Chapter 6 Accounting for Property,
Plant, and Equipment(PPE)
Corresponding to chapters 10&11
of the supplementary textbook
1
Ordinary course of business: Merchandising
PPE (Ch. 6)
Collect cash
Cash
Purchase
Accounts
receivable
Sales
on credit
Cash
sales
Merchandises
Inventories
Intangible assets (Ch. 7)
2
Examples of PPE
Land
Samsung
Electronics
Buildings and structures
Machinery
Construction in progress
Others
Land
Buildings
NAVER
Building structures
Machinery
Vehicles
Equipment
Construction in progress
Others
Land and buildings
Apple
Machinery, equipment and internal-use software
Leasehold improvements
3
Vary across
firms
PPE
Identify PPE at a cafe

Property, Plant and Equipment

Definition: Tangible assets that are held for use in operations (such as,
production or supply of goods and services, and administrative purposes)
and that are expected to be used more than one year.

4
Characteristics:

Possess physical substance

Acquired for use in operations and not for sale

Long-term in nature and usually depreciated
Lifecycle of PPE
Acquisition cost
$110 MN
How much does the company actually
spend to use the building for 50 years?
$100 MN
Residual value
$10 MN
Recognize as expense over 50 years
∙∙∙
Acquisition
of building
PPE
Use 50 years
Sold for $10 MN
Useful life
Expense Expense Expense Expense
…
Expense
$110 MN
Depreciation Expense
Recover $10 MN
What type of PPE?
Acquisition cost?
How much is depreciation
expense for each year?
Gain or loss on
disposal of PPE
5
Determine Acquisition costs
$110 MN
$10 MN
∙∙∙
Acquisition
of building
What type of PPE?
Acquisition cost?
6
Use 50 years
Sold for $10 MN
 What PPE? Land, Building, Machinery, Equipment, etc.?
 Principle
 All expenditures incurred to acquire PPE and make it ready
for its intended use
 Examples of costs included in the acquisition cost:
 Purchase price (deduct discount or rebate)
 Costs directly related to purchase: freight, closing costs
Determine Acquisition costs
Land


Purchase price

Closing costs: title to the land, professional fees, recording fees

Costs incurred in getting the land ready for its intended use: grading clearing

Land improvements that have an indefinite life

Land improvements that have a definite life: not Land but Land Improvement
Example


A company purchases land with an old building on it in order to build a new
building
7

Should the cost to tear down the old building be included in Land or Building?

What about selling price of the old building scrap?
Determine Acquisition costs
Should the following expenditures be capitalized?

8

Assembling and installation costs for a new machine
○

Cost to promote a new product

Cost to repair a machine after being used

Legal cost to register a newly purchased land

Salary of an employee who was hired to acquire a specific asset

Salary of an employee of the purchase department

Fire insurance for the factory after it started its operation

Custom duty to import machinery
Ⅹ
○
Ⅹ
○
Ⅹ
Ⅹ
○
Borrowing costs during construction
20x1.1.1
20x1.12.31
20x2.12.31
Beginning of
construction
Borrow
$100,000
20x3.12.31
Completion of
construction
Pay
$30,000
Pay
$30,000
Pay
$40,000
The company pays interest of 10% at the end of each year
Should the company include interest in the acquisition cost?
 Capitalize the actual borrowing costs incurred during construction
Qualifying assets: assets that require a substantial period of time to complete
Capitalization period: as long as the following three conditions are present
 Expenditures for the asset are being incurred
 Construction is in progress
 Borrowing cost is being incurred




9
Other issues related to acquisition costs

Deferred-payment contracts
 Purchase a car on long-term credit contracts


20x1.1.1
20x1.12.31
20x2.12.31
20x3.12.31
Buy a car
Pay $10,000
Pay $10,000
Pay $10,000
Use present value of future cash flows as the acquisition cost
Lump-sum purchases
 Purchase a group of assets at a single lump-sum price
 Allocate the total costs among the assets on the basis of their relative fair value
 Purchase land and building and pay cash of $80,000
 Fair value of land $60,000; fair value of building $40,000
 Allocation of the costs:

10
Fair value
Relative ratio
Cost allocation
Land
$60,000
60%
$80,000x60%= $48,000
Building
$40,000
40%
$80,000x40%= $32,000
Total
$100,000
The entry to record the transaction?
$80,000
Acquisition through exchange of non-cash assets

Exchanges of Non-cash assets
Give land
Company



Receive building
Another
company
What is the acquisition cost of the building?
Should the company recognize gain or loss on the disposal of land?
When the exchange has commercial substance
 Commercial substance: future cash flows change as a result of the exchange
 Acquisition cost of building: at fair value of land or fair value of building,
whichever is clearly more evident
 Example: book value and fair value of land are $80,000 and $70,000 and fair
value of building is $90,000. Fair value of land is clearly more evident
 Acquisition cost of building: $70,000
 Recognize loss of $10,000 ($70,000-$80,000) on the disposal of land
Building
70,000
Loss on disposal of land
10,000
Land
80,000
11
Acquisition through exchange of non-cash assets

Exchanges of Non-cash assets
Give truck A
Company


Receive truck B
Another
company
Determine whether the exchange has or lacks commercial substance
If the exchange lacks commercial substance
 Recognize no gain or loss on the exchange
 Book value of the truck A: $8,000
 Regardless of fair values of the old truck and new truck, recognizes the new truck
at the book value of the old truck ($8,000)
 Recognize no gain or loss on the disposal of the old truck
Vehicle(new truck)
Vehicle(old truck)
12
8,000
8,000
Depreciation
13
Depreciation
Acquisition cost
$110 MN
Actual payment to use
building over 50 years
$100 MN
Residual value
$10 MN
Recognize as expense over 50 years
∙∙∙
Acquisition
of building
PPE
$110 MN
Use 50 years
Expense Expense Expense Expense
Depreciation Expense
How much is depreciation
expense for each year?
14
Sold for $10 MN
…
Expense
Recover $10 MN
Depreciation of PPE with indefinite life: Don’t!
$100 BN
Acquire land
∙∙∙
Useful life?

How long does the land last? Can you determine the useful life of the land?

How much of the land is consumed each year?

If the useful life of PPE is indefinite, do not depreciate
15
Factors involved in depreciation process
Acquisition cost
$110 MN
Residual value
$10 MN
∙∙∙
Acquire building
Use 50 years
Sold for $10 MN
① Depreciable base: Total amount to be recognized as depreciation expenses over
useful life
 Acquisition cost minus residual value (salvage value)
② Useful life: may be different from physical life ⇒ Estimated service life
 If a company has a policy to replace computers every 5 years?
③ Method of depreciation: determine deprecation expense of each year
 Reflect the pattern in which economic benefits of the asset are to be consumed
⇒ Companies must re-estimate residual value, useful life, and depreciation method at
the end each fiscal year
16
Korea Air PPE footnote disclosure
Depreciation component
Building and Structures
40 years
Machinery
8-15 years
Aircraft
Leased aircraft
Airframe
6-15 years
Major overhaul
3.6-12 years
Engine
Leased engine
Engine
Major overhaul
Two components
15 years
3.3-8.8 years
Aircraft materials
15 years
Vehicle
6 years
Other PPE, Other leased assets
6 years
Lease improvements
17
Component
useful life
6.8-11 years
Two components
Methods of depreciation

Depreciation methods

Activity method (Units-of-use or production method)


Straight-line method



Depreciate based on use or productivity
Depreciate the same amount each year
Diminishing-charge methods: annual depreciation expense declines as time
passes

Sum-of-the-years’-digits

Declining-balance method (constant rate method)
Information for illustration: a crane was purchased on January 1, 20x1

Acquisition cost of crane: $500,000

Estimated useful life: 5 years

Estimated residual value: $50,000

Productive life in hours: 30,000 hours
18
Activity method

How to compute annual depreciation expense?
(Cost-Residual value)ⅹ
Hours used each year
Total estimated hours

Hours used each year: first year 3,000 hours, second year 6,000 hours

Depreciation expense in the first year:

How much was the crane used in the first year? 3,000/30,000=10%

Depreciation expense=($500,000-$50,000)x3,000/30,000=$45,000

Journal entry:
Equipment
Depreciation expense

500,000 Cash
45,000 Accumulated depreciation
Presentation in the statement of financial position
$500,000
Statement Equipment
of financial Accumulated depreciation
position
Carrying amount

Depreciation expense for the second year?

19
500,000
($500,000-$50,000)x(6,000/30,000)=$90,000
(45,000)
$455,000
45,000
Straight-line method

(Cost-Residual value)
How to compute annual depreciation expense?
Estimated service life

Annual depreciation expense:


($500,000-$50,000)/5 years=$90,000
Presentation in the statement of financial position
Year
Depreciation
expense
Jan. 1, 20x1
20
Accumulated
depreciation
Carrying amount
(Book value)
$0
$500,000
Dec. 31, 20x1
$90,000
$90,000
410,000
Dec. 31, 20x2
90,000
180,000
320,000
Dec. 31, 20x3
90,000
270,000
230,000
Dec. 31, 20x4
90,000
360,000
140,000
Dec. 31, 20x5
90,000
450,000
50,000
Total
$450,000
Residual value
Sum-of-the-years’-digits method

How to compute annual depreciation expense?
(Cost-Residual value)ⅹ
Remaining life
Sum of the years
1+2+3+4+5=15

Depreciation expense in the 1st year=$500,000-$50,000)x(5/15)=$150,000

Depreciation expense in the 2nd year=$500,000-$50,000)x(4/15)=$120,000

Depreciation expense in the 3rd year=$500,000-$50,000)x(3/15)=$90,000

Depreciation expense in the 4th year=$500,000-$50,000)x(2/15)=$60,000

Depreciation expense in the 5th year=$500,000-$50,000)x(1/15)=$30,000
Year
Dep. expense
Acc. depreciation
Jan. 1, 20x1
21
Carrying amount
$500,000
Dec. 31, 20x1
$150,000
$150,000
350,000
Dec. 31, 20x2
120,000
270,000
230,000
Dec. 31, 20x3
90,000
360,000
140,000
Dec. 31, 20x4
60,000
420,000
80,000
Dec. 31, 20x5
30,000
450,000
50,000
Residual
value
Constant rate method

How to compute annual depreciation expense?
Beginning carrying amount ⅹ Depreciation rate


How to determine the constant depreciation rate?

Double-declining-balance method: twice the straight-line rate{(1/5)x2=40%}

Fixed-rate-method:
residual value 1/useful life
1-( acquisition cost )
Annual depreciation expenses under the double-declining-balance method
Year
Dep. expense
Acc. Dep.
Jan. 1, 20x1
22
Carrying
amount
$500,000
Dec. 31, 20x1
$500,000x40%=$200,000
$200,000
300,000
Dec. 31, 20x2
$300,000x40%=$120,000
320,000
180,000
Dec. 31, 20x3
$180,000x40%=$72,000
392,000
108,000
Dec. 31, 20x4
$108,000x40%=$43,200
435,200
64,800
Dec. 31, 20x5
$14,800
450,000
50,000
Partial periods
$110 MN
9 months
20x1.4.1
12 months
20x1.12.31
20x2.12.31
Depreciation expense:
$10 mn/5x(9/12)=$1.5 mn
Depreciation expense:
$10 mn/5x(12/12)=$2 mn
Acquire machinery
Useful life 5 years
Residual value $10 mn
Straight-line method
Machinery 110
Cash
110
Dep Exp.
1.5
Acc. Dep.
23
1.5
Dep Exp.
2
Acc. Dep.
2
Change in estimated service life and salvage value
$110 MN
Machinery(Cost)
110
Acc. Dep.
(60)
Carrying amount
50
New estimated service years: 4 yrs.
20x1.1.1
20x3.12.31 20x4.12.31 20x5.12.31
Acquire machinery
Useful life 5 years
Residual value $10 mn
Straight-line method
Changes in estimates:
Remaining life: 4 yrs.(Incl. 20x4)
Salvage value: $0
Account for as if a new machine with
service life of 4 years and salvage
value of $0 at the beg. of 20x4
New annual depreciation expense:
($50-$0)/4 yrs.=$12.5
24
20x7.12.31
Impairment-Cost model


25
An asset is impaired when the carrying amount of the asset can not be
recovered either through using it or selling it.
That is, when the carrying amount of an asset is higher than either valuein-use or net fair value (fair value less selling expense)
Impairment – Cost model
After
depreciation
Are impairment
indicators present?
No
Yes
Impairment test:
Compare Carrying
amount (CA) to
Recoverable amount (RA)
Recoverable amount:
Higher of Net Fair Value
or Value-in-use
Is Carrying amount
higher than Recoverable
amount?
YES: CA > RA
Recognize difference between
CA and RA as a loss
after recognizing a loss on
impairment, always
CA = RA
26
NO: CA < RA
Do nothing
Illustration of Impairment loss







At Dec. 31, 20x1, Hanoi has equipment with a cost of $26,000, and accumulated
depreciation of $12,000, after the current year’s depreciation has been recorded.
The equipment has a total useful life of 4 years with a residual value of $2,000.
Hanoi uses the straight-line method for depreciation.
What is annual depreciation expense? ($26,000-$2,000)/4=$6,000
How many years have passed since the equipment was acquired? 2 years
What is the carrying amount of the equipment at Dec. 31, 20x1?
$26,000-$12,000=$14,000
If the recoverable amount for the equipment at Dec. 31, 20x1 is $11,000, is the
equipment impaired?
What is a loss on impairment? $14,000-$11,000=$3,000
Journal entry for impairment:
Loss on Impairment
3,000
Accumulated Impairment loss-Equip. 3,000
⇒ Carrying Amount :
after impairment
at Dec. 31, 20x1

Equipment (cost)
Accumulated depreciation
Accumulated impairment loss
Carrying amount
Depreciation for 20x2: ($11,000-$2,000)/2=$4,500
27
$26,000
(12,000)
(3,000)
Recoverable
$11,000
amount
Reversal Impairment loss
Dec. 31, 20x1
Equipment(Cost)
26,000
Acc. Depreciation
(12,000)
Accumulated impairment loss (3,000)
Carrying amount
11,000



Dec. 31, 20x2
Depreciation
Equipment(Cost)
26,000
26,000
after
Acc. depreciation
(16,500)
(16,500)
recovery
Acc. Impairment loss (3,000)
(2,500)
Carrying amount
6,500
7,000
At Dec. 31, 20x2, Hanoi has determined that the recoverable amount of the
equipment is $7,000.
If recoverable amount is higher than carrying amount, reverse impairment up to
the limit
Limit of the recovery: the carrying amount that would result if the impairment
loss had not been recognized
Equipment(Cost)
26,000
Acc. depreciation ($6,000x3 years)
Carrying amount


4,500
(18,000)
8,000
Recovery of Impairment loss: $7,000-$6,500=$500
Journal entry:
Accumulated impairment loss-Equip. 500
Recovery of Impairment Loss
28
500
Revaluation
29
Does the cost model reflect value of PPE?
$290 MN
$250 MN
Acquire land
$200 MN
$180 MN
20x1.1.1 …
20x3.12.31
…
20x5.12.31
…
30
carrying amount
under the cost
model
20x7.12.31 … 20x9.12.31
Which model better reflects value of the land?
Which model is better?
Revaluation
model
Revaluation

K-IFRS: allow both models

Cost model



Acquisition cost: fair value of the asset plus directly related expenditures

Subsequent to acquisition: Cost less Accumulated depreciation (cost model)

No revaluation
Revaluation model

Acquisition cost: fair value of the asset plus directly related expenditures

Subsequent to acquisition: Cost less Accumulated depreciation (cost model)

Then, revaluate to fair value
Revaluate by class of assets: within the class, all or nothing
① land ② land and building ③ machinery ④ equipment ⑤ aircraft ⑥ vehicle, etc.

Revaluation period

Keep the asset’s value up to date

If price rapidly fluctuates, annual revaluation

If price changes are not rapid, revaluate less frequently
31
Revaluation surplus
Any changes above the cost:
recognize as OCI
Acquire land
$200 MN
Cost
Any changes below the cost:
recognize as PL(net income)
20x1.1.1 …
20x3.12.31 …
20x5.12.31
…
20x7.12.31 … 20x9.12.31
Comprehensive Income
Statement
Any changes Below the cost
Net Income(profit or loss)
Any changes above the cost
Other Comprehensive Income
Comprehensive Income
32
Illustration of Revaluation of Land
$290 MN
$250 MN
50
up
Acquire land
$200 MN
70
down
50↓
20↓
110 90↑
up
20↑
Cost
$180 MN
20x1.1.1 …
Land
Cash
200
200
20x3.12.31 …
20x5.12.31
20x7.12.31 … 20x9.12.31
Unrealized gain(OCI)
50
Loss on impairment(PL) 20
Land
70
Land
50
Unrealized gain(OCI) 50
33
…
Land
110
Recovery of loss(PL)
20
Unrealized gain(OCI) 90
Homework Assignment
-
Assignment: Ch 6 Assignment (posted in 강의자료실)
-
Submit to eclass 과제 및 평가
-
File name: Ch6_last name
-
Submission date:
34