Chapter 10
Acquisition of Property, Plant,
and Equipment
Prepared by:
Dragan Stojanovic, CA
Rotman School of Management, University of Toronto
Acquisition of Property, Plant,
and Equipment
Recognition and
Cost Elements
•Property, plant,
and equipment
assets
•Recognition
principle
•Asset components
•Cost elements
•Self-constructed
assets
•Borrowing costs
•Dismantling and
restoration costs
Measurement of
Cost
•Cash discounts
•Deferred payment
terms
•Lump sum
purchase
•Non-monetary
exchanges
•Contributed assets
and government
grants
•Specific assets
Measurement after
Acquisition
•Cost model
•Revaluation
model
•Fair value model
•Costs incurred
after acquisition
IFRS / Private
Entity GAAP
Comparison
•Comparison of
IFRS and
private entity
GAAP
•Looking ahead
2
Acquisition of Property, Plant,
and Equipment
Recognition and
Cost Elements
•Property, plant,
and equipment
assets
•Recognition
principle
•Asset components
•Cost elements
•Self-constructed
assets
•Borrowing costs
•Dismantling and
restoration costs
Measurement of
Cost
•Cash discounts
•Deferred payment
terms
•Lump sum
purchase
•Non-monetary
exchanges
•Contributed assets
and government
grants
•Specific assets
Measurement after
Acquisition
•Cost model
•Revaluation
model
•Fair value model
•Costs incurred
after acquisition
IFRS / Private
Entity GAAP
Comparison
•Comparison of
IFRS and
private entity
GAAP
•Looking ahead
3
Property, Plant, and Equipment
•
•
•
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
Acquisition Cost
• Historical cost is the basis for determining cost
• Historical cost is:
• the asset’s 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 asset’s cost, if they increase
future service potential, or
• expensed, if they do not add to the asset’s
original service potential
5
Asset Components
• 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
asset’s 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
Cost Elements
• 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 asset’s
eventual disposal (e.g. site restoration)
• IFRS and private entity GAAP share the above
approach, but sometimes differ in specific
application
7
Self-Constructed Assets
• 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
Borrowing Costs
•
•
•
Under IFRS, borrowing costs that are incurred during
acquisition, construction or production of qualifying
assets must be capitalized as part of the asset’s cost
Private entity GAAP allows a choice of capitalizing or
expensing such interest costs
Most common approach is explained in Appendix 10A
9
Dismantling and Restoration
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
Acquisition of Property, Plant,
and Equipment
Recognition and
Cost Elements
•Property, plant,
and equipment
assets
•Recognition
principle
•Asset components
•Cost elements
•Self-constructed
assets
•Borrowing costs
•Dismantling and
restoration costs
Measurement of
Cost
•Cash discounts
•Deferred payment
terms
•Lump sum
purchase
•Non-monetary
exchanges
•Contributed assets
and government
grants
•Specific assets
Measurement after
Acquisition
•Cost model
•Revaluation
model
•Fair value model
•Costs incurred
after acquisition
IFRS / Private
Entity GAAP
Comparison
•Comparison of
IFRS and
private entity
GAAP
•Looking ahead
11
Cash Discounts
• 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
Deferred Payment Terms
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
Deferred Payment Contracts
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
Deferred Payment Contracts
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
Lump-Sum Purchases
• 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
Lump Sum Purchase
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%
$80,000
Total
i.e.
$80,000
x .25
17
Non-Monetary Exchanges
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
Non-Monetary Exchanges
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
Exchange of Non-monetary
Assets
• 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
Exchange of Non-monetary
Assets
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
Monetary Exchange of Assets
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
Record the purchase in IPI’s books:
Equipment (new)
13,000
Accumulated Depreciation (old) 4,000
Loss on Disposal
2,000
Equipment (old)
Cash
12,000
7,000
22
Non-monetary Exchange with
Commercial Substance
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:
Record purchase in Cathay’s books:
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
Non-monetary Exchange – No
Commercial Substance
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
Record transaction on Westco books:
Building (new)
Accumulated Depreciation (old)
Building (old)
Cash
450,000
100,000
520,000
30,000 24
Contribution of Assets
•
Referred to as non-reciprocal transfers: transfer of
assets where nothing is given up in exchange
(e.g., donations, gift, government grants)
•
Asset’s 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)
Specific Assets: 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
Land Improvements
• Permanent improvements to the land such as
landscaping are added to the Land account
• Improvements with limited lives (such as
driveways, 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
Specific Assets: 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
Specific Assets: 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
Specific Assets: 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
Specific Assets: 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
Specific Assets: Natural Resource
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
Specific Assets: Biological Assets
•
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
Acquisition of Property, Plant,
and Equipment
Recognition and
Cost Elements
•Property, plant,
and equipment
assets
•Recognition
principle
•Asset components
•Cost elements
•Self-constructed
assets
•Borrowing costs
•Dismantling and
restoration costs
Measurement of
Cost
•Cash discounts
•Deferred payment
terms
•Lump sum
purchase
•Non-monetary
exchanges
•Contributed assets
and government
grants
•Specific assets
Measurement after
Acquisition
•Cost model
•Revaluation
model
•Fair value model
•Costs incurred
after acquisition
IFRS / Private
Entity GAAP
Comparison
•Comparison of
IFRS and
private entity
GAAP
•Looking ahead
34
Measurement after Acquisition
•
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
Revaluation Model
•
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
Revaluation Model
•
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
Revaluation Model: Example –
Convo 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
Revaluation Model: Example –
Convo Corp
Revaluation entries at December 31, 2012
Depreciation for 2010-2012
(100,000–0)/25yrs = 4,000/yr
X 3 years = 12,000
Building
Before
After
Revaluation
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
Accumulated Depreciation
Building
12,000
Building (90,000 – 88,000)
Revaluation Surplus (OCI)
2,000
12,000
2,000
39
Revaluation Model: Example –
Convo Corp
Revaluation entries at December 31, 2015
Depreciation for 2013-2015
(90,000 – 0) / 22yrs = 4,091/yr Before
X 3 years = 12,273
Building
After
Revaluation
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
Accumulated Depreciation
Building
12,273
Revaluation Surplus (OCI)
Revaluation Loss (to income)
Building
2,000
727
12,273
2,727
40
Fair Value Model
•
•
•
•
•
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 asset’s life
Note that fair value must be disclosed in
financial statements, even if cost model is
chosen instead of fair value model
41
Fair Value Model: 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
Fair Value Model: Example
February 2, 2011 (acquisition)
Investment Property – Mall
1,043,000
Maintenance Expense
2,000
Mortgage Payable
730,000
Tenant Deposits Liability
37,000
Cash
278,000
43
Fair Value Model: Example
December 31, 2011
Loss in Value of Inv. Property
Investment Property – Mall
(1,043,000 – 1,040,000)
3,000
3,000
December 31, 2012
Loss in Value of Inv. Property
12,000
Investment Property – Mall
12,000
(1,040,000 – 1,028,000)
December 31, 2013
Investment Property – Mall
Gain in Value of Inv. Property
(1,040,000 – 1,028,000)y
72,000
72,000
44
Costs Subsequent to Acquisition
•
•
•
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, Major Overhauls,
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 asset’s 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 asset’s carrying value
46
Rearrangement and Reinstallation
•
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
Acquisition of Property, Plant,
and Equipment
Recognition and
Cost Elements
•Property, plant,
and equipment
assets
•Recognition
principle
•Asset components
•Cost elements
•Self-constructed
assets
•Borrowing costs
•Dismantling and
restoration costs
Measurement of
Cost
•Cash discounts
•Deferred payment
terms
•Lump sum
purchase
•Non-monetary
exchanges
•Contributed assets
and government
grants
•Specific assets
Measurement after
Acquisition
•Cost model
•Revaluation
model
•Fair value model
•Costs incurred
after acquisition
IFRS / Private
Entity GAAP
Comparison
•Comparison of
IFRS and
private entity
GAAP
•Looking ahead
49
Looking Ahead
• 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