Lesson 9: Property, Plant, and Equipment Flashcards
What is Property, Plant, and Equipment (PPE)?
-tangible assets for use in business operations to earn revenue
-not intended for resale
-kept and used by the business for MORE THAN 1 ACCOUNTING PERIOD
-non-current assets
What are the common types of PPE?
-Property (land and/or buildings)
-Fixtures and fittings (chairs, cabinets, electrical wiring, etc.)
-Equipment (computers, fax machines, photocopiers, etc)
-Motor vehicles (motor van, cars, etc)
EXCEPT for freehold land, which is NON-DEPRECIABLE,
all PPE have LIMITED USEFUL LIVES and are DEPRECIABLE
What are Capital Expenditures?
-costs to acquire assets that will benefit the business in the current and future years (Eg. Purchase of PPE)
-charged to an ASSET account, subsequently allocated as an expense to the years it benefits
-includes major improvements and additions to PPE when they:
-increase the capacity of the asset
-improves the quality of services or efficiency
-extends its useful life
What are Revenue Expenditures?
-costs to acquire assets and services that will be used up in a particular year (Eg. rent, repairs, salaries, cost of inventories sold)
-charged to an EXPENSE account and MATCHED AGAINST THE REVENUE EARNED for the year it benefits
-Includes ordinary repairs - expenditures incurred to MAINTAIN PPE in good working condition or to return to its prior condition (Eg. repainting of buildings, repairs and maintenance of buildings/machines/vehicles)
What is the Materiality Concept?
Transactions that have little effect on financial statements may be treated in the most expedient manner
What does the cost of an item of PPE include?
-Purchase price (including any import duties and non-refundable taxes) LESS any trade discount and rebates
-Initial delivery and handling costs
It also includes any costs directly attributable to bringing the asset to the location and condition necessary for it to be capable of operating in the manner intended by management
such as:
- Costs of site preparation
- Installation and assembly costs
- Costs of testing (eg. test runs, etc)
- Professional fees (engineer, architect, lawyer fees )
What is Depreciation of PPE?
Depreciation is the systemic allocation of the cost of PPE over its useful life
Note:
PPE are NON-CURRENT ASSETS when acquired as they will benefit the business in current and future years
Note:
a portion of the cost of the PPE must be allocated as DEPRECIATION EXPENSE to every year it benefits to ensure accurate matching of expenses against revenue generated by the use of PPE
What are the factors to consider in the measurement of depreciation?
-Cost of the asset
-Expected Residual Value (Scrap value or salvage value)
-Useful life of the asset
What are the causes of Depreciation?
-Wear and Tear
-Physical Deterioration
-Obsolescence
What is Overhaul?
examination of a machinery or system, with repairs or changes made if necessary
Note:
for second hand non-current assets, expenditure incurred to repair or OVERHAUL the asset to put them in working condition should be TREATED AS PART OF COST OF THE ASSET
This will be considered a CAPITAL EXPENDITURE necessary to bring the motor vehicle to the condition necessary for it to be CAPABLE OF OPERATING AS INTENDED
What is Residual value?
Residual value 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.
Note:
The total amount of depreciation to be charged over an asset’s useful life is the cost of the asset LESS its residual value
What is the Useful Life of the asset?
This is the estimated period of time that the asset is expected to be used in carrying out the business activities
What are the the 2 main Depreciation methods?
- Straight line
- Reducing (Diminishing) Balance
What is the Straight line method?
With the straight line method, each accounting period is allocated a UNIFORM AMOUNT OF THE DEPRECIABLE VALUE (cost of PPE less any residual value).
This method assumes that depreciation is a uniformed function of time.
This method is suitable when the PPE provides equal benefits over its useful life
How do you calculate Depreciation per period?
Depreciation per period = Depreciable value x Rate of Depreciation
OR
Depreciation per period = (Cost - Estimated residual value)/ Estimated useful life
How do you find the uniform amount of the depreciable value?
Cost of PPE less any residual value
What is Net Book Value (NBV)?
NBV or carrying amount of the asset is cost less accumulated depreciation
What is the Reducing (diminishing) Balance Method?
Each accounting period is allocated a UNIFORMED RATE OF NBV.
As the rate remains constant while the book value declines, ANNUAL DEPRECIATION IS LESS EACH YEAR.
This method is suitable when the PPE provides GREATER BENEFITS IN THE EARLY YEARS OF ITS USEFUL LIFE THAN IN THE LATER YEARS.
Note:
IAS 16 requires that the depreciation method chosen to reflect the PATTERN OF CONSUMPTION OF THE ECONOMIC BENEFITS embodied in the asset. (ie. match the usage pattern)
How do you choose the method of depreciation?
For PPE with a reasonably constant pattern of consumption, the allocation basis should be done using the STRAIGHT-LINE method.
Assets that generate more revenue earlier in their useful lives and less in later years should use the REDUCING BALANCE method.
Note:
methods once selected should be applied consistently throughout its useful life UNLESS CHANGES IN CIRCUMSTANCES MAKE IT NO LONGER APPLICABLE
This is to comply with the Consistency Concept
What is the Consistency Concept?
The same accounting methods should be applied by a firm FROM PERIOD TO PERIOD. This is to ensure that the financial statements of different periods are COMPARABLE
When would an asset be impaired?
An asset is impaired when its carrying amount is greater than its recoverable amount
What is Recoverable amount?
Recoverable amount is the higher of FAIR VALUE less cost to sell and VALUE-IN-USE
How is the fair value of PPE determined?
The fair value of PPE is determined from market based evidence by professional appraisal or valuation
Why is depreciation a non-cash expense?
Depreciation is a non-cash expense as it does not result in an outflow of cash from the
business.
The outflow of cash occurs when the PPE was first bought.
As PPE is used by the business to earn revenue over several accounting period ( useful life), depreciation is the systematic allocation of the cost of PPE over its useful life.
The cost of using the PPE should be matched with the revenue it helped earn.
This is in line with the Matching Concept in
accounting which states that for profit determination, all cost incurred to earn a revenue must
be matched with the revenue it helped earned.
