Property, Plant and Equipment (Part 1) 61 Chapter 15 Property, Plant and Equipment (Part 1) Related standard: PAS 16 Property, Plant and Equipment Overview on the topic Our discussion on Property, Plant and Equipment (PPE) is subdivided into the following chapters: Chapter Title Sub-topics 15 PPE - Part 1 Initial recognition & measurement 16 PPE - Part 2 Subsequent measurement Learning Objectives 1. Measure the initial cost of a PPE and identify the point where the capitalization of costs ceases. 2. Provide examples of the common classes of PPE and state some of the peculiar costs capitalized for each class. 3. Identify the different modes of acquisition of PPE and state the initial measurement of cost for each mode. Property, Plant and Equipment (PPE) Property, plant and equipment are: a. Tangible assets (have physical substance); b. Used in business (used in the production or supply of goods or Services, for rental, or for administrative purposes); and Long-term in nature (expected to be used for more than one Period), Examples of PPE: 2 Land used in business Land held for future plant site Building used in business Equipment used in the production of goods Equipment held for environmental and safety reasons PBoerChapter jg OS Equipment held for rentals ipa Major spare parts and long-lived stand-by equip) Furniture and fixture Bearer plants ogg om The following are not PPE: a. Land held for speculation . Land held for an undetermined future use ¢. Land and/or building classified as investment property unde PAS 40 Investment Property ' d. Property held for sale in the ordinary course of business e. Assets classified as held for sale under PFRS 5 f. Biological assets related to agricultural activity, other than bearer plants g. Intangible assets h. Minor spare parts and short-lived stand-by equipment Recognition An item of PPE is recognized if: a. itis 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. (PAs 16.7) Spare parts, stand-by equipment and servicing equipment ate recognized as PPE if they meet the definition of PPE (i.e., they are expected to be used for more than on ic ct ; e period); i = classified as inventory. (PAS 16.8) p Ms otheexvise, aad Safety and environmental equ; ; quipment are zed as PPE because, although they do not direct] wualy ie economic benefits of other existing assets re crease the in obtaining the future economic 7 uley are necessary example, a factory may be : environmental equipment by peas to install safety andProperty, Plant and Equipment (Part 1) 63 Initial Measurement An item of PPE is initially measured at cost. > Cost is “the amount of cash or cash equivalents paid or the fair value of the other consideration given to acquire an asset at the time of its acquisition or construction or, where applicable, the amount attributed to that asset when initially recognized in accordance with the specific requirements of other PFRSs.” (PAS 16.6) Cost is measured at the cash price equivalent at the acquisition date. If payment is deferred beyond normal credit terms, the difference between the cash price equivalent and the total payment is recognized as interest expense over the credit period. Cost comprises the following: a. b. Purchase price, including import duties, nonrefundable purchase taxes, less trade discounts and rebates. Direct costs of bringing the asset to the location and condition necessary for it to be used in the manner intended by management. Initial estimate of dismantlement, removal and site restoration costs for which the entity incurs an obligation by acquiring or using the asset other than to produce inventories. Examples of directly attributable costs: a. pone m Costs of employee benefits arising directly from the construction or acquisition of PPE; Costs of site preparation; Initial delivery and handling costs (eg., freight costs); Installation and assembly costs; Testing costs, net of disposal proceeds o during testing; and Professional fees. f samples generated (PAS 16.17)Chapter So s.r—“— tright: oul Examples of costs that are expensed : ility. a. Costs of opening a new faci ice (includi b. Costs of producing a new product or service (including COsty isi ional activities). of advertising and promotional ; : i i ation or wi c. Costs of conducting business in a new pan ith a ney class of customers (including costs of sta g). d. Administration and other general overhead costs. (PAS 16.19) Cessation of capitalization of costs i ; Capitalization of costs ceases when the PPE is 7 the location ang condition necessary for it to be capable of operating in the manner intended by management. Therefore, costs incurred in using or redeploying PPE are not capitalized. | Illustration 1: Acquisition on cash basis | ABC Co. imported a piece of factory equipment for P200,000. ABC | Co. incurred the following additional costs: | Non-refundable purchase taxes 20,000 | Broker's commission 10,00 Freight and handling costs 2,000 Import duties 50,000 Installation (including P1,000 cost of platform for the equipment) 4,000 Testing and trial runs 3,000 General and administrative costs 8,400 Advertisement for the related new product 5,600 ' The samples generated from the trial runs were sold for P1,000. / Requirements: Compute for the initial cost of the equipment Solutions: Purchase price | Non-refundable purchase taxes 200m | Broker's commission 20; St | Freight and handling costs 100 Import duties 2 50,00!Property, Plant and Equipment (Part 1) 65 Installation 4,000 Testing 3,000 Sub-total 289,000 Proceeds from sale of samples generated (1,000) Initial cost of equipment 288,000 The general and administrative and advertisement costs are expensed. lournal entries: Date | Factory equipment 289,000 Cash 289,000 to record the capitalizable costs of equipment . Date | Cash 1,000 Factory equipment 1,000 to record sale of samples generated from testing Date | General and administrative expenses 8,400 Advertising expense 5,600 Cash 14,000 to record the non-capitalizable costs as expenses Illustration 2: Acquisition on account ABC Co. acquired a piece of equipment for P112,000 on account. The credit term is ‘2/15, n/30’. The discount is computed based on the purchase price. The purchase price is inclusive of 12% value added tax (VAT). ABC Co. is VAT-registered and any input VAT Paid is refundable through deduction from the monthly output VAT remitted to the Bureau of Internal Revenue (BIR). Additional costs incurred include P10,000 cost of training the staff who will be Operating the equipment and P15,000 cost of relocating the equipment to a new location after it was installed in the location Originally intended by management. Requirement: Compute for the initial cost of the equipment. Solution:112 Purchase price inclusive of VAT 7m Divide by: i Purchase price exclusive of var gx P112,000) @ 009 Cash discount based on purchase price Cea ra Cash price equivalent 764 Journal entry: Date of | Equipment gee purchase | Input VAT (112,000 - 100,000) . Accounts payable 109,760 VAT is deducted from the invoice price because it is a refundable tax. Only non-refundable taxes are included in the cost of a PPE. Non-refundable taxes are those whose eventual payment cannot be transferred to others. However, if ABC Co. is not a VAT-registered payer (eg, ABC Co. is a bank), the VAT paid is included as cost of the equipment. Non-VAT payers cannot transfer the eventud payment of VAT to others. The cash discount is deducted in order to compute for the cash price equivalent of the equipment. If the equipment wa purchased on cash basis rather than on account, ABC Co. would have paid for the equipment at an amount excluding the cash discount (i.e., the cash price equivalent). Scenario 1: If payment is made within the discount period, th entry will be as follows: Date | Accounts payable Cash 109,760 10978 the Scenario 2: If payment i: entry will be eee = made beyond the : Date | Accounts payable Purchase discount lost ee Cash 2,240 oo? L 412! iscount period, Regardless of the scenario, 8 the equipment is me ed net of the discount,Property, Plant and Equipment (Part 1) 67 Illustration 3: Deferred settlement — with cash price equivalent On January 1, 20x1, ABC Co. purchased a piece of furniture with an installment price of P130,000 and a cash price equivalent of P100,000 by paying P10,000 down Payment and issuing a one-year noninterest-bearing note of P120,000 payable in equal semi-annual installments on July 1 and December 31, 20x1. Requirement: Compute for the initial cost of the furniture. Solution: The furniture is initially recognized at the cash price equivalent of P100,000. The difference between the total payment and the cash price equivalent is recognized as interest expense over the credit period using the effective interest method. The effective interest rate can be determined in various ways, including the “trial and error” approach. Journal entry: Jan. | Furniture and fixture (cash price equivalent) 100,000 20x1 | Discount on notes payable (squeeze) 30,000 Cash (down payment) 10,000 Notes payable (face amount) 120,000 Illustration 4: Deferred settlement — no cash price equivalent On January 1, 20x1, ABC Co. purchased fixtures with an installment price of P130,000 by paying P10,000 down payment and issuing a three-year noninterest bearing note of P120,000 Payable in three equal annual installments starting December 31, 20x1. The prevailing rate for the note on January 1, 20x1 is 12%. Requirement: Compute for the initial cost of the fixtures. Solution: : . : Since the cash price equivalent is not given, the fixtures will be initially recognized at the cash down payment plus the presentChapter 15 (Sn err e total pa value of the note. The difference a ne patie at the initial cost is recognized as interest P a _ thod. period using the effective interest me! 10, Cash down payment ; 112%, n=3 96. 7 PV of note (120K + 3) x PV of ordinary annuity of ” ies 3 Initial cost of the fixtures 073 The entry to.record the purchase is as follows: Jan. 1, | Furniture and fixture 106,073 201 | Discount on notes payable (120,000 - 96,073) 23,927 Cash Lae Notes payable 120,000 (Amortization table — installments) Cash Interest Present D hers ate payments expense a aes value Jan. 1, 20x1 96,073 Dec. 31, 20x1 40,000 11,529 28,471 67,602 Dec. 31, 20x2 40,000 8,112 31,888 35,714 Dee. 31, 20x3 40,000 4,286 35,714 0 The entries for the payments on the not e payabl Ws: Dec. 31, | Notes payable i ry oT 7x1 | Interest expense 11529 Discount on notes payable : 11,59). Cash Dec. 31, | Notes payable 20:2 | Interest expense a Discount on notes alla Cah Payable git Dec. 31, | Notes payable 20x3 Interest expense Discount o; can nm Notes payableProperty, Plant and Equipment (Part 1) 69 Illustration 5: Deferred settlement ~ no cash price equivalent On January 1, 20x1 ABC Co. acquired a building for P950,000, including P5,000 non-refundable purchase taxes. The purchase agreement provided for payment to be made in full on December 31, 20x1. Legal fees, related to the acquisition, amounting to P2,000 were paid on January 1, 20x1. The effective interest rate is 10% Requirement: Compute for the initial cost of the building. Solution: Purchase price including non-refundable purchase taxes 950,000 Multiply by: PV of P1 @10%, n=1 (or simply divide by 110%) 0.90909 Cash price equivalent of building purchased 863,636 Legal fees 2,000 Initial cost of the building 865,636 Classes of PPE A class of property, plant and equipment is a grouping of assets with similar nature and use in an entity’s operations. The following are examples of separate classes of PPE: land; land and buildings; machinery; ships; aircraft; motor vehicles; furniture and fixtures; office equipment; and bearer plants hora moano op Land (Property) a . Land is classified as PPE if it is used in the entity’s operations as “owner occupied” property, €.8-, land on which the entity’s office building was constructed, land used as plant site, and land held for future plant site.Chapter 15 OS The following are not PPE: a. iness — clasgi¢: Land being sold in the ordinary course of bus: ASSifieg as “Inventory” - classifi _ “Noncurrey b. Land held for sale under PFRS 5 asset held for sale” jation — classif; i reciation — classifieq c. Land held for long-term capital app’ as “Investment property” : _ a d. Land held for a currently undetermined future use — classifieg as “Investment property” : : e. Land held as site for a building being constructed developed for future use as investment property — classified ag “Investment property” . f. Land leased out under operating lease — classified as “Investment property” g- Land leased out under finance lease — derecognized in the lessor’s books of accounts Cost of land a. Purchase price including other necessary costs, such as broker’s commissions, b. Closing costs, such as titling costs, attorney’s fees, and recording fees, 7 intended as in, Betting the land in the condition for its 7 SuCN as gi i + 11. wane and clearing, urveying, 8rading, filling, draining d. Unpaid taxes Prior to q ate buyer. Taxes incurred a piduisition assumed by the recognized as expense the date of acquisition at e. Assumption of any liens » MO} ___ property. "8 ages, or encumbrances on the f. Special assessments impr for local el provements, such ag pave 8°Vernment-maintain drainage systems, Ments, street 1; and : : et lights, sewers, 8- Option Paid to acquire th acquired are reco, © land, nia Ptions Paid on items *! ed as &xpengeProperty, Plant and Equipment (Part 1) 71 h. Costs incurred to induce tenants to vacate Premises and costs of relocating and reconstructing property belonging to others. i, Initial estimate of restoration costs for which the entity has a present obligation. j. Any additional land improvements that have indefinite useful life, such as costs of draining, clearing, grading, leveling and filling, surveying, subdividing, improvements. and other permanent Land improvement Land improvements are enhancements to the land which have a definite useful life, such as private driveways, walks, fences, parking lots, drainages and water systems, and cost of trees, shrubs, plants and other landscaping. Land normally has an indefinite useful life and thus not subject to depreciation. On the other hand, land improvements have a definite useful life. Therefore, land improvements are recognized separately from land and depreciated over their estimated useful lives. Building (Plant) Building is classified as PPE if it is used in the entity’s operations as “owner occupied” property, e.g., office building. Building being constructed or developed for future use as “owner occupied” Property is also classified as PPE. The following are not PPE: a. Building being sold in the ordinary course of business — classified as “Inventory” a . b. Building held for sale under PFRS 5 - classified as “Noncurrent asset held for sale” c. Building being constructed or developed for future use as investment property — classified as “Investment property. . d. Building leased out under operating lease - classified as “Investment property”Chapter js 72 5 : — derecogni A e. Building leased out under finance lease - derecognizeg in thy lessor’s books of accounts building rich aiarsey including other necessary Costs, such A broker’s commissions and legal fees. b b. Assumption of any liens, mortgages, or encumbrances on 4, ropert c aan to acquire the building. Options paid on items not acquired are charged to expense. d. Unpaid taxes prior to date of acquisition assumed by the buyer Taxes incurred after the date of acquisition are recognized x expense. Costs incurred to induce tenants to vacate premises. f. Costs of getting the building in the condition for its intended use, such as remodeling, renovation, and other repairs prior to occupancy. Repairs and maintenance costs incurred after occupancy are recognized as expense. Building improvement Building improvements are subse: increase the useful life or im Examples: a. Cost of elevator, escalator, or similar item that was originally included in the blueprint of a self-constructed b. Ventilation, plumbing ight : ting systems installed after occupancy of 4 purchased building or the completion of a sel constructed building. If installed Prior to occupancy or dui construction, these ite, ; adi account. a capitalized to the build c. Immovable fixtures atta in ved would Necessarily q, ilding which, if remo 18 compartments and cy building, e.g, partiti ' anes. Movable § ‘ed ® furniture and fixtures, eg, signage, ixtures are classifi quent expenditures that eithe Prove the current state of a building building. ched to the bu amage theProperty, Plant and Equipment (Part 1) 73 Equipment Equipment refers to delivery and transportation equipment, office equipment, machinery, furniture and fixtures, furnishings, factory equipment, and similar fixed assets. : Cost of equipment a. Purchase price including other necessary costs, such as broker’s commissions and non-refundable purchase taxes. b. Freight, handling charges, and insurance on the equipment while in transit c. Cost of necessary special foundations or platform d. Assembling and installation costs Cl Costs of testing and conducting trial runs, net of proceeds from sale of any salvaged materials from testing. f. The initial estimate of decommissioning and restoration costs for which the entity has a present obligation The cost of equipment does not include the following: a. Cost of relocating the equipment after it has been put to the location and condition originally intended by management - this is recognized as expense. b. Cost of training personnel who will be responsible in operating the equipment — recognized as expense. c. Cost of dismantling and removing old equipment, which belongs to the entity, prior to the installation of new equipment — recognized as expense except when the cost was previously recognized as liability. Bearer plants A bearer plant is a living plant that: : a. is used in the production or supply of agricultural produce; b. is expected to bear produce for more than one period; and Id as agricultural produce, ©. has a remote likelihood of being so except for incidental scrap sales. (PAS 16.6)7 qa 74 MP Be unte’ imilar to self-co, te d for simu ns earer olants are accol ; : : assets. PAS 16 uses the term ‘construction’ to include act it tha oe n oe plants before th ky t are ecessary to cultivate the beare ' ey ate the ocatior : i i yi anagement, 1 ti and condition intended b mi 8 : ase of items of PPE . a Seti oe of two or more PPE ees at a lump, price (basket price) is allocated to the individual assets baseq a their relative fair values at the date of purchase. ' The main reason for the allocation is Subsequen, measurement. Some of the items purchased may be non-deprecigy while some are depreciable, and even if all the items an depreciable, each may have a different useful life. Land, buildings and equipment are separate classes tt PPE. Therefore, they are accounted for separately even when they are acquired together. Land has an indefinite useful life and i therefore not depreciated (with some exceptions such as quarts and sites used for landfill), Buildings and equipment on the othe hand have finite useful lives and are therefore depreciated. Land and building aci The lump-sum purchase Therefore, the fooc r both land and building event On cost is nevertheless allocat® a. the entity intends . demolish it in the building is deprec; ee the building only in the meantine™ os In this case, the cost allocated yi ver the Period of expected usageProperty, Plant and Equipment (Part 1) = b. the entity intends to demolish the building right away. In this case, the cost allocated to the building is recognized as loss. If a new building is constructed following the demolition, the cost of the new building shall not be affected by the cost allocated to the building demolished. However, if the building is unusable, from the perspective of both the entity and market Participants, such that the building has an insignificant fair value, the total acquisition cost is allocated only to the land. In this case, the building is not recognized as an asset because the asset recognition criteria are not met. The lump-sum acquisition cost is not allocated if both the land and building are classified as inventory or investment property measured at fair value. This is because, in these cases, the land and building are accounted for as a single asset. However, if the land and building are classified as investment property measured at cost, the lump-sum acquisition cost is allocated because in this latter case, the land and building are accounted for as separate assets. Demolition costs The accounting treatment for demolition costs depends on the reason for the demolition. Case 1: To construct a new building An old building is demolished to make way for the construction of a new building. Accounting for demolition cost: The cost of demolishing or ra: of site preparation that is directly the new building. Therefore, th cost of the new building. This app an existing asset or is newly acquired. zing the old building qualifies as cost attributable to the construction of e demolition cost is capitalized as lies whether the old building isMo may be capitalized as Cost of t of the building demolishe, vt Only the demolition costs new building. The carrying amoun' any, is recognized as loss. Any proceeds from sa’ demolition are deducted from the capitalized. Je of salvaged materials fron, demolition cost tha . i Case 2: To clear the land for a possible future sale An old building is demolished to clear the land for a possible Fut sale. The demolition costs are incurred to shoulder the burden ¢ demolishing for the buyer. Accounting for demolition cost: The demolition cost is capitalized only if it enhances the futur economic benefits of the land; otherwise, it is expensed (eg, cost of disposal). If the decision to demolish occurs prior to the classificatin of the land as “held for sale” under PFRS 5 Noncurrent assets held fu sale and Discontinued Operations, the demolition cost is treated s “costs to sell” when measuring the asset at the lower of carryin; amount and fair value less costs to sell. If the demolition cost is a prerequisite to the sale of land classified as inventory, the demolition cost is treated as “costs # sell” when measuring the asset at the lower of cost and net realizable value. Any proceeds from sale of salvaged materials from the demolition are deducted from the demolition cost that * capitalized or expensed. Illustration 1: Lump-sum acquisition - building not demolished On April 1, 20x1, ABC Co. purchased land and building by P# . P10,000,000 and assuming a mortgage of P2,000,000. The land building have fair values of 5,000,000 “an 4 P10,0000 respectively. ABC Co. will use the buildi J Co. also incurred the following costs: aus ing as its new office:15,000,000 | Property, Plant and Equipment (Part 1) 77 Legal cost of conveying and registering title to land 8,000 Payment to tenants to vacate premises 9,000 Option paid on the land and building 6,000 Option paid on similar land and building not acquired 3,000 Broker's fee on the land and building 15,000 Unpaid real estate taxes prior to April 1, 20x1 assumed by ABC Co. - assessed on land 30,000 Real estate taxes after April 1, 20x1 20,000 Repairs and renovation costs before the building is occupied 40,000 Repair costs after the building is occupied 50,000 Requirement: Allocate the costs. Solution: The lump-sum purchase price is determined as follows: Cash payment 10,000,000 Mortgage assumed 2,000,000 Lump-sum purchase price 12,000,000 OR Apr. 1, co lee + (squeeze) ——> | 12,000,000 Building Cash 10,000,000 Mortgage payable 2,000,000 The fractions used in the cost allocation are derived from the Telative fair values as follows: Fair values Fractions nd 5,000,000 5/15 Building 10,000,000 10/15Chapters wo 4,000,000 ~ B000Rh (12M x 10/15) ); (12M x 8,000 " Lump-sum price (12M x 5/15) | : 5 d registering title to Legal cost of conveying an land Payment to tenants to vacate premises 3,000 6.0 (9K x 5/18); (9K x 10/15) . Sonn Option paid on the land and building / 4.0 (6K x 5/15); (6K x 10/15) Broker's fee on the land and building 5,000 10,0) (ISK x 5/15); (15K x 10/15) Unpaid real estate taxes prior to April 1, 20x1 30,000 assumed by ABC Co. ~ assessed on land 40,001 Repairs and renovation costs before the building is occupied Totals 4,048,000 8,060,004 % Notes: © The lump-sum acquisition cost is allocated to both the land and the building based on their relative fair values. @ The other costs directly attributable to the acquisition ae accounted for as follows: a. The payment to tenants to vacate premises, option on land and building acquired, and broker's fee are allocated to both the land and building based also on their relative fair values b. . The legal cost of conveying and registering title to land and t unpaid taxes prior to acquisition date assessed on the land capitalized to the land only. c. The repairs and renovation costs before occupancy f building are capitalized to the building only @ The other costs not capitalized are expensed. , Illustration 2: Lump-sum acquisition — ABC Co. purchased land and buildin P12,000,000. After the acquisition, Aj building and started the constructi information is as follows: building demolished J ig at a lump-sum price BC Co. razed the ost ion of a new one. AdditProperty, Plant and Equipment (Part 1) 79 Title guarantee 20,000 Option paid for the land and old building acquired 6,000 Payments to tenants to vacate premises 12,000 Demolition cost (salvaged materials were sold for P15,000) 60,000 Fair value of materials salvaged from the old building and used in the new building 30,000 Construction cost of new building (completed) 8,500,000 Requirement: Allocate the costs assuming: a. the land and old building have fair values of P5,000,000 and P10,000,000, respectively; and b. the old building is unusable and has an insignificant fair value. Solutions: Requirement (a): Old building has fair value Old New Land building _ building Lump-sum price 4,000,000 8,000,000 - (12M x 5/15); (12M x 10/15) Title guarantee 20,000 e - Option paid for the land and old 2,000 4,000 - bldg. acquired (6K x 5/15); (6K x 10/15) : Payments to tenants to vacate 4,000 8,000 - Premises (12K x 5/15); (12K x 10/15) Demolition cost - - 60,000 Proceeds from sale of salvaged - - (15,000) Materials Fair value of materials salvaged - - - from the old bldg. and used in the new building Constructi ildi : - 8,500,000 Totats ction cost of pew Pune. 4,026,000 8,012,000 8,545,000 aaiats _Chapter Oo & Notes: : the lump-sum prj aa r value, Price = When the old building has 1 are allocated to both the lan irect costs of acquisition sate : a even if the building 15 to be demolisheg ti . t ilding demoli ; away. The cost allocated to the building lished lig P8,012,000) is recognized as loss. | © The demolition cost capitalized to the new building is ne x terials. the proceeds from sale of salvaged ma - x The fair value of materials salvaged from the old building and Use in the new building is simply ignored. The salvaged materiak are already included in the cost of the new building throug, the demolition cost that was capitalized. (The entry would have bee, debit to new building to capitalize the fair value and credit to new building to record ty fair value as reduction in demolition cost, net effect is zero.) The entries are as follows: Lump sum purchase price Date | Land 4,000,000 Building - old 8,000,000 Cash 12,000,000 to record the purchase ow a lump sum price Additional costs: Title guarantee, etc, Date | Land 26,000 Building - old ; 100 ding 12,0 3g 00 to record the additional Costs of tit itl option, and payments to tenants to — ee Demolition cost Date | Building - new | Cash 60,000 A ool )Property, Plant and Equipment (Part 1) Salvaged materials 81 Date | Cash Building - new to record the proceeds materials as reduction in the de to the new building — from sale of salvaged molition cost capitalized 15,000 15,000 Construction costs Date | Building - new Cash building to record the construction costs of the new 8,500,000 8,500,000 Allocated cost of old building demolished Date Building - old building as loss Loss on derecognition of asset to record the allocated cost of the demolished 8,012,000 8,012,000 Requirement (b): Old building has no fair value Lump-sum price Title guarantee Option paid for the land and old building acquired Payments to tenants to vacate Premises Demolition cost Proceeds from sale of salvaged Materials Fair value of materials salvaged ; ftom the old building and used in the new building Construction cost of new building _ Totals — Land 12,000,000 20,000 6,000 12,000 12,038,000 Old building New building 60,000 (15,000) 8,500,000 8,545,000_& Notes: . hehe “ When the old building is unusable (i.e., no Ngnes and best y, such that it has no fair value, the lump-sum price and g direct costs of acquisition are allocated only to the land, “ The cost of the new building is the same whether or not cost allocated to the old building. Decommissioning and Restoration costs Aside from the purchase price and direct costs of acquisition, th, cost of a PPE also includes the initial estimate of dismantlemen, removal and site restoration costs (a.k.a. ‘decommissioning anj restoration costs’) for which the entity incurs an obligation by acquiring or using the asset other than to produce inventories. The decommissioning and restoration costs are initially measured at fair value, which is usually the present value of the estimated costs. (PAS 37 and IFRIC 1) Illustration: Cost of equipment — with decommissioning cost ABC Co. acquired an oil rig for P100,000,000. Installation an! other necessary costs in bringing the equipment to its intended condition for use totaled P20,000,000. A law requires ABC Co." dismantle the equipment and restore the installation site afte! years. The estimated decommissioning and restoration costs a P10,000,000. The appropriate pre-tax discount rate is 12%. Requirement: Compute for the initial cost of the equipment. Solution: Purchase price ‘ 1 9,000.0! Direct costs 20 00,00 PV of decommissioning and restorati ‘ (10M x PV of 1 @12%, n=20) or (10M x 0.1036 i costs ws Cost of equipment ay The entry to record the acquisition of the equipment is a5 foo”eo Property, Plant and Equipment (Part 1) 83 Date | Equipment 121,036,668 Cash 120,000,000 Asset retirement obligation 1,036,668 “Asset retirement obligation” represents the provision (liability) recognized for the restoration and decommissioning costs. The subsequent accounting for the decommissioning and restoration costs is discussed in detail in Chapter 17. QD Remember the following: The initial cost of a purchased PPE consists of the following: a. Purchase price (including nonrefundable purchase taxes, less discounts) b. Direct costs PV of decommissioning and restoration costs Self-constructed assets An entity may opt to construct a PPE (e.g., a building or machine) rather than purchase it from another party. The entity measures the cost of a self-constructed asset using the same principles used fora purchased asset. The cost of a self-constructed building includes the following: a, Materials, labor, and overhead costs incurred during Construction Architectural costs, supervision costs, and costs of building permit Excavation costs Insurance costs and safety inspection fees Costs of temporary structures built during construction, such as temporary safety fence, construction offices, sleeping quarters for laborers, and materials and tools shed Borrowing costs to the extent that they are capitalizable under PAS 23 Borrowing Costs. b, PChapter js BS set does not include the followin, Si : The cost of a self-constructed a! ieconstruction ~ these are hd a. Internal profits or savings on S€ recognized. material, labor, or b. Cost of abnormal amounts of wasted Othe, resources due to inefficiencies - recognized as sae c. Costs of uninsured hazards or claims for ee accidents . recognized as expense. Only insurance iets Paid may by capitalized as cost of a self-constructed building. d. Costs of private driveways, walks, permanent fences, parking lots, and drainages and water systems that aa a included jn the. building’s blueprint - these are capitalized as ly improvements. However, if these are included in the buildings blueprint, they are capitalized as cost of the self-constructed building.” e. Income from incidental operations - recognized as income, and hence do not affect the cost measurement’ of a PPE. For example, a vacant lot may be temporarily used as parking space before or during the construction of a building. The income and the related expenses from the parking space are recognized in profit or loss and do not affect the cost of either the land or the building. If included in the building’s design or blueprint, the cost of pavements, parking lo and similar items are recorded as cost of the building; if excluded from the building! building, it would be impractical to trace the cost of the i from the cost the building. For example, ‘of the total 8,000 bags of ee ante ae were used on the parking lot?’ or “of the total 9,000 1, aan ey str workers, how many were spent in Constructing the " te labor hours of cot ial the pavement, parking lot, or siziiar item is cor Pere oe On the other ded b building's design or blueprint), all the nstructed separately (not inclu Costs incurred would be directly traceable ® °. improvement; and thus, Separate record}, feasible, “ording to the land improvement accout Illustration: Cost of self-con, structed asse unchany een 3 lot for 2,000,000, I Jy after ur ¥ UU, i i ween Started cong; ction of a mumediatel ly ie ot ‘0. incurred the following addits new building on onal costs:Property, Plant and Equipment (Part 1) 85 Land titling cost 10,000 Special assessment 5,000 Survey costs 15,000 Materials, labor and overhead costs 5,500,000 Cash discounts on materials purchased not taken 30,000 Clerical and other costs related to construction 14,000 Excavation costs 100,000 Architectural fees and building permit 60,000 Supervision by management on construction 12,000 Insurance premiums paid for construction workers 130,000 Payment of workers’ claims for injuries not covered by insurance 45,000 Savings on construction 200,000 Cost of changes to plans and specifications due to 140,000 inefficiencies Paving of streets and sidewalks (not included in blueprint) 10,000 Income earned on a vacant space rented as parking lot during construction 9,000 Requirement: Allocate the costs. Solution: Land New Land improvement building _ Purchase price of lot 2,000,000 - - Land titling cost 10,000 - - Special assessment 5,000 . : | Survey costs 15,000 7 7 Materials, labor & overhead - : 5,500,000 | Cash discounts on materials - 7 (30,000) Purchased not taken - 14,000 Clerical and other costs . ’ telated to construction 100,000 Brcavation costs : : 60,000 Architectural fees & bldg. permit - " 12,000 1 Supervision by management on ' Construction