Chapter Five

5. Accounting for Property Plant & Equipment

5.1 Nature of property plant & equipment

Property, plant and equipment are tangible assets that are held for use in the production or supply
of goods or services, for rental to others, or for administrative purposes and they are expected to
be used for more than one accounting period
 They are expected to be “Used in operations” and not to be used for resale.
 They are Long-term in nature (used for more than one accounting periods) and their cost
is allocated over their useful life.
 They Possess physical substance or they are tangible, we can see and touch

5.2 Recognition of Property, Plant, and Equipment

The recognition of property, plant and equipment depends on two criteria:
a) It is probable that future economic benefits will flow to the entity
b) The cost of the asset to the entity can be measured reliably

5.3. Initial measurement at acquisition

Once an item of property, plant and equipment qualifies for recognition as an asset, it will
initially be measured at cost. The standard lists the components of the cost of an item of
property, plant and equipment.
1. Purchase price, including import duties and non-refundable purchase taxes, less trade
discounts and rebates.
2. Costs attributable to bringing the asset to the location and condition necessary for it to be
used in a manner intended by the company.
Example:
– The cost of site preparation
– Initial delivery and handling costs
– Installation costs
– Testing costs
– Professional fees (architects, engineers)
– Borrowing costs
– Cost of dismantling and removing the asset and restoring the site on which it
is located
The following costs will not be part of the cost of property, plant or equipment unless they can
be attributed directly to the asset's acquisition, or bringing it into its working condition.

 General administration and other overhead costs

 Start-up and other similar pre-production costs
 Initial operating losses before the asset reaches planned performance. All of these will
be recognised as an expense rather than an asset.
Example: An entity has recently acquired a machine with the following details:

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 1) List price, Br 4,800,000
2) Trade discount,12.5% on list price
3) Administrative costs, Br 15,000
4) Initial delivery and handling cost, Br 55,000
5) Consultants used to advice on the acquisition, Br 300,000
6) Routine Repair &Maintenance costs ,Br 40,000
7) Major Repair &Maintenance costs ,Br 480,000
8) Start-up costs , Br. 100,000

Required: Determine cost of machine?

Suppose Smart Touch needs property and purchases land for $50,000 with a note payable for the
same amount on August 1, 2011. Smart Touch also pays cash of $4,000 for purchase tax, $5,000
to remove an old building, and a $1,000 survey fee. What is the company’s cost of land?
Purchase price of land $50,000
Add related costs:
Purchase tax $4,000
Removal of building 5,000
Survey fee 1,000 10,000
Total cost of land $60,000
The entry to record the purchase of the land on August 1, 2011, follows:
Land 60,000
Notes payable 50,000
Cash 10,000
Suppose Smart Touch then pays $20,000 for fences, paving, lighting, landscaping, and signs on
February 15, 2012. The following entry records the cost of these land improvements:
Land Improvements 20,000
Cash 20,000
Land and land improvements are two entirely separate assets. Recall that land is not depreciated.
However, the cost of land improvements is depreciated over that asset’s useful life.

5.4. Costs subsequent to Acquisition of property plant & equipment

Costs subsequent to acquisition are recognised as an asset when the costs can be measured
reliably and it is probable that the company will obtain future economic benefits. Other with it
can be recognised as expense. Evidence of future economic benefit would include:

 Increasing the capacity,

 Improving the quality of output,
 Extending useful life of the asset or
 Reducing the operating costs of the assets.

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Expenditure incurred in replacing or renewing a component of an item of property, plant and
equipment must be recognised in the carrying amount of the item. The carrying amount of the
replaced or renewed component must be derecognized.

Routine repairs and maintenance and servicing costs are recognized in profit or loss when the
costs are incurred.

5.5. Valuation of property, plant and equipment after acquisition

Companies value property, plant, and equipment in subsequent periods using either the cost
method or fair value (revaluation) method.

 Cost model. Carry the asset at its cost less depreciation and any accumulated impairment
loss.
 Revaluation model. Carry the asset at a revalued amount, being its fair value at the date
of the revaluation less any subsequent accumulated depreciation and subsequent
accumulated impairment losses.

5.5.1. Depreciation of PPE

The costs of PPE should be recorded as an expense over their useful lives. This periodic
recording of the cost of such asset as an expense is called depreciation. In each period the
carrying amount of the asset in the statement of financial position is reduced by the depreciation
charged. Over time, all PPEs, with the exception of land, lose their ability to provide services.
Because land has an unlimited life, it is not depreciated.

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Depreciation of a plant asset is based on three main factors:
1. Asset’s initial cost
2. Estimated useful life
3. Estimated residual value
Initial cost is a cost which includes all items spent for the asset to perform its intended function
by the management.
Estimated useful life is the period over which an asset is expected to be available for use by an
entity; or the number of production or similar units expected to be obtained from the asset by an
entity.Useful life may be expressed in years, units, and output.
Estimated residual value—also called salvage value or scrap value is the asset’s expected cash
value at the end of its useful life.
Depreciable cost = Cost – Estimated residual value
The adjusting entry to record depreciation debits Depreciation Expense and credits a contra asset
account entitled Accumulated Depreciation. The use of a contra asset account allows the original
cost to remain unchanged in the in the asset account.
5.5.1.1. Depreciation methods
There are many depreciation methods for property plant & equipment but three are used most
commonly:
 Straight-line
 Units-of-production
 Declining-balance
 Sum of years digit method
Depreciable Depreciation Depreciation
Method Useful Life Cost Rate Expense
1. Straight-line years Cost – RV Straight line rate* Constant
2. Units-of- total units of Cost – RV Cost – RV Variable
Production production total units of production
3. Double- years Declining BV, Straight line rate* × 2 Declining
Declining balance but not below RV
4. Sum of years years Cost – RV Cost – RV*years digit Declining
digit method
*Straight-line rate = (1/useful life), RV= Residual Value, BV= Book Value

Comprehensive example
Starbucks purchased a coffee drink machine on January 1, 2011, for $50,000. Expected useful
life is 5 years or 30,000 drinks. In 2011, 3,000 drinks were sold, in 2012, 14,000 drinks were
sold, in 2013 12,000 drinks were sold and assuming 1,000 drinks were sold in 2014. Residual
value is $5,000.Under three depreciation methods, annual depreciation and total accumulated
depreciation at the end of 2011, 2012, 2013, 2014 and 2015 are;
1. Straight-Line method

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 Each year= ($50,000 - $5,000) × 1/5 = $9,000
Year DB DR Annual Depr. Exp. Accu. Depr. Book Value
Start $50,000
2011 45,000 1/5 $9,000 $9,000 41,000
2012 45,000 1/5 9,000 18,000 32,000
2013 45,000 1/5 9,000 27,000 23,000
2014 45,000 1/5 9,000 36,000 14,000
2015 45,000 1/5 9,000 45,000 5,000
2. Units-of-Production
Depreciation per unit = $50,000 - $5,000 = $1.5/drink
30,000 units
Year DB/units/ DR Annual Depr. Expense Accu. Depr. Book Value
Start $44,000
2011 3,000 1.5/ unit $4,500 $4,500 45,500
2012 14,000 1.5/ unit 21,000 25,500 24,500
2013 12,000 1.5/ unit 18,000 43,500 6,500
2014 1,000 1.5/ unit 1,500 45,000 5,000
3. Double-Declining-Balance
2011: ($50,000 - 0) × 2/5 = $20,000
2012: ($50,000 - $20,000) × 2/5 = $12,000
2013: ($50,000 - $32,000) × 2/5= $7,200
2014: ($50,000 - $39,200) × 2/5= $4,320
2015: ($50,000 - $43,520) -5000 = $1.480
Year DB Annual Dep. Expense Accu. Depr. Book Value
Start $50,000
2011 50,000 $20,000 $20,000 30,000
2012 30,000 12,000 32,000 18,000
2013 18,000 7,200 39,200 10,800
2014 10,800 4,320 43.520 6,480
2015 6480 1480* 45,000 5,000

4. Sum of years digit method

Each fraction uses the sum of the years as a denominator. The numerator is the number of years
of estimated life remaining as of the beginning of the year. Alternate sum-of-the-years digit’
calculation= N (N+1)/2
Example if useful life of asset is 5 years; Denominator = 5+4+3+2+1= 15 or
N (N+1)/2= 5(5+1)/2=15
Numerator =remaining useful life at each year
 Depreciation rate =digits of numerator/denominator
 Depreciation expense = digits * depreciable amount

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 Year Depr. base Digit/DR Dep. Expense Accu. Depr. Book Value
Start $50,000
2011 45,000 5/15 15,000 15,000 35,000
2012 45,000 4/15 12,000 27,000 23,000
2013 45,000 3/15 9,000 36,000 14,000
2013 45,000 2/15 6,000 42,000 8,000
2013 45,000 1/15 3,000 45,000 5,000
5.5.2. Revaluation of PPE
Following initial recognition of an item of PPE, it may be carried at a revalued amount, assuming
that its fair value can be measured reliably. If the revaluation model is used, then valuations
should be carried out at regular intervals to ensure that the valuation remains up to date. The
valuation may be upward and downward valuation.

5.5.2.1. Upward valuations

An increase in value of an asset is recognized in other comprehensive income and accumulated
in equity under the heading of revaluation surplus. However, if an upward valuation reverses an
earlier downward valuation which was recognized directly in profit or loss, the upward
valuation is also recognized directly in profit or loss to the extent that it reverses the previous
decrease. Any excess above the previous decrease in value should be recognized in other
comprehensive income and accumulated in equity under the general principle.
Example: Revaluation Surplus

Bink Co has an item of land carried in its books at $13,000. Two years ago a land values was
$15,000. There has been a surge in land prices in the current year, however, and the land is now
worth $20,000.

Account for the revaluation in the current year.

Solution: The journal entry is:
Land $7,000
Profit or loss $2,000
Revaluation surplus $5,000
Note. The credit to the revaluation surplus will be shown under 'other comprehensive income'.

5.5.2.2. Downward valuations

The case is similar for a decrease in value on revaluation. Any decrease should be recognised as
an expense, except where it offsets a previous increase taken as a revaluation surplus in owners'
equity. Any decrease greater than the previous upwards increase in value must be taken as an
expense in the profit or loss.

Example: Revaluation decrease

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Let us use the example given above. The original cost was $15,000; two years ago the asset was
revalued upwards to $20,000. The value has now fallen to $13,000.

Solution: The double entry is:

Revaluation surplus $5,000

Profit or loss $2,000
Asset value (statement of financial position) $7,000

5.6. Disposal of property plant & equipment

PPEs that are no longer useful may be disposed from the business accounts. The disposal of
property plant and equipment may be performed through discarding, selling and exchanging.

5.6.1. Discarding of property plant & equipment

If PPE is no longer used and has no residual value, it is discarded. The disposal of a depreciable
asset usually requires two journal entries:
1. An adjusting entry to update the depreciation expense and accumulated depreciation
accounts.
2. An entry to record the disposal. The cost of the asset and any accumulated depreciation at
the date of disposal must be removed from the accounts.
To illustrate, assume that equipment acquired at a cost of $25,000 is fully depreciated at
December 31, 2011. On February 14, 2012, the equipment is discarded. The entry to record the
discard is as follows:

Accumulated Depreciation—Equipment 25,000

Equipment 25,000

If an asset has not been fully depreciated, depreciation should be recorded before removing the
asset from the accounting records.
To illustrate, assume that equipment costing $6,000 with no residual value is depreciated at a
straight-line rate of 10%. On December 31, 2011, the accumulated depreciation balance, after
adjusting entries, is $4,750. On March 30, 2012, the asset is removed from service and discarded.
The entry to record the depreciation for the three months of 2012 before the asset is discarded is
as follows:
March 24 Depreciation Expense—Equipment ($600 × 3/12) 150
Accumulated Depreciation—Equipment 150
The discarding of the equipment is then recorded as follows:
March 24 Accumulated Depreciation—Equipment 4,900
Loss on Disposal of Equipment 1,100
Equipment 6,000

5.6.2. Selling of property plant & equipment

The entry to record the sale of PPE is similar to the entries for discarding an asset. The only
difference is that the receipt of cash is also recorded. The difference between any cash received
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on disposal of an asset and its book value at the date of disposal is treated as a gain or loss on the
disposal of the asset.

Assume that at the end of year 17, Southwest sold an aircraft that was no longer needed because
of the elimination of service to a small city. The aircraft was sold for $11 million cash. The
original cost of the flight equipment of $30 million was depreciated using the straight-line
method over 25 years with no residual value ($1.2 million depreciation expense per year). The
last accounting for depreciation was at the end of year 16.
Cash received $11,000,000
Original cost of flight equipment $30,000,000
Less: Accumulated depreciation ($1,200,000 × 17 years) 20,400,000
Book value at date of sale 9,600,000
Gain on sale of flight equipment $1,400,000
Depreciation expense must be recorded for year 17 before the entry for selling of the aircraft to
update the accumulated depreciation and depreciation expense.
1. Update depreciation expense for year 17:
Depreciation Expense 1,200,000
Accumulated Depreciation 1,200,000
2. Record the sale:
Cash 11,000,000
Accumulated Depreciation 20,400,000
Flight Equipment 30,000,000
Gain on Sale of Assets 1,400,000
If the asset sold at book value there will not be record as gain or loss. However, if the aircraft
sold at an amount below its book value loss on sale of plant assets has debit balance.

5.6.3. Exchanging of property plant & equipment

The general principle in exchanging asset is that the cost of a nonmonetary asset acquired in
exchange for another nonmonetary asset is the fair value of the asset transferred. A gain or loss
is recognized on the exchange as the difference between the fair value of the asset transferred
and its book value. When boot (monetary consideration) is given or received, the cost of the asset
acquired and the gain or loss in a nonmonetary exchange generally is determined by these
equations:

Cost of asset acquired = Fair Value of asset transferred + Boot Paid or – Boot Received
Gain (Loss) = Fair Value of Asset transferred – Book Value of Asset transferred

i. When exchange has commercial substance (Dissimilar Assets)

Dissimilar assets are assets that are not of the same general type, do not perform the same
function, and are not employed in the same line of business. Cash flow will be changed as a
result of this transaction. All gains and losses are recognized in full.

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To illustrate, assume that ABC Company acquired equipment from XYZ Company in exchange
for building. The building cost $200,000, has a book value of $ 50,000, and has a market value
of $ 45,000. The equipment has cost of $150,000 and book value of $30,000 on XYZ’s books.
The fair value of the equipment is $40,000.

Required: prepare journal entries for both companies under the following cases:
1. No Boot received and Boot paid
2. ABC company has Boot received of $10,000
3. ABC company has Boot paid of $7,000

Case 1: No Boot
ABC Company XYZ Company
Equipment 45,000 Building 40,000
Accumulated Depreciation 150,000 Accumulated Depreciation 120,000
Loss ($45,000 – $50,000) 5,000 Equipment 150,000
Building 200,000 Gain ($40,000 – $30,000) 10,000

Case 2: $10,000 Boot Received

ABC Company XYZ Company
Equipment 35,000 Building 50,000
Accumulated Depreciation 150,000 Accumulated Depreciation 120,000
Cash 10,000 Equipment 150,000
Loss ($45,000 – $50,000) 5,000 Cash 10,000
Building 200,000 Gain ($40,000 – $30,000) 10,000

Case 3: $7,000 Boot Paid

ABC Company XYZ Company
Equipment 52,000 Building 33,000
Accumulated Depreciation 150,000 Accumulated Depreciation 120,000
Loss ($45,000 – $50,000) 5,000 Cash 7,000
Building 200, 000 Equipment 150,000
Cash 7,000 Gain ($40,000 – $30,000) 10,000

ii. When exchange lucks commercial substance (Similar Assets)

Similar assets are of the same general type, perform the same functions, and are used in the same
line of business. Loss is recognized in full, irrespective of whether boot is received or paid.
However, because of the conservatism convention, no gain is recognized on the disposal of the
original asset, and the newly acquired asset records at the book value of the asset transferred.

When the fair value of the asset being transferred is less than the book value, the following
equation applies to record the exchange of similar assets.
Cost of asset acquired = Fair Value of asset transferred + Boot Paid or – Boot Received

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When the fair value of the asset being transferred is greater than the book value, the following
equations apply:
Cost of asset acquired = Book Value of asset transferred + Boot Paid
Or
Cost of asset acquired = BV of asset transferred – Boot Received

Example:
Scenario I: Exchange of similar assets: No Boot
Company A Company B
Cost of equipment transferred $100,000 $60,000
Accumulated Depreciation 54,000 32,000
Fair Value of equipment transferred 40,000 40,000
Company A Company B
Equipment 40,000 Equipment 28,000
Accumulated Depreciation 54,000 Accumulated Depreciation 32,000
Loss ($40,000 – $46,000) 6,000 Equipment 60,000
Equipment 100,000
Scenario II: Exchange of similar assets when there is Boot
Company A Company B
Cost of equipment transferred $100,000 $60,000
Accumulated Depreciation 54,000 32,000
Fair Value of equipment transferred 40,000 35,000
Cash received (paid) 5,000 (5,000)
Company A Company B
Equipment ($40,000 – 5,000) 35,000 Equipment ($28,000 + 5,000) 33,000
Accumulated Depreciation 54,000 Accumulated Depreciation 32,000
Loss ($40,000 – $46,000) 6,000 Equipment 60,000
Cash 5,000 Cash 5,000
Equipment 100,000

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