10
AcquisitionofProperty,Plant,
andEquipment
Prepared Chapter by:
Dragan Stojanovic, CA
Rotman School of Management, University of Toronto
AcquisitionofProperty,Plant,and
Equipment
Recognition and
Recognition
Cost Elements
Cost
Property, plant,
and equipment
assets
Recognition
principle
Asset components
Cost elements
Self-constructed
assets
Borrowing costs
Dismantling and
restoration costs
Measurement of
Cost
Cost
Cash discounts
Deferred payment
terms
Lump sum
purchase
Non-monetary
exchanges
Contributed assets
and government
grants
Specific assets
Measurement after
Measurement
Acquisition
Acquisition
Cost model
Revaluation
model
Fair value model
Costs incurred
after acquisition
IFRS / Private
IFRS
Entity GAAP
Comparison
Comparison
Comparison of
IFRS and
private entity
GAAP
Looking ahead
2
AcquisitionofProperty,Plant,and
Equipment
Recognition and
Recognition
Cost Elements
Cost
Property, plant,
and equipment
assets
Recognition
principle
Asset components
Cost elements
Self-constructed
assets
Borrowing costs
Dismantling and
restoration costs
Measurement of
Cost
Cost
Cash discounts
Deferred payment
terms
Lump sum
purchase
Non-monetary
exchanges
Contributed assets
and government
grants
Specific assets
Measurement after
Measurement
Acquisition
Acquisition
Cost model
Revaluation
model
Fair value model
Costs incurred
after acquisition
IFRS / Private
IFRS
Entity GAAP
Comparison
Comparison
Comparison of
IFRS and
private entity
GAAP
Looking ahead
3
Property,Plant,andEquipment
Also known as tangible capital assets, plant
assets, and fixed assets
Examples: land, building, equipment, and
natural resource properties
Major characteristics include:
1. Acquired and held for use in operations and
not for resale
2. Long-term in nature and usually subject to
depreciation
3. Possess physical substance
4
AcquisitionCost
Historical cost is the basis for determining cost
Historical cost is:
the assets cash or cash equivalent price, and
the cost of getting the asset ready for its
intended use
Costs incurred after acquisition are:
added to the assets cost, if they increase
future service potential, or
expensed, if they do not add to the assets
original service potential
5
AssetComponents
Both IFRS and private entity GAAP require
componentization, although IFRS guidance is
more detailed
Components of a single asset (e.g. roof of a
building) should be recognized separately if they
make up a relatively significant portion of the
assets total cost
Significant professional judgment is required in
applying componentization, and other factors to
consider include differing useful lives and
differing patterns of economic benefits
6
CostElements
Capitalized cost of property, plant, and
equipment includes all expenditures needed to:
acquire the asset (purchase price, net of
discounts and rebates)
bring it to its location and to state where it is ready
for use (including delivery, site preparation,
installation, assembly, professional fees, etc)
discharge obligations associated with assets
eventual disposal (e.g. site restoration)
IFRS and private entity GAAP share the above
approach, but sometimes differ in specific
application
7
SelfConstructedAssets
These are assets constructed by the business
for use in operations
The cost of self-constructed assets includes:
Direct materials,
Direct labour,
Directly attributable overhead (e.g. variable
manufacturing overhead)
8
BorrowingCosts
Under IFRS, borrowing costs that are incurred during
acquisition, construction or production of qualifying
assets must be capitalized as part of the assets cost
Private entity GAAP allows a choice of capitalizing or
expensing such interest costs
Most common approach is explained in Appendix 10A
9
DismantlingandRestoration
Costs
Companies are often responsible for costs
associated with dismantling the asset, removing
it, and restoring the site at the end of its useful
life
These costs are often referred to as asset
retirement costs and meet the recognition
criteria for capitalization as part of PP&E asset
costs
IFRS and private entity GAAP share the above
approach, but sometimes differ in specific
application
10
AcquisitionofProperty,Plant,and
Equipment
Recognition and
Recognition
Cost Elements
Cost
Property, plant,
and equipment
assets
Recognition
principle
Asset components
Cost elements
Self-constructed
assets
Borrowing costs
Dismantling and
restoration costs
Measurement of
Cost
Cost
Cash discounts
Deferred payment
terms
Lump sum
purchase
Non-monetary
exchanges
Contributed assets
and government
grants
Specific assets
Measurement after
Measurement
Acquisition
Acquisition
Cost model
Revaluation
model
Fair value model
Costs incurred
after acquisition
IFRS / Private
IFRS
Entity GAAP
Comparison
Comparison
Comparison of
IFRS and
private entity
GAAP
Looking ahead
11
CashDiscounts
When cash discounts are offered on the
purchase of plant assets, the Net-ofDiscount Method is the preferred method
The asset cost is reduced by the discount
amount even if discount is not taken
12
DeferredPaymentTerms
Deferred Payment Contracts
Assets, purchased through long-term credit,
are recorded at the present value of the
consideration exchanged
When no interest rate is stated, the cash
price of the purchased asset is used to
determine imputed interest rate
Interest expense is recognized over the
term of the deferred payment contract
13
DeferredPaymentContracts
Example:
Sutter Corporation, given:
Five-year, $100,000 non-interest bearing
note issued in exchange for new equipment
Market interest rate = 10%
Payable over 5 years$20,000 per year
Record acquisition of equipment
14
DeferredPaymentContracts
Calculate Present Value (PV) of Note:
Annuity Payment = $20,000, n=5, i=10%
PVA (Present Value of an annuity) = $75,816
Entry at date of purchase:
Equipment
75,816
Notes Payable
75,816
Entry to record interest expense at end of year:
Interest Expense (75,816 x 10%) 7,582
Notes Payable
7,582
15
LumpSumPurchases
Lump Sum Purchase
Cost of assets, acquired at a single lump
sum price, is allocated to assets on the
basis of their relative fair market values
Example: Inventory, land, and building
purchased for lump sum of $80,000
Fair market values for these assets are:
16
LumpSumPurchase
Asset
Inventory
Fair Market Proportion
Cost
Value
Allocation
$ 25,000
25%
20,000
Land
25,000
25%
20,000
Building
50,000
50%
40,000
$100,000
100%
i.e.
$80,000
x .25
$80,000
Total
17
NonMonetaryExchanges
Share-Based Payments
When property is acquired by issuing shares,
the fair value of the asset received or the fair
value of the shares given up is used for the
cost of the asset
Private entity GAAP and IFRS have slightly
different application of this general approach
If the shares are actively traded, the market
value of publicly traded shares is used
18
NonMonetaryExchanges
Asset Exchange
Monetary exchange of assets occurs when:
Non-monetary assets (e.g., PP&E) are
acquired for cash or other monetary assets
(e.g., accounts and notes receivable), or
Non-monetary assets are disposed of in
exchange for monetary assets
Non-monetary transaction or exchange of
assets occurs when:
Non-monetary asset is exchanged for
19
another non-monetary asset
ExchangeofNonmonetaryAssets
The basic standard is that the non-monetary
exchange is valued at:
the fair value of the asset given up, or
the fair value of the asset received
whichever is more reliably measurable, and
gain or loss on the exchange is recognized
in income
Monetary transactions are accounted for on the
same basis
20
ExchangeofNonmonetaryAssets
Exception to standard:
If one or more of the following conditions exist:
1. transaction lacks commercial substance,
2. fair values are not determinable,
Then:
new asset cost equals book value of assets
given up, and
no gain is recognized (but losses are
recognized)
21
MonetaryExchangeofAssets
Example: Information Processing Inc. (IPI)
exchanges a used machine for a new model
Fair value of used machine:
$ 6,000
Book value of used machine:
$ 8,000
(Cost=$12,000; Accum. Depreciation=$ 4,000)
Cash paid to seller:
$ 7,000
RecordthepurchaseinIPIsbooks:
Equipment (new)
13,000
Accumulated Depreciation (old) 4,000
Loss on Disposal
2,000
Equipment (old)
Cash
12,000
7,000
22
NonmonetaryExchangewith
CommercialSubstance
Cathay Corp. exchanges a number of trucks for land:
Fair value of trucks:
Book value of trucks:
(Cost=$64,000; Accum. Depreciation=
Cash paid to seller:
RecordpurchaseinCathaysbooks:
Land
53,000
Accumulated Depreciation Trucks
22,000
Trucks
Cash
Gain on Disposal of Trucks
$ 49,000
$ 42,000
$ 22,000)
$ 4,000
64,000
4,000
7,000
23
NonmonetaryExchangeNo
CommercialSubstance
Westco Ltd. exchanges a commercial property in Ontario
for almost identical one in Alberta from Eastco Ltd.
(assume no commercial substance)
Fair value of Westco property
$615,000
Book value of Westco property:
$420,000
(Cost=$520,000; Accum. Depreciation=$ 100,000)
Book value of Eastco property:
$395,000
(Cost=$540,000, Accum. Depreciation=$145,000)
Cash paid to seller:
$ 30,000
RecordtransactiononWestcobooks:
Building (new)
Accumulated Depreciation (old)
Building (old)
Cash
450,000
100,000
520,000
30,000 24
ContributionofAssets
Referred to as non-reciprocal transfers: transfer of
assets where nothing is given up in exchange
(e.g., donations, gift, government grants)
Assets fair market value used as cost of asset
Two approaches :
1. Capital Approach: credit Donated Capital; used for
shareholder contributions only; otherwise not GAAP
2. Income Approach: credit represents income; used
for non-owner contributions;
Cost Reduction Method: credit the respective
asset account (benefit recognized through
reduced depreciation expense)
Deferral Method: credit Deferred Revenue
25
(benefit amortized into income)
SpecificAssets:Land
Land costs include:
1. Purchase price
2. Closing costs (title, legal, and recording fees)
3. Costs of getting land ready for use (such as
removal of old building, clearing, grading, filling
and draining)
4. Assumption of liens or encumbrances
5. Additional improvements with an indefinite life
Sale of salvaged materials reduces cost of land
Special assessments for local improvements (e.g.,
pavement) are part of land cost
26
LandImprovements
Permanent improvements to the land such as
landscaping are added to the Land account
Improvements with limited lives as
driveways, (such walkways, fences, and parking
lots) are recorded in a separate Land
Improvements account
These costs are separated from Land as they
are depreciated over their estimated useful
lives
27
SpecificAssets:Buildings
Building costs include all costs directly related to
buying or constructing the building
The removal of an old building previously owned
and used increases loss on the disposal of the old
building
If land is purchased with an old building on it, any
demolition costs less salvage value is charged to
Land
28
SpecificAssets:Leasehold
Improvements
In long-term lease contracts, the lessee may
pay for improvements on the leased property
Examples: construction of building on leased
land, improvements to leased building
These costs are recorded in a separate
account called Leasehold Improvements
Leasehold improvements are depreciated
over the lesser of the remaining lease life and
the useful life
29
SpecificAssets:Equipment
Includes delivery equipment, office equipment,
factory equipment, machinery, and furniture
Cost of equipment includes all necessary and
reasonable costs incurred to get asset ready for its
intended use
Includes:
Purchase price
Freight and handling charges
Insurance while in transit
Costs of special foundation, assembly and
installation
Cost of trial runs
30
SpecificAssets:Investment
Property
Property that is held to generate rental
revenue and/or appreciate in value, rather than
sell as part of ordinary business or
use in production, administration, or
supplying of goods and services
IFRS allows for special accounting subsequent
to acquisition
31
SpecificAssets:NaturalResource
Properties
Also known as wasting assets
Examples: oil and gas resources, and mineral deposits
Main characteristics:
1. Asset is completely removed or consumed
2. Asset does not retain original characteristics
Costs to be capitalized relate to four activities:
1. Acquisition of properties
2. Exploration
3. Development
4. Restoration
Capitalized costs make up the depletion base, and are
depreciated through depletion charge into inventory
32
SpecificAssets:BiologicalAssets
Examples: fruit trees, grapevines, livestock
Special standard under IFRS
Measure at fair value less costs to sell, with
changes in values going through income
statement
33
AcquisitionofProperty,Plant,and
Equipment
Recognition and
Recognition
Cost Elements
Cost
Property, plant,
and equipment
assets
Recognition
principle
Asset components
Cost elements
Self-constructed
assets
Borrowing costs
Dismantling and
restoration costs
Measurement of
Cost
Cost
Cash discounts
Deferred payment
terms
Lump sum
purchase
Non-monetary
exchanges
Contributed assets
and government
grants
Specific assets
Measurement after
Measurement
Acquisition
Acquisition
Cost model
Revaluation
model
Fair value model
Costs incurred
after acquisition
IFRS / Private
IFRS
Entity GAAP
Comparison
Comparison
Comparison of
IFRS and
private entity
GAAP
Looking ahead
34
MeasurementafterAcquisition
There are three main measurement methods to
account for property, plant, and equipment
subsequent to acquisition:
1. Cost Model (CM)
2. Revaluation Model (RM)
3. Fair Value Model (FVM)
Under private entity GAAP, CM must be used
Under IFRS, companies have the following
choices:
For investment property assets: CM or FVM
For other PP&E assets: CM or RM
35
RevaluationModel
PP&E assets carried at
fair value at the date of revaluation, less
any subsequent accumulated depreciation
and impairment losses
Available only for PP&E assets whose fair
value can be measured reliably
Revaluation must be frequent enough so that
carrying value is not materially different from
assets fair value (not necessarily every year)
36
RevaluationModel
When carrying value of asset increases (debit)
When carrying value of asset decreases (credit)
Credit Revaluation Surplus (equity, OCI), unless increase
reverses previous declines recognized in income (in this
case, recognize increase in income to extent of prior
declines)
Debit Revaluation Surplus (equity, OCI) to the extent the
account has credit balance for the asset. Otherwise, debit
is recognized as decrease in income.
There can be no net increase in net income from
revaluing the asset over its life
Revaluation Surplus is transferred directly to Retained
Earnings (either each period, or at only at time of
disposal)
37
RevaluationModel:ExampleConvo
Corp
Convo Corp (CC) purchased $100,000 building on January
2010 (fiscal year end December 31)
Revaluation: every 3 years
Depreciation: straight-line
Useful life: estimated 25 years at purchase (no residual)
Fair value at December 31, 2012: $90,000
Fair value at December 31, 2015: $75,000
Required: Prepare all journal entries needed at
revaluation dates noted above.
38
RevaluationModel:ExampleConvo
Corp
Revaluation entries at December 31, 2012
Depreciationfor20102012
(100,0000)/25yrs=4,000/yr
X3years=12,000
Before
After
Revaluation
Building
Adjustment
Revaluation
100,000
(12,000)
90,000
2,000
Accumulated depreciation
(12,000)
12,000
nil
Carrying amount
88,000
2,000
90,000
AccumulatedDepreciation
Building
12,000
Building(90,00088,000)
RevaluationSurplus(OCI)
2,000
12,000
2,000
39
RevaluationModel:ExampleConvo
Corp
Revaluation entries at December 31, 2015
Depreciationfor20132015
(90,0000)/22yrs=4,091/yr
X3years=12,273
Before
After
Revaluation
Building
Adjustment
Revaluation
90,000
(12,273)
75,000
(2,727)
Accumulated depreciation
(12,273)
12,273
nil
Carrying amount
77,727
(2,727)
75,000
AccumulatedDepreciation
Building
12,273
RevaluationSurplus(OCI)
RevaluationLoss(toincome)
Building
2,000
727
12,273
2,727
40
FairValueModel
Available as measurement option for investment
properties (under IFRS only)
Investment property measured at fair value
subsequent to acquisition
Changes in value reported in net income during
period of change
No depreciation is recognized over assets life
Note that fair value must be disclosed in
financial statements, even if cost model is
chosen instead of fair value model
41
FairValueModel:Example
Erican Corp (EC) purchases shopping mall on February 2, 2011
Purchase price:
Property transfer fee:
Legal fees:
Empty store painting (before rent):
Mortgage financing assumed (rest in cash):
Tenant damage deposits acquired:
1,000,000
40,000
3,000
2,000
730,000
37,000
Fair values:
December 31, 2011:
December 31, 2012:
December 31, 2013:
1,040,000
1,028,000
1,100,000
REQUIRED: Prepare all necessary journal entries to December 31, 2013
42
FairValueModel:Example
February 2, 2011 (acquisition)
Investment Property Mall
Maintenance Expense
Mortgage Payable
Tenant Deposits Liability
Cash
1,043,000
2,000
730,000
37,000
278,000
43
FairValueModel:Example
December 31, 2011
Loss in Value of Inv. Property
Investment Property Mall
(1,043,000 1,040,000)
December 31, 2012
Loss in Value of Inv. Property
Investment Property Mall
(1,040,000 1,028,000)
December 31, 2013
InvestmentPropertyMall
Gain in Value of Inv. Property
(1,040,000 1,028,000)y
3,000
3,000
12,000
12,000
72,000
72,000
44
CostsSubsequenttoAcquisition
If costs incurred achieve greater future benefits, capitalize costs
(Capital expenditure)
If costs maintain a specific level of service, expense costs
(Revenue expenditure)
Major types of expenditures are:
Additions: Increase or extension of existing assets
Replacements, major overhauls, and inspections:
Substitution of a new part/component for an existing asset,
and overhauls/inspections whether or not physical parts are
replaced
Rearrangement and reinstallation: Moving an asset from one
location to another
Repairs: Costs that maintain assets in good operating
condition
45
Replacements,MajorOverhauls,and
Inspections
Generally meet definition for capitalization, and costs added to
carrying amount
However, replaced assets or previous overhauls and/or
inspections already have a depreciated carrying value on books
Therefore, original assets carrying value should be removed
If original cost and accumulated depreciation are not known,
they must be estimated
Private entity GAAP is less strict than IFRS and allows for new
cost to be debited to Accumulated Depreciation or simply added
to assets carrying value
46
RearrangementandReinstallation
Accounting treatment for rearrangement and
reinstallation costs:
1. If the original installation cost is known,
record as a replacement
2. If the original installation cost is not known,
cost is expensed
3. If the original installation cost is not known
and amount is material, capitalize cost
(private entity GAAP only)
47
Repairs
Ordinary repairs are costs that keep asset in
good operating condition
Ordinary repairs are treated as an expense
Examples: replacement of minor parts,
repainting, lubricating equipment
48
AcquisitionofProperty,Plant,and
Equipment
Recognition and
Recognition
Cost Elements
Cost
Property, plant,
and equipment
assets
Recognition
principle
Asset components
Cost elements
Self-constructed
assets
Borrowing costs
Dismantling and
restoration costs
Measurement of
Cost
Cost
Cash discounts
Deferred payment
terms
Lump sum
purchase
Non-monetary
exchanges
Contributed assets
and government
grants
Specific assets
Measurement after
Measurement
Acquisition
Acquisition
Cost model
Revaluation
model
Fair value model
Costs incurred
after acquisition
IFRS / Private
IFRS
Entity GAAP
Comparison
Comparison
Comparison of
IFRS and
private entity
GAAP
Looking ahead
49
LookingAhead
LookingAhead
There are two significant projects under
review by IASB
Development of new and comprehensive
accounting standards for extractive industries
(e.g. mining, oil, gas)
Development of new fair value measurement
guidance
50
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51