TOA 05 43 PPE - PPE exam PDF

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826 R. Papa St. Sampaloc, Manila

Philippine School of Business CPA REVIEW Administration THEORY OF ACCOUNTS HAND OUT NO. 05-43

Gutierrez/Ocampo May 2006

PROPERTY, PLANT AND EQUIPMENT Applying PHILIPPINE ACCOUNTING STANDARD (PAS) 16 Property, Plant and Equipment . DEFINITIONS BASED ON PAS 16 Property, plant and equipment are tangible items that: a. are held for use in the production or supply of goods or services, for rental

to others, or for administrative purposes; and b. are expected to be used during more than one period.

Carry amount is the amount at which an asset is recognized after deducting any accumulated depreciation and accumulated impairment losses. Cost is the amount of cash or cash equivalents paid and the fair value of the other consideration given to acquire an asset at the time of its acquisition or construction. Depreciable amount is the cost of an asset, or other amount substituted for cost less its residual value. Depreciation is the systematic allocation of the depreciable amount of an asset over its useful life. Entity-specific value is the present value of the cash flows an entity expects to arise from the continuing use of an asset and from its disposal at the end of its useful life or expect to incur when setting a liability. Fair value is the amount for which an asset could be exchanged between knowledgeable, willing parties in an arm’s length transaction. An impairment loss is the amount by which the carrying amount of an asset exceeds its recoverable amount. Recoverable amount is the higher of an asset’s net selling price and its value in use. The residual value of an asset is the estimated amount that an entity would currently obtain from disposal of the asset, after deducting the estimated costs of disposal, if the asset were already of the age and in the condition expected at the end of its useful life. Useful life is: a. the period over which an asset is expected to be available for use by an entity; or b. the number of production of similar units expected to be obtained from the asset

by an entity.

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RECOGNITION The cost of an item of property, plant and equipment shall be recognized as an asset if, and only if: a. it is probable that future economic benefits associated with the item will flow to

the entity; and b. the cost of the item can be measured reliably

MEASUREMENT AFTER RECOGNITION Cost Model After recognition as an asset, an item of property, plant and equipment shall be carried at its cost less any accumulated depreciation and any accumulated impairment losses. Revaluation Model After recognition as an asset, an item of property, plant and equipment whose fair value can be measured reliably shall be carried at a revalued amount, being its fair value at the date of the revaluation less any subsequent accumulated depreciation and subsequent accumulated impairment losses. Revaluations shall be made with sufficient regularity to ensure that the carrying amount does not differ materially from the which would be determined using fair value at the balance sheet date. Acquisition of Property, Plant, and Equipment Property, plant, and equipment are valued in the accounts at their historical cost. Historical cost is measured by the cash or cash equivalent price of obtaining the asset and bringing it to the location and condition necessary for its intended use. Thus, charges associated with freight costs and installation are considered a part of the asset's cost. Balance Sheet Presentation The assets normally classified on the balance sheet as property, plant, and equipment include land, buildings, and various kinds of machinery and equipment. The cost of each item includes the acquisition price plus those expenditures incurred in getting the asset ready for its intended use. In the case of land, cost typically includes (a) purchase price; (b) closing costs such as title, attorney, and recording fees; (c) cost of grading, filling, draining, and clearing the property; (d) assumption of any encumbrances on the property; and ( e) any land improvements that have an indefinite life. The cost of removing an old building from land purchased for the purpose of constructing a new building is properly charged to the land account. Also, when improvements that have a limited life (fences, driveways, etc.) are made to the land they should be set up in a separate Land Improvements account so they can be depreciated over their estimated useful life. Building costs include materials, labor, and overhead costs incurred during construction. Also, any fees such as those incurred for building permits or the services

TOA 05-43

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of an attorney or architect are included in acquisition cost. In general, all costs incurred from excavation of the site to completion of the building are considered part of the building costs.

With respect to equipment, cost includes purchase price plus all expenditures related to the purchase that occur subsequent to acquisition but prior to actual use. These related costs would include such items as freight charges, insurance charges on the asset while in transit, assembly and installation, special preparation of facilities, and asset testing costs. Self-Constructed Assets When machinery and equipment to be used by an entity are constructed rather than purchased, a problem exists concerning the allocation of overhead costs. These costs may be handled in one of three ways: (a) assign no fixed overhead to the cost of the constructed asset, (b) assign a portion of all overhead to the construction process, or (c) allocate overhead on the basis of lost production. The second method appears preferable because of its consistency with the historical cost principle. It should be noted that the cost recorded for a constructed asset can never exceed the price charged by an outside producer. Interest Costs Capitalization of interest cost incurred in connection with financing the construction or acquisition of property, plant, and equipment is addressed in IAS/PAS No. 23, Borrowing Cost. The profession generally follows the rule of capitalizing only the actual interest costs incurred during construction. While some modification to this general rule occurs, its adoption is consistent with the concept that the historical cost of acquiring an asset includes all costs incurred to bring the asset to the condition and location necessary for its intended use. To qualify for interest capitalization, assets must require a period of time to get them ready for their intended use. Assets that qualify for interest cost capitalization include assets under construction for an enterprise's own use (such as buildings, plants, and machinery) and assets intended for sale or lease that are constructed or otherwise produced as discrete projects (like ships or real estate developments). The period during which interest must be capitalized begins when three conditions are present: (a) expenditures for the asset have been made; (b) activities that are necessary to get the asset ready for its intended use are in progress; and (c) interest cost is being incurred. The amount of interest that may be capitalized is limited to the lower of (a) actual interest cost incurred during the period or (b) the amount of interest cost incurred during the period that theoretically could have been avoided if the expenditure for the asset had not been made (avoidable interest). The potential amount of interest that may be capitalized during an accounting period is determined by multiplying interest rate(s) by the weighted-average amount of accumulated expenditures for qualifying assets during the period. In some instances, a company may purchase a group of plant assets at a single lump sum price. The best way to allocate the purchase price of the assets to the individual

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items is the relative fair market values of the assets acquired. To determine fair market value, an appraisal for insurance purposes, the assessed valuation for property taxes, or simply an independent appraisal by a qualified appraiser might be used. When assets are acquired for an entity's stock, the best measure of cost is the fair market value of the stock issued. Exchanges of Property, Plant, and Equipment Nonmonetary assets such as inventory or property, plant, and equipment are items whose price may change over time. Controversy exists in regard to the accounting for these assets when one nonmonetary asset is exchanged for another nonmonetary asset. A critical element in accounting for the exchange of nonmonetary assets is the type of assets involved. If the transaction involves the exchange of dissimilar assets, the cost of the nonmonetary asset acquired is normally recorded at the fair value of the asset given up and a gain or loss is recognized. The only time the fair value of the asset acquired is used to value the transaction is when its fair value is more clearly evident than the fair value of the asset given up. Similar nonmonetary assets are assets that are of the same general type, that perform the same function, or that are employed in the same line of business. When similar nonmonetary assets are exchanged and a loss results, the loss should be recognized immediately. A loss is indicated when the fair value of the asset given up is less than its book value. Also, a gain on the exchange on similar nonmonetary assets should be recognized by comparing the book value of the asset given up with the fair value of that same asset.

Costs Subsequent to Acquisition Costs related to plant assets that are incurred after the asset is placed in use are either added to the asset account (capitalized) or charged against operations (expensed) when incurred. In general, costs incurred to achieve greater future benefits from the asset should be capitalized, whereas expenditures that simply maintain a given level of service should be expensed. For the costs to be capitalized, one of three conditions must be present: (a) the useful life of the asset must be increased, (b) the quantity of service produced from the asset must be increased, or (c) the quality of the units produced must be enhanced. In many instances, a considerable amount of judgment is required in deciding whether to capitalize or expense an item. However, consistent application of a capital/expense policy is normally more important than attempting to provide theoretical guidelines. Generally, expenditures related to plant assets being used in a productive capacity may be classified as: (a) additions, (b) improvements and replacements, (c) reinstallation and rearrangement, and (d) repairs.

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Ordinary repairs are expenditures made to maintain plant assets in operating condition. They are charged to an expense account in the period in which they are incurred. Dispositions of Plant Assets When a plant asset is disposed of, the accounting records should be relieved of the cost and accumulated depreciation associated with the asset. Depreciation should be recorded on the asset up to the date of disposal, and any resulting gains or losses should be reported. Plant assets may be retired voluntarily or disposed of by sale, exchange, involuntary conversion, or abandonment. Miscellaneous Valuation of property, plant, and equipment on a basis other than historical cost has been widely discussed by those concerned with the financial reporting process. However, historical cost continues to be recognized as the accepted method for valuing these assets in the financial statements. One valuation approach that is sometimes allowed and not considered a violation of historical cost is a method referred to as prudent cost . This concept holds that if for some reason you were ignorant about a certain price and paid too much for an asset originally, it is theoretically preferable to charge a loss immediately.

MULTIPLE CHOICE 1. Kramer Service Corporation bought a building lot to construct a new corporate office building. An older home on the building lot was razed immediately so that the office building could be constructed. The cost of purchasing the older home should be a. b. c. d.

recorded as part of the cost of the land. written off as a loss in the year of purchase. written off as an extraordinary item in the year of purchase. recorded as part of the cost of the new building.

2.

Donated equipment for which the fair value has been determined should be recorded as a debit to the appropriate equipment account and a credit to a. Other Income. b. Retained Earnings. c. Capital Stock. d. Revenue or gain.

3.

An asset is being constructed for an enterprise's own use. The asset has been financed with a specific new borrowing. The interest cost incurred during the construction period as a result of expenditures for the asset is a. a part of the historical cost of acquiring the asset to be written off over the estimated useful life of the asset. b. interest expense in the construction period. c. recorded as a deferred charge and amortized over the term of the borrowing. d. a part of the historical cost of acquiring the asset to be written off over the term of the borrowing used to finance the construction of the asset.

4. If the cost of ordinary repairs is capitalized as an addition to the building account during the current year, a. net income for the current year will be understated.

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b. stockholders' equity at the end of the current year will be understated. c. total assets at the end of the current year will not be affected. d. total liabilities at the end of the current year will not be affected. 5. A company purchased land to be used as the site for the construction of a plant. Timber was cut from the building site so that construction of the plant could begin. The proceeds from the sale of the timber should be a. classified as other income. b. netted against the costs to clear the land and expensed as incurred. c. deducted from the cost of the plant. d. deducted from the cost of the land. 6. When a company purchases land with a building on it and immediately tears down the building so that the land can be used for the construction of a plant, the costs incurred to tear down the building should be a. amortized over the estimated time period between the tearing down of the building and the completion of the plant. b. expensed as incurred. c. added to the cost of the plant. d. added to the cost of the land. 7. A donated plant asset for which the fair value has been determined, and for which incidental costs were incurred in acceptance of the asset, should be recorded at an amount equal to its a. incidental costs incurred. b. fair value and incidental costs incurred. c. book value on books of donor and incidental costs incurred. d. book value on books of donor. 8. According to IAS/PAS 23, "Capitalization of Interest Cost," interest should be capitalized for assets that are a. in use or ready for their intended use in the earnings activities of the enterprise. b. being constructed or otherwise being produced as discrete projects for an enterprise's own use. c. not being used in the earnings activities of the enterprise and that are not undergoing the activities necessary to get them ready for use. d. routinely produced but require an extended period of time and are used in the earnings activities of the enterprise. 9. A company is constructing an asset for its own use. Construction began in 2004. The asset is being financed entirely with a specific new borrowing. Construction expenditures were made in 2004 and 2005 at the end of each quarter. The total amount of interest cost capitalized in 2005 should be determined by applying the interest rate on the specific new borrowing to the a. total accumulated expenditures for the asset in 2005. b. average accumulated expenditures for the asset in 2005. c. average expenditures for the asset in 2005. d. total expenditures for the asset in 2005. 10. An improvement made to a machine increased its fair market value and its production capacity by 25 percent without extending the machine's useful life. The cost of the improvement should be a. expensed. b. debited to Accumulated Depreciation. c. capitalized in the machine account. d. allocated between Accumulated Depreciation and the machine account.

11. An item of property, plant and equipment should be recognized as an asset when I. It is probable that future economic benefits associated with the asset will flow to the enterprise. II. The cost of the asset to the enterprise can be measured reliably. a. Both I and II b. Neither I nor II c. I only d. II only

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12. Which is not an essential characteristic of property, plant and equipment?

a. The property, plant and equipment are subject to depreciation. b. The property plant and equipment are tangible assets. c. The property, plant and equipment are used in production or supply of goods and services, for rental and administrative purposes. d. The property, plant and equipment are expected to be used over a period of more than one year. 13.

The depreciable amount of an item of property, plant and equipment is the a. Cost of the asset, or other amount substituted for cost in the financial statements, less its residual value. b. Net amount which the enterprise expects to obtain for an asset at the end of its useful life after deducting the expected costs of disposal. c. Amount of cash or cash equivalent paid or the fair value of other consideration given to acquire an asset at the time of its acquisition or construction. d. Amount at which an asset is recognized in the balance sheet after deducting any accumulated depreciation and accumulated impairment losses thereon.

14. It is the amount for which an asset could be exchanged between knowledgeable, willing parties in an arm’s length transaction. a. Cost c. Realizable value d. Fair value b. Sales price 15.Which is incorrect concerning recognition of property, plant and equipment? a. Most spare parts and servicing equipment are usually carried as inventory and recognized as an expense when consumed. b. Major spare parts and stand-by equipment qualify as property, plant and equipment when the enterprise expects to use them during more than one period. c. If spare parts and servicing equipment can be used only in connection with an item of property, plant and equipment, they are accounted for as property, plant and equipment and are depreciated over the useful life of the related asset. d. Property, plant and equipment acquired for safety and environmental reasons qualify for recognition as assets. 16. The cost of an item of property, plant and equipment includes all of the following, except a. Trade discount and rebates b. Purchase price c. Import duties and nonrefundable purchase taxes d. Directly attributable costs of bringing the asset to working condition for its intended use. 17. a. b. c. d.

Directly attributable costs of bringing the asset to working condition for its intended use include all, except Initial operating losses incurred prior to an asset achieving planned performance Cost of site preparation Delivery, handling and installation costs Estimated cost of dismantling and removing the asset and restoring the site, to the extent that it is recognized as a provision...