Chapter 7

PPE and Intangibles

 Learning Objectives
• Understand the different types of long-term assets
• Determine the cost of PPE on Initial Recognition
• Understand when to capitalize or expense subsequent
costs
• Measure and record depreciation
• Understand the recognition and subsequent
measurement of intangible assets
• Evaluate a company's performance based on its assets
 Property Plant & Equipment(PPE)
• Called fixed assets, are long term, non-current or long lived assets
that are tangible.
• Expected to be used during more than one period.
• Primary source of guidance for accounting for PPE is IAS 16.
• For instance: land, buildings, equipment etc…
• Used for
– Production or supply of goods or services
– Rental to others
– Administrative purposes
Top 10 PPE Categories
 Intangible assets
• They are identifiable non-monetary assets without physical substance.
• Non monetary simply refers to that asset not expressed in fixed or
determinable amount of money.
Includes:
a) Goodwill
b) Capitalized development cost
c) Trade marks & trade names
d) Patent & technology
e) Other intangible assets

Accounting for intangibles is similar to accounting for PPE.

 Other non-current asset
a) Construction in Progress.
b) Investment property
c) Lease Asset with corresponding lease liability.
 Recognition of PPE & Intangible
assets
These are recognized in the financial statements
using the same way as other assets, when:
(1)It is probable that future economic benefits
associated with the item will flow to the
entity.
(2)The cost of the item can be measured reliably.
 Measurement of PPE on Initial
Recognition
• The cost of any asset is the sum of all the costs
incurred to bring the asset to its intended use.
• The cost of an item of PPE includes:
a) Purchase price including import duties, non
refundable purchase taxes, after deducting the trade
discounts & rebates.
b) Any costs directly attributable to bringing the asset
to the location * condition necessary for it to be
capable of operating in the manner intended by
management.
 When to capitalize or expense subsequent
costs
• IAS 16 states that an entity should not recognize the
costs of the day-to-day servicing in the carrying
amount of an item in the PPE. Such costs are charged
to income statement.
• Expenditure that increase the asset’s capacity or
extend its useful life are called capital expenditure.
• These are the costs which is added to the asset
account & not expensed immediately.
Capital expenditure…
 Measure & record Depreciation

Carrying amount Accumulated

=
of an item PPE - Cost
depreciation

Depreciation is the systematic allocation of the

cost of a long-term asset over its useful life.
Allocating cost of Assets Over Useful Life
 How to allocate Depreciation
3 things are important about the asset:
a) Cost
b) Estimated Useful Life
c) Estimated Residual Value

Factors to be considered for Estimated Asset’s Useful Life

d) Expected usage of the asset.
e) Expected physical wear & tear.
f) Technical & commercial obsolescence
g) Legal or similar limits on the use of the asset.
 Depreciation Methods
a) Straight-line (constant allocation)
b) Unit-of-production(by actual usage)
c) Double-declining-balance(accelerated
allocation)
As an asset is used in operations:
 The accumulated depreciation increases.
 The carrying amount of the asset decreases.
 Straight line Method
Under this method, an equal amount of depreciation
is assigned to each year of asset use.

Straight line Depreciation per year

= Cost – Residual value
Useful life in years
Assuming the cost of the asset $41000, residual value
$1000 & the useful life is 5 years.
Therefore (41000-1000)/5 = 8000
Straight line Depreciation Schedule
 Units-of-production Method
a) Under this method, a fixed amount of depreciation is
assigned to each unit of output or service produced by
the asset.
b) Depreciable cost is divided by the useful life-in units of
production-to determine this amount.
c) This per unit depreciation expense is multiplied by the
number of units produced each period to compute
depreciation.

Units of production
= of
depreciation per unit Cost – Residual Value
product Useful life in units of production
 Illustration
Cost of the machinery = $41,000
Residual value = $1000
Total units of production = 100,000 units
Current year production = 20,000 units
Depreciation per unit = (41000-1000)/100000
= 0.40 per unit
Depreciation for the year = 0.40 * 20,000 units
= $8000
Units of Production Depreciation
Schedule
Double-Declining-Balance Method
• This method is also referred as Accelerated depreciation Method writes off
a larger amount of the asset’s cost near the start of its useful life than the
straight line method costs.
• First, compute straight line depreciation rate per year. A 5 year truck has a
straight line depreciation rate of 1/5 or 20%.
• Second, multiply the straight line rate by 2 to compute the DDB rate.
Double-Declining – Balance
Depreciation Schedule
DDB differs from other methods in 3 ways:

Depreciation is not constant, it’s expenses in the early

years are significantly more than in later years

Residual Value is ignored initially, first year

depreciation is computed on the asset’s full cost.

Depreciation expense in the final year is the “plug”

amount needed to reduce the asset’s book value to the
residual amount.
 Choosing a Depreciation Method
• The choice of depreciation method will impact the profit of
any entity.
• IAS 16 requires that the depreciation method chosen ought to
reflect the pattern of consumption of the economic benefits
embodied in the asset.
• At every financial year-end, an entity should review the
depreciation method unless there is a significant change in the
pattern of consumption, it should continue to apply the method
consistently from period to period.
 Continued…
• For PPE assets with a reasonably constant
pattern of consumption - Straight- line method.
• For those PPE that wear out because of
physical use rather than obsolescence -Units-of-production
• For PPE that generate more revenue earlier in their useful lives
& less at later - Accelerated method
Other issues in Accounting for PPE
a) Choice of depreciation method
- Different depreciation method may be used for financial
reporting versus tax reporting.
b) Depreciation for partial years
c) The estimates of useful life and residual value
d) Alternative models for measurement of PPE
subsequent to initial recognition
e) Companies that have gain or losses when they sell
PPE.
 Depreciation for tax purposes
• Companies usually use straight line method of
depreciation for reporting to their
shareholders.
• Tax regulations could provide alternative
depreciation methods or schedules that are
more favorable than what is being used for
financial reporting.
 Cash Flow advantage of Accelerated
Depreciation over Straight line
Depreciation for Income Tax Purposes
 Depreciation for Partial Years
Companies purchase the assets whenever they need, not
just at the beginning of the year. Therefore companies
must compute depreciation for partial years .
Entity can compute the partial depreciation through:
a) First, compute depreciation for full year.
b) Second, multiply full year depreciation by the
fraction of the year that the asset is held.
 Changes in estimates of Useful lives or
Residual Values
• Changes in estimates are accounted
prospectively which means “from now on”
• The change to a shorter useful life increased
the depreciation for the year is an accounting
estimates.
• Change in estimates may also occur for
residual values & are accounted for similarly.
 Illustration
• Using straight line method, the company would record $5000
depreciation each year ($50,000/10)
• Suppose the asset is being used for 4 years, the accumulated
depreciation reached $20,000, the balance would be
$30,000(50,000-20,000).
• Based on the assets condition, management will believe that
the asset will remain useful for 8 more years.

Asset’s remaining (New) Estimated

(New) Annual
depreciable book useful life
depreciation
value remaining
$3750
$30,000 8 years
 Impairment of PPE
IAS 36- Impairment of Assets provides guidance on this matter.
An asset is impaired when its carrying amount is higher than its
recoverable amount.
Recoverable amount is higher of fair value less cost to sell &
value-in-use.
Suppose that when the carrying amount of the factory was $700
m, the fair value less cost to sell was $300 m and the value-in-
use was $100m.
The impairment loss of $400 ($700-$300)
 Using fully Depreciated Assets
• A fully depreciated asset is one that has
reached the end of its estimated useful life.
• The equipment’s book value is zero, but that
doesn’t mean the equipment is worthless.
Accounting for Natural Resources
• Natural resources are PPE of a special type, such as
iron ore, petroleum (oil) & timber. As PPE are
expensed through depreciation, natural resources
assets are expensed through depletion.
• Depletion expense is that portion of the cost of a
natural resources that is used up in a particular period.
• Depletion expense is computed in the same way as
units-of-production depreciation.
 Understand the recognition & subsequent
measurement of Intangible assets
• Intangible assets are identifiable, long – lived assets without physical
substance. They are valuable because they carry special rights from
patents, copyrights, trademarks, franchises, leaseholds & goodwill.

• Intangibles assets fall into two categories:

 Intangibles with finite lives that can be measured reliably
We record amortization for these intangibles. Intangibles with finite lives
are also subjected to impairment tests.
 Intangible with indefinite lives
They have indefinite lives, these intangibles are not amortized. Instead they
are tested for impairment for any loss in value, the loss is recorded when it
occurs.
 Patents
• Patents
– Patents are granted by a government to give holder
the exclusive right for a certain number of years to
produce and sell an invention.
– The invention may be a specific product or
process.
 Copyrights
• Copyrights are exclusive rights to reproduce & sell a
book, musical composition, film or other work of art.
• Copyrights also protect computer software programs.
• Copyrights in certain jurisdictions can extend up to
70 years beyond author’s life.
• The cost of obtaining a copyright from the
government is low, but a company may pay a large
sum to purchase an existing copyright from the owner
or to buy a company for its copyrights.
 Franchises & Licenses
• These are privileges granted by a private
business or a government to sell a product or
service in accordance with specific conditions.
• The useful lives of many franchises & licenses
are usually indefinite & therefore are not
amortized.
 Goodwill
• Goodwill is defined as the excess of the cost of purchasing
another company over the sum of the fair values of the
acquired company’s net assets (assets-liabilities).
• IAS 38 prohibits the recognition of internally generated
goodwill.
• The only goodwill that is presented in the financial
statements is goodwill that results from business
combinations or mergers & acquisitions.
• Unlike other intangible with finite useful lives, goodwill is
not amortized & is subjected to strict impairment tests.
 Accounting for Research &
Development Costs
• In an entity with significant research and
development (R&D) activities,
• IAS 38 specifies the accounting treatment for
R&D expenditures is literally split in the middle
between research & development.
• Under IFRS, costs associated with the creation of
intangible assets are classified into research phase
costs & development phase costs.
• Cost in research phase are always expensed.
 Continued…
• Costs in the development phase are capitalized if the company
can demonstrate meeting all the following 6 criteria:
 The technical feasibility of completing the intangible asset
 The intention to complete the intangible asset
 The ability to use or sell the intangible asset
 The future economic benefits
 The availability of adequate resources to complete
development of the asset
 The ability to reliably measure the expenditure attributable to
the intangible asset during its development.
 Accounting for the Impairment of an
Intangible Asset
• Some intangibles such as goodwill, licenses & some
trademarks have indefinite lives & therefore are not subject to
amortization. But all intangibles are subject to a write – down
when their value decreases.
Reporting Long term Assets transactions on
the Statement of Cash flows

2 main types of long

term asset transaction

Acquisitions settled in Disposals settled in

cash cash
Illustration
Evaluate a company’s performance based on
its assets

Two ratios directly related to non current assets:

 Asset turnover ratio
 Return on asset
Decision guidelines
Continued….
 Question
Which statement is false?
a) Depreciation is based on the matching principle because it
matches the cost of the asset with the revenue generated over
the asset’s useful life.
b) Depreciation is a process of allocating the cost of a PPE over
its useful life.
c) Depreciation creates a fund to replace the asset at the end of
its useful life.
d) The cost of a PPE minus accumulated depreciation equals the
asset’s book value.
 Solution!!
c) Depreciation creates a fund to replace the
asset at the end of its useful life.
 Question
In July 2016 (mid-year), company A purchased a new
piece of equipment that cost $65,000. The estimated
useful life is 10 years & estimated residual value is
$5,000.
What is the depreciation expense for 2016 if A uses the
straight line method?
a) $3,000
b) $6,000
c) $3,250
d) $6,500
 Solution!!
A) $3,000
= ($65,000 - $5,000)/10*6/12
=$3,000
 Question
Which of the following is not a capital expenditure?
a) A complete overhaul of an air-conditioning system
b) Replacement of an old motor with a new one in a
piece of equipment
c) The cost of installing a piece of equipment
d) The addition of a building wing
e) A tune-up of a company vehicle.
 Solution
E) A tune-up of a company vehicle.
 Question
Which of the following assets is not subject to a
decreasing book value through depreciation,
depletion or amortization?
a) Goodwill
b) Natural resource
c) Land improvements
d) Intangibles
 Solution!!
A) Goodwill
END OF CHAPTER 7