Asset Valuation
Property, Plant and Equipment
1
Introduction
• Property, plant and equipment are defined
as fixed tangible assets which are held by a
company for use in the production or
supply of goods and services, for rental to
others, or for administrative purpose
2
The notion of cost
• Historical Cost
• Replacement Cost
• Fair value
3
Historical cost
4
Historical Cost
• Historical cost is the amount paid to
acquire goods or services.
• It includes all expenditures which prepare
the asset for intended use
• Apart from the invoice price of the asset, it
also includes the freight charges, import
duties and installation costs of the asset
5
Replacement cost
6
Replacement Cost
• Replacement cost is the current cost to
replace or to purchase an item similar to
the existing item
• It abandons the realization concept
• Under replacement cost accounting, the net
profit obtained from the profit and loss
account includes both the operating income
and holding gain
7
Fair value
8
Fair value
• It is the amount for which as asset could be
exchanged for in a fair transaction
9
Example 1
10
Example 1
Chan started a business with a capital of 1000 units of
stock at $1 per unit. On 1 October, he sold 700 units at
$2 per unit. The price level indicates for the year are:
Replacement Cost
1 Jan 2007
$1.0
1 October 2007
$1.3
31 December 2007
$1.5
Profit and loss account for the year ended 31 December 2007
Historical cost
Replacement cost
Sales (700*$2)
1400
1400
700*1.3
Less: Cost of sales
700
910
Gross profit
700
490
Realized holding gain
210
700*0.3
Unrealized holding gain
150
11
Net profit
700 300*0.5
850
Balance Sheet as at 31 December 2007
Historical cost
Replacement cost
Stock
300
450
Cash
1400
1400
1700
1850
Capital
1000
1000
Add Profit – realized
700
700
- unrealized
150
1700
1700
12
Valuation of Property, plant and
equipment
• Property, plant and equipment are fixed tangible
assets that
– Are held by an enterprise for use in the production or
supply of goods or services, for rental to others, or for
administrative purpose; and
– Are expected to be used during more than one period
• Property, plant and equipment should be carried
at its cost less any accumulated depreciation and
any accumulated impairment losses
13
Land and buildings
14
Land and buildings
• Freehold land
• Leasehold land
• Buildings
15
Freehold Land
• It has an unlimited useful life, and its value
does not decline over time, so it should be
treated as non-depreciable assets
16
Leasehold land
• Leasehold land should be regarded as
depreciable assets whether the lease is
more than 50 years or not
17
Buildings
• Buildings have limited useful lives. The
cost should be allocated over their useful
economic lives, so they should be regarded
as depreciable assets
18
Exception to the treatment of
land and buildings
• Land and buildings held for resale
• Investment properties
19
Land and building held for resale
• They should be treated as trading stock.
These assets are stated at the lower of cost
and net realizable value
• No depreciation should be provide for
20
Investment properties
• They are land and buildings held as
investments, and not for the consumption
in the operation of business
• They should not be subject to depreciation,
except when the lease of a property is for
less than 20 years
• They should be valued at open market
value
21
• An increase in value should be credited to
the investment property revaluation reserve
• A decrease in value should be debited to
the investment property revaluation
reserve. If the reserve is insufficient, the
decrease can also be debited to the profit
and loss account
22
Initial measurement of property,
plant and equipment
• Cost of property, plant and equipment
• Expenditures not included in the cost of
property, plant and equipment
23
Cost of property, plant and
equipment
• An item of property, plant and equipment
should be recognized as an asset and
recorded at its cost
• Cost= Purchase Price + Other acquisition
costs – Trade discounts - rebates
24
Example 2
• Cost of property
Construction cost
Stamp duty
Legal cost
Land premium
Cost of site preparation
Cost of dismantling the old property
$
2000000
140000
50000
5000000
400000
100000
7690000
25
Example 3
• Cost of equipment
Purchase price
Less: Trade discounts
Import duty
Delivery cost
Installation cost
$
200000
20000
180000
10000
4000
3000
197000
26
Expenditures not included in the cost
of property, plant and equipment
• Assets are recorded at their cash prices.
Interest expenses should not be included in
the purchase price unless they are
capitalized in accordance with the SSAP
19 ‘ Borrowing cost’
27
• If the asset is produced by the firm itself, the
following costs should not be included in the cost
of property, plant and equipment:
–
–
–
–
–
Administrative cost
General overhead cost
Start-up and similar pre-production costs
Internal manufacturing profit
Abnormal amounts of wasted material, labour, or
other resources incurred in the production of a selfconstructed asset
28
Subsequent expenditure
• Improvement on property, plant and equipment
can be recognized as assets only when the
expenditure can improve the condition of assets
beyond their originally assessed standard of
performance
• Examples of improvements, can be capitalized,
include:
– Modifying an asset to extend its useful life and to
increase its productive capacity;
– Upgrading an asset to achieve a substantial
improvement in the quality of output
29
– Adopting new production processes to assure a
substantial reduction in previously assessed
operating costs
• It the subsequent expenditure only restores
or maintains the future economic benefits
to the originally assessed standard, it
should be written off as an expense when it
is incurred. Examples include repairing and
maintenance
30
Revaluation
31
Revaluation
• Two different bases for the determination
of the carrying amount (NBV) of property,
plant and equipment
• As asset may be stated either:
– At cost less accumulated depreciation and any
accumulated impairment losses
– At a revaluated amount, being the fair value
(fair market value), less any subsequent
accumulated depreciation
32
• Owning to the substantial difference
between the cost and market value of land
and buildings, revaluation of land and
buildings is a common practice in Hong
Kong
• The fair value is determined by appraisal
normally undertaken by professional
qualified valuers
33
• Although revaluation of plant and
equipment is permitted by the SSAP,
enterprises seldom recognize the market
value of plant and equipment in their
balance sheets
34
Several points should be noted
upon revaluation of asset:
• An increase in the value of property, plant and
equipment should be credited directly to equity
under the heading of “ revaluation reserve”
• Accumulated depreciation prior to the revaluation
should be credited to the revaluation reserve
• After revaluation, depreciation should be charged
against the revalued amount
• When the revalued asset is disposed of, the
revaluation reserve should be transferred directly
to the retained profits but not to the profit and
loss account
35
Example 4
• The purchase price of land and buildings
was $100 million at 1 January 2000. 10%
depreciation on cost was charged
Revalued on 1 January 2002
Sold on 1 January 2003
$120m
$140m
36
The Journal
Dr.
$m
Cr.
$m
2002
Jan 1 Land and Buildings
20
Provision for deprecation
($100*10%*2)
20
Revaluation reserve
40
Being surplus on revaluation transferred to the
revaluation reserve
Dec 31 Profit and loss (120/8)
15
Provision for depreciation
Being provision for deprecation on the
revalued amount over the remaining
useful economic life
15
37
The Journal
Dr.
$m
2003
Jan 1 Bank
140
Provision for deprecation
15
Land and buildings
Profit and loss – gain
Being disposal of land and buildings
Jan 1 Revaluation reserve
40
Retained profit
Being transfer of the realized revaluation
reserve to the retained profits
Cr.
$m
120
35
40
38
Treatment of revaluation surplus
and deficit
• An increase in value should be credited
directly to equity under the heading of
‘revaluation reserve’
• A decrease should be charged directly
against the revaluation reserve
• If the amount of the revaluation reserve is
insufficient to write off the decrease in
value, the decrease can be recognized as an
expense in the profit and loss account
39
• If the fair value rises again, the revaluation
deficit recognized as expenses previously
should be reversed and credited to the
profit and loss account as income
40
Example 5
• On 1 Jan 2000, A Ltd. purchased a freehold land
at a cost of $100 million. No depreciation would
be provided on the freehold land
• On 31 Dec 2002, owing to the property market
boom, the freehold land was revalued to $140
million
• On 31 Dec 2003, the property market crashed.
The freehold land was revalued to $90 million
• On 31 Dec 2004, the housing policy changed and
the property market boomed again. The freehold
land was revalued to $160 million.
41
The Journal
Dr.
$m
2000
Jan 1 Freehold land
Bank
Being purchase of Freehold land
Cr.
$m
100
2002
Dec 31 Freehold land
40
Revaluation reserve
Being surplus on revaluation transferred
to the revaluation reserve
100
40
42
The Journal
Dr.
$m
40
10
Cr.
$m
2003
Dec 31 Revaluation reserve
Profit and loss
Freehold land
50
The revaluation deficit should be directly charged
against the revaluation reserve. The excess amount of
revaluation deficit over the related revaluation reserve
should be charged as an expense to the profit and loss
account
2004
Dec 31 Freehold land
70
Profit and loss
10
Revaluation reserve
60
Being reversal of the write down of $10 million and
revaluation of the asset to its fair value
43
Impairment loss
44
Impairment loss
• Property, plant and equipment should be
stated at cost less accumulated depreciation
and any accumulated impairment losses
• An asset is impaired when its carrying
amount exceeds its recoverable amount
• If there is no indication of impairment loss,
it is not required to make a formal estimate
of recoverable amount
45
Definition
•
•
•
•
Carrying amount
Recoverable amount
Net realizable value
Value in use
46
Carrying amount
• Carrying amount is the net book value at
which an asset is recognized in the balance
sheet
Carrying amount
= Historical cost – Accumulated depreciation –
Accumulated impairment losses
47
Recoverable amount
• Recoverable amount is the higher of an
asset’s net realizable value and value in use
48
Net realizable value
• Net realizable value is the amount at which
an asset could disposed of, less any direct
selling costs
49
Value in use
• Value in use is the present value of
estimated future cash flows expected to
arise from the continuing use of an asset
and from its disposal at the end of its
useful life
50
• When an impairment loss occurs, the
revised carrying amount shown in the
balance sheet is calculated as follows:
Revised carrying amount
Lower of
Carrying amount
OR
Recoverable amount
Higher of
Net realizable value
Value in use
51
Indications of impairment
• The enterprise should estimate the
recoverable amount of assets if the
following indications of impairment
appear:
– External indicators
– Internal indicators
52
External indicators
• A significant decline in the market value of
asset
• Material adverse changes in the
technological, economic or regulatory
environment
• Long-term increase in market interest rates
which results in a material decrease in the
asset’s recoverable amount
53
Internal indicators
• Obsolescence or physical damage of an
asset
• Discontinued operation or major
reorganization
• Evidence indicating that the economic
performance of an asset is worse than
expected
54
Treatment of impairment loss
• If the carrying amount (cost less
accumulated depreciation) exceeds the
recoverable amount (the higher of net
realizable value and value in use), there
will be impairment loss
55
Accounting entries
Dr. Profit and loss
Dr. Accumulated
depreciation
Cr. Asset
Dr. Revaluation reserve
Cr. Asset
Assets previously stated at
cost
Dr. Revaluation reserve
(first)
Dr. Profit and loss
Cr. Asset
Assets previously revalued
and the revaluation reserve
is less than the impairment
loss
Assets previously revalued
and the revaluation reserve
is greater than the
impairment loss
56
Example 6
57
• On 1 January 1991, Fortune Ltd. bought a
building at a cost of $2000000. The building had
a useful life of 20 years and depreciation was
charged on a straight line basis
• Owing to the changes in market condition,
Fortune Ltd. considered that the building might
be impaired. On 31 December 2002, the directors
estimated that the net selling price was $480000
(estimated selling cost of $50000 less selling cost
of $20000) and the value in use of the asset was
$300000
58
Historical cost
Accumulated depreciation as
at December 2002 (2000000*5%*12)
Less: Recoverable amount
(the higher pf the net selling price
of $480000 and the value in use of
$30000)
Impairment loss
$
2000000
120000
800000
480000
320000
59
The Journal
Dr.
$m
Profit and loss
320000
Provision for depreciation
1200000
Buildings (2000000 – 480000)
Cr.
$m
1520000
60
Example 7
61
• On 1 January 1991, Fortune Ltd. bought a building at a
cost of $2000000. The building had a useful life of 20
years and depreciation was charged on a straight line
basis
• On 1 January 2001, caused by the property market boom,
the building was revalued to $2500000 with a remaining
useful life of 10 years
• Owing to the changes in market conditions, Fortune Ltd
considered that the building might be impaired . On 31
December 2002, the directors estimated that the net
selling price was $480000 (estimated selling cost of
$500000 less selling cost of $20000) and the value in use
of the asset was $300000
62
Revalued amount
Accumulated depreciation as
at December 2002 (2500000*2/10)
Less: Recoverable amount
(the higher pf the net selling price
of $480000 and the value in use of
$30000)
Impairment loss
$
2500000
500000
2000000
480000
1520000
63
The Journal
Dr.
$
2001
Jan 1 Building
500000
Provision for depreciation
($2000000*5%*10)
1000000
Revaluation reserve
Being surplus on revaluation transferred
to the revaluation reserve
2001
Dec 31 Profit and loss
250000
Provision for depreciation
($2500000*10%)
Being provision for depreciation
on the revalued amount
Cr.
$
1500000
250000
64
The Journal
Dr.
Cr.
$
$
250000
2002
Dec 31 Profit and loss
Provision for depreciation
($2500000*10%)
Being provision for depreciation
on the revalued amount
2002
Dec 31 Revaluation reserve (1st )
1500000
Profit and loss (then)
20000
Provision for depreciation
500000
Buildings
(2500000-480000)
Being carrying amount written down
to the recoverable amount
250000
2020000
65
Subsequent reversal of an
Recoverable amount
impairment loss
• After the recognition of an impairment loss, the
depreciation should be provided on the revised
carrying amount, less any residual value, over its
remaining useful life
• If the impairment loss recognized in previously
years decreases or on longer exists, the carrying
amount of the asset should be increased to its
recoverable amount. That increase is a reversal of
an impairment loss
• The reversal of impairment loss is restricted to
the amount that will restore the carrying amount
66
as if no impairment loss has been recognized
Example 8
67
• On 1 January 1991, Fortune Ltd. bought a
building at a cost of $2000000. The building had
a useful life of 20 years and depreciation was
charged on a straight line basis
• Owing to the changes in market conditions,
Fortune Ltd. considered that the building might
be impaired. On 31 December 2002, the directors
estimated that the recoverable amount was
$480000.
68
Ans.
• An impairment loss of $320000 was recognized
(I.e. 2000000*8/20 - $480000)
• After recognition of impairment loss, the
depreciation 60000 (I.e. 480000*1/8) should be
provided on the revised carrying amount of
$480000 over its remaining useful life of 8 years
• The carrying amount at 31 December 2003 was
$420000(I.e. $480000*7/8)
69
Ans
• After the recognition of impairment loss,
the depreciation $60000 should be
provided on the revised carrying amount of
$480000 over its remaining useful life of 8
years
70
• Owning to the change of the housing
policy, the directors determined the
recoverable amount at 31 December 2004
has increased to $1700000
71
Ans
• The recovery of carrying amount is shown
$
as follows:
Carrying amount as at 31 Dec 2003 as if no
impairment loss has been recognized
($800000*7/8)
Less: Carrying amount as at 31 Dec 2003
after recognizing the impairment loss
Reversal of impairment loss
700000
420000
280000
200000*8/20
72
Ans.
The Journal
Dr.
Cr.
Buildings
280000
Profit and loss
280000
*The carrying amount of buildings will be shown as $700000
73
• If the enterprise wants to recognize the
market value of the property (I.e.
$1700000) in its balance sheet, the
remainder of the uplift (I.e. $1000000)
would be treated as a revaluation
movement
74
Ans.
The Journal
Dr.
Buildings
1220000
Provision for depreciation (480000*1/8) 60000
Profit and loss (first)
Cr.
280000
*The carrying amount of buildings will be shown as $700000
75
Investments
• Both long-term investments and current
investments should be valued at the lower
of cost and market value
• Investment are recorded at their cost of
acquisition, while permanent decreases in
value may be written off against current
profits. Increases in value are not
recognized until realized
76
Example
• Cost of quoted securities in 1995 $100,000
• Market value of investment in 1996
$95,000
• Market value of investment in 1997
$110,000
77
Ans:
1996 Dr. Profit and loss
$5000
Cr. Provision for Diminution in
value of investment
$5000
1997 Dr.Provision for Diminution in
value of investment
Cr. Profit and loss
$5000
$5000
Balance Sheet as at 31 Dec (extract)
$
1996 Investments
Quoted securities ,at market value (cost$100000) 95000
1997 Investments
Quoted securities ,at cost (mkt. value$110000) 100000
78