FAR - Property, Plant and Equipment

THE CPA BOARD EXAMS OUTLINES by theMahatma

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FINANCIAL ACCOUNTING AND REPORTING

PROPERTY, PLANT & EQUIPMENT Supplementary discussions based on lectures by Tom Siy, CPA, Christian Aris Valix, CPA and Dean Archimedes Ibay, CPA (CPAR)

CAPITALIZABLE COSTS

 Generally, capitalizable costs to PPE includes the purchase price, import duties and nonrefundable taxes while excluding trade discounts, rebates and purchase discounts (whether taken or not)  Certain special items and to which PPE item they should be capitalized (or expensed) are as follows: o Option payments made for the acquired land, machine or building are capitalized to the respective accounts. Such payments are made to bind the seller to not sell the property until the lapse of the option contract. If the property is not acquired, the option payment is expensed o Training costs for employees who will use certain machineries are always expensed o Testing costs for new machines are always capitalized, which includes allowances and accommodation costs for the technicians o Survey costs are always capitalized to land, even though they were made with the intent of constructing a building o Value-added taxes are not considered in the purchase price o Insurance policy payments to secure new machinery in transit or any potential mishaps during construction are capitalized to respective accounts. Injury claims during construction that’s not covered by insurance are expensed  A new interpretation has been released that prescribes new treatment to net demolition costs and the fair value of the demolished building. They are as follows: o If the building is demolished without the intent of building a new one, net demolition costs are capitalized to land o If there is intention to build, they are capitalized to the new building o If land is part of inventory (such as that of real estate businesses) or considered an investment property, the costs are capitalized to it o The fair value of the demolished building is expensed, except if the land is part of inventory where it is capitalized to land

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BORROWING COSTS

 Interest expense is capitalized for assets that take a substantial amount of time to be used or sold. However, inventory produced on a repetitive basis that do take a substantial time to be produced is not qualified for interest capitalization  Borrowing costs may be classified as specific (debt is for financing the construction of the asset) or general (other debts outstanding during the construction). All interest from specific debts are capitalized, while only a portion is capitalized from general debts  Computation of capitalizable borrowing costs follows the following formula: Weighted average expenditures, one year DEDUCT: Specific debt face value Amount related to general borrowings MULTIPLY: Capitalization rate Capitalized interest from general debt Actual interest from specific debt Total capitalizable interest

XX XX XX x% XX XX XX

The total capitalized interest is deducted from the total nominal interest from both general and specific debts for the interest expense for the period On January 2, 2019, Pineapple Co. began construction of a new office building. It was completed June 30, 2020. Expenditures on the project were as follows: January 3, 2019 Php 2,500,000 March 31 3,000,000 June 30 4,000,000 October 31 3,000,000 January 31, 2020 1,500,000 March 30 2,500,000 May 31 3,000,000 On January 2019, the company acquired a construction loan for Php 5,000,000 at 10% interest, outstanding for all of 2019 and 2020. Other outstanding loans include a Php 25,000,000 loan at ILLUSTRATION (CPAR PRE-WEEK ITEM)

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8%, and a mortgage of Php 15,000,000 on a building at 6%. Determine the capitalizable interest and the interest expense for 2019 STEP 1: Since specific to the construction, the interest from the

specific debt is capitalized entirely. Thus, Php 5,000,000 × 10% = Php 500,000 STEP 2: Determine the weighted average expenditures for 2019, covering only those expenses for that year. Thus, [(Php 2,500,000 × 12/12) + (Php 3,000,000 × 9/12) + … + (Php 3,000,000 × 2/12)] = Php 7,250,000 STEP 3: Following the formula, deduct Php 7,250,000 with the face value of the specific debt to obtain Php 2,250,000 STEP 4: Compute for the capitalization rate by dividing the total nominal interest from all general borrowings over the face value of all general borrowings. Thus: Php 2,900,000 ÷ Php 40,000,000 = 7.25%. The capitalized interest from general borrowings should be Php 163,125 STEP 5: Add the actual specific interest with that of general borrowings to obtain total capitalized interest for 2019 of Php 663,125 STEP 6: Following the formula, the interest expense for the period should be Php 2,736,875 (Php 3,400,000 – Php 663,125) Using the same example, compute for the capitalizable interest and interest expense for 2020 STEP 1: Since the construction was finished halfway through the

second year, and the debts were outstanding throughout the year, the amount of interest to be capitalized from the specific debt is for the half-year only. Thus, Php 5,000,000 × 10% × 6/12 = Php 250,000 STEP 2: The weighted average expenditures of 2020 shall be composed of the total actual expenses of the past year (not averaged), the capitalized interest of 2019, and the weighted average expenses of 2020. Thus, [(Php 13,163,125 × 6/6) + (Php 1,500,000 × 5/6) + … + (Php 3,600,000 × 1/6)] = Php 16,163,125

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STEP 3: Deduct Php 16,163,125 from the full face value of the

specific debt to obtain Php 11,163,125 STEP 4: The capitalization rate to be used remains to be 7.25%, but since the project was finished halfway through the year, it will be reduced to 3.625% (7.25% × 6/12). The capitalized interest from general borrowing should be Php 404,663 STEP 5: Add the two capitalizable interests for Php 654,663 STEP 6: The interest expense for 2020 should be Php 2,745,337 (Php 3,400,000 – Php 654,663)

GOVERNMENT GRANTS

 Grants from the government may be relating to property or incomegeneration efforts, each to be accounted for in a distinct way  If the government grants funding to acquire depreciable property for the entity, it may be accounted by (a) recording a deferred income account, or (b) reducing the cost of the property by the amount of the grant If recorded as a deferred income (liability), income is recognized on a straight-line basis just as the property is depreciated. No such income is recognized when the grant is accounted as costreduction. The reduced cost of the asset shall be used for depreciation  If the grant is for other purposes other than above (including acquisition of non-depreciable assets), income is recorded when relevant expenses have been incurred, as per the matching principle. When the expenses are already incurred when the grant is receivable, the entire grant is recorded income outright  Conditions are usually attached to the grants. If the conditions are not satisfied, the grants become repayable If the grant is for a depreciable asset recorded as deferred income,

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the amount already recorded as income through straight-line amortization is recorded as a loss. If recorded as a reduction to cost, the amount of grant is added back to the cost of the asset. This addition is depreciated up to the date when the grant is made repayable

DEPRECIATION OF CASH GENERATING UNITS

 A cash generating unit is a group of dissimilar long-lived assets used as a single unit, usually composed of land, building and machinery. They are depreciated using the composite method, which a variant of the straight-line method  The total costs of the assets belonging to the cash generating unit is multiplied with a given composite rate to derive the annual depreciation. The accumulated depreciation pertains to no particular PPE in the unit, which means that if one of the properties is sold, there would be no gain or loss recognized. Accumulated depreciation would be debited/credited with the difference of the selling price and cost If a new asset is included in the cash generating unit, the same composite rate is used for the group’s depreciation

DEPRECIATION OF PROPERTY USED IN EXTRACTING OPERATIONS

 The depreciation of property such as buildings used in mining and similar operations follows the following rules: o If the property has future uses after the operations are finished, it is depreciated with its useful life o If the property has no future use, the lives of the asset and the wasting asset (mineral resource) are considered. If the life of the asset is shorter, the asset is depreciated with its useful life. If the life of wasting asset is shorter, it is depreciated

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through the production method – just like in depletion Mina Mining Co. built necessary structures and sheds on its mining site for Php 12,000,000, having estimated useful lives of 15 years and no residual value. The company also bought a machine with no expected future uses worth Php 1,800,000 (useful life = 12 years). This machine, however, is expected to be useful halfway through the operations. Mining operations are expected to last for 11 years. A total of 150,000 tons of minerals are expected to be recovered, with 15,000 tons to be extracted annually. However, only 7,500 tons will be recovered on the last year. Determine the depreciation charges for the building and the machine for years 1, 7 and 11  Since the life of the mining operations is shorter for both assets, they shall be depreciated using the production method. Each asset shall have their own depreciation rate to be multiplied against the current production for their depreciation charge. Thus, the rate for the building is 80 (Php 12,000,000 ÷ 150,000 tons) and for the machine, 12 (Php 1,800,000 ÷ 150,000 tons)  The production for year 1 is 15,000 tons. Thus the depreciation charges are Php 1,200,000 and Php 180,000 for the building and machine, respectively  It is stated that the machine will be useable for half the duration of the operations. Also, 7,500 tons will be recovered on the last year of operations. Despite being halfway through the 11-year operation, the depreciation of the machine will use 7,500 tons as basis. Thus, it has a depreciation charge of Php 90,000 for year 7  On year 11, the building will use 7,500 as basis for depreciation. Thus, its charge is Php 600,000 ILLUSTRATION (CPAR PRE-WEEK ITEM)

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