Chapter 14

Non-current assets:
acquisition and depreciation

©2018 John Wiley & Sons Australia Ltd

 Learning objectives

After studying this presentation you should be able to:

14.1 explain the nature of property, plant and
equipment
14.2 compute the cost of property, plant and
equipment
14.3 apportion the cost of a lump‐sum payment for
multiple asset acquisitions
14.4 describe the basics of the acquisition of assets
under a lease agreement
 Learning objectives

14.5 discuss the nature of depreciation and determine

the amount of depreciation expense using
several different cost allocation methods
14.6 describe how to account for subsequent costs
incurred in relation to property, plant and
equipment
14.7 record property and plant records in the
property and plant subsidiary ledger
 Learning objectives

14.8 illustrate the reporting requirements for

property, plant and equipment and depreciation in
an entity’s financial reports
14.9 analyse and interpret information on property,
plant and equipment and appreciate the critical
nature and importance of management
decisions in relation to property, plant and
equipment.
 The nature of property, plant and
equipment

• Management’s intention to use these assets for the

future production of goods or services over several
accounting periods is the main factor that distinguishes
them from other assets sold to earn income.
• The future economic benefits contained in property,
plant and equipment will be received over two or more
accounting periods, the depreciable amount of these
assets must be allocated in a systematic manner over
their useful lives to measure depreciation.
 Determining the cost of property, plant
and equipment

• In order to determine the acquisition cost of a plant

asset, the entity must measure the fair value of the
items it has given up to acquire the asset, and not
the fair value of the asset which is being acquired.
• Fair value is the price that would be received to sell
an asset or amount paid to transfer a liability in an
orderly transaction between market participants at
the measurement date.
 Determining the cost of property, plant
and equipment

• Care should be taken that only reasonable and

necessary expenditures are included.
• When an entity constructs an asset for its own use,
the acquisition cost includes all expenditures
incurred directly for construction, such as labour,
materials and insurance paid during construction.
• A qualifying asset is defined as an asset that
necessarily takes a substantial period of time, i.e.
usually longer than 1 year, to get ready for its
intended use or sale.
 Apportioning the cost of a lump-sum
acquisitions

• In a lump‐sum acquisition, several items of property,

plant and equipment may be acquired for a lump-
sum payment without an identification of the cost of
each asset.
• According to IFRS 3/AASB 3 Business Combinations,
when the lump‐sum acquisition does not constitute
the acquisition of a business entity, the cost of the
acquisition must be allocated on the basis of the fair
values on the acquisition date of the assets acquired.
 Assets acquired under a lease agreement

• The entity leasing the assets is referred to as the

lessee, and the supplier is called the lessor.
• An operating lease is one where the lessor effectively
retains substantially all the risks and rewards
attaching to ownership of the leased asset.
• A finance lease is one where substantially all those
risks and rewards are effectively transferred from the
lessor to the lessee, even though legal ownership
remains with the lessor.
 Depreciation

• The nature of depreciation:

– Four factors which contribute to a depreciable
asset having a limited useful life:
• Expected usage of the asset, as assessed by
reference to the asset’s expected output.
• Expected wear and tear through physical use, in
excess of that which maintenance can restore.
• Technical and commercial obsolescence.
• Legal or similar limits on the use of an asset,
such as the expiry dates of leases.
 Depreciation

• Determining the amount of depreciation:

– Useful life:
• The period over which an asset is expected to
be available for use by an entity
• The number of production or similar units
expected to be obtained from the asset by an
entity.
 Depreciation

• Determining the amount of depreciation:

– Residual value:
• If the residual value is expected to be an
insignificant amount in relation to the asset’s
cost, it is often ignored in calculating
depreciation. Residual value is sometimes
referred to as salvage value or trade‐in value.
 Depreciation

• Depreciation methods:
– Straight‐line method:
• The straight‐line depreciation method allocates
an equal amount of depreciation to each full
accounting period in the asset’s useful life.
 Depreciation

• Depreciation methods:
– Diminishing balance method:
• The diminishing balance depreciation method
results in decreasing depreciation charge over
the useful life of the asset.
 Depreciation

• Depreciation methods:
– Sum-of-years’-digits method:
• A different way of applying the diminishing
balance method and results in a decreasing
depreciation charge over the useful life of the
asset.
• Depreciation for each period is determined by
multiplying the recorded cost less residual
value, i.e. its depreciable amount, by
successively smaller fractions.
 Depreciation

• Depreciation methods:
– Units-of-production method:
• The units‐of‐production depreciation method
relates depreciation to use rather than to time.
• This method is particularly appropriate for
assets where consumption of economic
benefits varies significantly from one period to
another.
 Depreciation

• Comparison of depreciation methods:

– The straight‐line method produces uniform
charges to depreciation over the life of the asset.
– The benefits received from the use of the asset
are assumed to be received evenly throughout the
asset’s life.
– The units‐of‐production method produces
depreciation charges that may vary significantly
from one accounting period to another as the use
of the asset varies.
 Depreciation

• Revision of depreciation rates and methods:

– Two of the factors used to determine periodic
depreciation:
• Residual value and useful life.
– Small errors in estimates occur frequently and are
generally ignored because their effects are not
material.
– The usual procedure is to spread the remaining
depreciable amount of the asset over its
remaining useful life.
 Depreciation

• Accumulated depreciation does not represent cash:

– Does not represent a cash reserve built up to
replace assets when they wear out.
– The accumulated depreciation account is a contra‐
asset account with a credit balance, representing
that portion of an asset’s recorded cost that has
been transferred progressively to depreciation
expense since the asset was acquired.
 Subsequent costs

• According to the standard, the initial cost and

subsequent costs of an item of property, plant and
equipment should be recognised as an asset only
under the following recognition principle, i.e. if:
– it is probable that the future economic benefits
associated with the item will flow to the entity
– the cost(s) of the item can be measured reliably.
 Subsequent costs

• Overhauls and replacement of major parts:

– Major reconditioning and overhaul expenditures
are made to extend an asset’s expected future
benefits beyond the original estimate by adding
materially to the asset’s future capability to
produce goods or perform services.
 Subsequent costs

• Leasehold improvements:
– If an entity has leased an asset, particularly on a
long‐term basis, it is commonplace for the entity
to incur additional costs to ensure that the asset is
suitable for its own intended use.
– For example, the entity may incur the costs of
constructing a road across land that it has leased,
or install partitioning on the floor of a building it
has leased.
 Subsequent costs

• Leasehold improvements:
– These additional costs are called leasehold
improvements and are debited to a Leasehold
Improvements account.
– For depreciation purposes, the depreciable
amount of leasehold improvements should be
allocated progressively over the unexpired period
of the lease, or the useful lives of the
improvements, whichever is the shorter.
 Subsequent costs

• Spare parts and service equipment:

– An entity’s supply of spare parts and/or service
equipment for an asset may become redundant if
the asset is retired or discontinued.
– Hence, the spare parts and/or service equipment
do not have separate lives of their own.
– In this circumstance, the cost of these spare parts
and equipment should be treated as a separate
item of property, plant and equipment.
 Property and plant records

• Property, plant and equipment are normally divided into

functional groups with a separate general ledger account
and accumulated depreciation account provided for
each group.
• The subsidiary ledger records provide information for
the preparation of income tax returns and for supporting
insurance claims in the event of loss from theft and
accident.
• The records also contain information for preparing year‐
end adjustments for depreciation and space for entries
to record the disposal of the asset.
 Disclosure of property, plant and
equipment

• For general purpose financial statements, it is a

requirement of IAS 16/AASB 116 that the
depreciation methods used, the useful lives or the
depreciation rates used, and the aggregate
depreciation expense be disclosed.
• Furthermore, both the cost of depreciable assets and
their accumulated depreciation must be shown in
the financial report.
• Accumulated depreciation is disclosed as a deduction
from the assets or class of assets to which it relates.
 Disclosure of property, plant and
equipment

• Property, plant and equipment may be reported in the

balance sheet or in an accompanying schedule as
follows.
 Analysis, interpretation and management
decisions

• Analysis and interpretation:

Analysis, interpretation and management
decisions

• Management decisions:
– The planning and financing of capital investments,
such as the replacement of equipment, expansion
of production facilities and introduction of a new
product line, is an important area of management
decision making.
– This function of management is known as capital
budgeting.
 Summary

• The nature of property, plant and equipment.

• The cost of property, plant and equipment.
• The cost of a lump‐sum payment for multiple asset
acquisitions.
• The basics of the acquisition of assets under a lease
agreement.
• The nature of depreciation and determine the
amount of depreciation expense using several
different cost allocation methods.
 Summary

• How to account for subsequent costs incurred in

relation to property, plant and equipment.
• Property and plant records in the property and plant
subsidiary ledger.
• The reporting requirements for property, plant and
equipment and depreciation in an entity’s financial
reports.
• Analysing and interpreting information on property,
plant and equipment.
 Summary

• The critical nature and importance of management

decisions in relation to property, plant and
equipment.
 Concepts of Capital

• Financial capital
– Capital is synonymous with the net assets (equity)
of the entity
– Profit exists only after the entity has maintained
its capital, measured as the dollar value (or
purchasing power) of equity at the beginning of
the period

• Physical capital
– Capital is viewed as the operating capability of the