capitalization rate used to determine
borrowing cost to be capitalized.

3. Which of the following statements about the capitalization of borrowing cost as part of the
cost of a qualifying asset is true?
A. Capitalization always continues until the asset is brought into use.
B. Capitalization always commences as soon as expenditure of the asset is incurred.
C. Capitalization always commences as soon as interest on relevant borrowings is being
incurred.
D. If funds come from general borrowings, the amount to be capitalized is based on the
weighted average amount of expenditures.

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4. If the qualifying asset is financed by specific borrowing, the capitalizable borrowing cost is
equal to
A. Zero
B. Actual borrowing cost incurred
C. Actual borrowing cost incurred up to completion of asset
D. Actual borrowing cost incurred up to completion of asset minus any investment income
from the temporary investment of the borrowing

5. Assets that qualify for interest capitalization include

A. Asset that is ready for the intended use.
B. Asset under construction for an entity's use.
C. Asset that is not currently being used because of excess capacity.
D. All of these assets qualify for interest capitalization.

6. On January 1, 2014, Compassionate Company began construction of homes for those

families that were hit by the storm surge as a consequence of a super typhoon and were
homeless. The construction is expected to take 3.5 years and is being financed by
issuance of bonds for P7,000,000 at 12% per annum with a term of 3.5 years.
The bonds were issued on January 1, 2014 at face value but the bonds carry a 1.5%
issuance cost. The bond issuance cost is amortized using straight line. The project is also
financed by issuance of share capital of P5,000,000 with a 14% cost of capital.
What amount of borrowing cost should be capitalized in 2014?
A. 840,000
B. 870,000
C. 1,040,000
D. 1,070,000

7. Jugular Company started construction on a building on January 1 of the current year and
completed construction on December 31 of the same year. The entity had only two interest-
bearing 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 - P2,500,000;

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Ending balance in construction in progress before capitalization of interest -

P3,600,000;
6% note incurred specifically for the project - P1,500,000; and
9% long-term note - P5,000,000.
What is the amount of capitalizable interest for the current year?
A. 150,000
B. 180,000
C. 225,000
D. 279,000

8. During 2014, Joshua 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, 2014, and 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 1,2013. What amount of interest
should be capitalized during 2014?
A. 150,000
B. 247,000
C. 300,000
D. 472,000

On January 1, 2014, Carcass Company took out a loan of P24,000,000 in order to finance
specifically the renovation of a building. The renovation work started on the same date. The loan
carried annual interest at 10%. Work on the building was substantially complete on October 31,
2014. The loan was repaid on December 31, 2014 and P200,000 investment income was
earned in the period to October 31; 2014 on the proceeds of the loan not yet used for the
renovation.
9. What is the interest expense for 2014?
A. 0
B. 200,000
C. 400,000

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D. 600,000

10. Warhead Company had loans outstanding during 2014 and 2015.
Specific construction loan, 10% - P2,000,000; and
General loan, 12% - P15,000,000.
The entity began the self-construction of a new building on January 1, 2014 and the
building was completed on December 31, 2015. Expenditures during 2014 and 2015 were:
January 1, 2014 2,000,000
July 1, 2014 4,000,000
November 1, 2014 3,000,000
July 1, 2015 1,000,000

What is the cost of the new building on December 31, 2015?

A. 10,000,000
B. 11,500,000
C. 11,660,000
D. 11,700,000

Peach Company purchased a machine for P7,000,000 on January 1, 2014 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.

11. What is the carrying amount of the asset on December 31,2015?

A. 3,900,000
B. 4,200,000
C. 4,400,000
D. 5,700,000

12. What is the deferred grant income on December 31,2015?

A. 0
B. 400,000

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C. 600,000
D. 800,000

13. On January 1, 2014, Downright Company received a grant of P1,500,000 from the
government to subsidize tuition fees for a period of 5 years. On January 1, 2016, the entity
violated certain conditions attached to the grant and therefore had to repay P1,200,000 to
the government. What amount should be recognized as loss resulting from the repayment
of the grant in 2016?
A. 300,000
B. 600,000
C. 900,000
D. 1,200,000

14. On January 1, 2014, Darwin 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. What is the carrying amount of the machine on December 31, 2015?
A. 3,200,000
B. 3,456,000
C. 4,000,000
D. 4,040,000

15. On January 1, 2014, Valiant Company received a grant of P60,000,000 to compensate for
costs to be incurred in planting trees over a period of 5 years. The entity will incur such
costs at P2,000,000 for 2014, P4,000,000 for 2015, P6,000,000 for 2016, P8,000,000 for
2017, and P10,000,000 for 2018. What amount of grant income should be recognized for
2014?
A. 4,000,000
B. 6,000,000
C. 8,000,000
D. 12,000,000

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16. Which disclosure is not required in relation to government grant?

A. Unfulfilled conditions and other contingencies attaching to government assistance.
B. The accounting policy adopted for government grant including method of presentation
adopted in the financial statements.
C. The name of the government agency that gave the grant along with the date of sanction
of the grant by the government agency and the date when cash was received in case of
monetary grant.
D. The nature and extent of government grant recognized in the financial statements and
an indication of other form of government assistance from which the entity has directly
benefited.

17. Which of the following is included in government assistance?

A. The provision of infrastructure in developing areas
B. The imposition of trading constraints on competitors
C. Improvement to the general transport and communication network
D. None of these can be included in government assistance

18. At the beginning of the current year, an entity received Grant One to give financial
assistance to the entity for start-up costs already incurred, and Grant Two to subsidize the
cost of purchasing computer software over a 5-year period. Which of the following
statements concerning recognition of income from the two government grants is true?
A. Grant One and Grant Two should be amortized as income over 5 years.
B. Grant One and Grant Two should be recognized as income in the current year.
C. Grant One should be amortized as income over 5 years and Grand Two should
recognized as income in the current year.
D. Grant One should be recognized as income in the current year and Grant Two should
be amortized as income over 5 years.

19. Which of the following statements is incorrect when a government provides an interest-free

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loan to an entity?
A. No interest expense is recognized.
B. The loan payable is initially reported at the present value.
C. The deferred grant income is amortized over the term of the loan using the straight line
method.
D. The interest element is amortized over the term of the loan using the effective interest
method.

20. In the case of grant related to income, which of the following accounting treatment is
prescribed?
A. Credit the grant to "retained earnings" on the balance sheet.
B. Credit the grant to "general reserve" under shareholders' equity.
C. Credit the grant to sales or other revenue from operations in the income statement.
D. Present the grant in the income statement as "other income" or as a separate line item,
or deduct it from the related expense.

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Tel Nos. 519-1960/4788671/4031985

REINFORCEMENT
ASSIGNMENT
DIRECTION: Use the problem to answer the requirements

Paula Company purchased a varnishing machine for P6,000,000 on January 1, 2014. The entity
received a government grant of P540,000 in respect of this asset on January 1, 2015. The
accounting policy is to depreciate the asset over 4 years on a straight-line basis and to treat the
grant as deferred income.

Requirement:
1. What is the carrying amount of the machine on December 31, 2015?
2. What amount should be reported as deferred grant income on December 31, 2015?
3. What net amount should be presented in income statement in relation to the grant in 2016?

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Tel Nos. 519-1960/4788671/4031985

REFERENCES
Suggested Textbooks:
Intermediate Accounting 1 (2019), Millan, Zeus Vernon B., Bandolin Enterprise, Baguio
City
Intermediate Accounting 1 (2020), Valix, Conrad, et.al., GIC Enterprise and Co., Inc.,
Manila

Additional Learning Materials:

Intermediate Accounting 4th Edition, Spiceland, Nelson and Thomas, McGraw Hill

Journals
Automate Accounting Journals, www.blackline.com
Partnership Accounting,www.Clifsnotes.com>Accounting Principles II
Warren, Carl S., Accounting 25th ed., (2015)

Suggested Websites:
www.iasplus.com
www.deloitte.com

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DR. FILEMON C. AGUILAR MEMORIAL COLLEGE OF LAS
PINAS
Golden Gate Subdivision, Talon III, Las Piñas City
Tel Nos. 519-1960/4788671/4031985

ANSWERS

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