Fa Ii Ch 1.Pptx

CHAPTER 1
PROPERTY, PLANT AND
EQUIPMENT

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Classification of Asset
Assets
Current
Assets

Long term
Assets

Plant
Assets

Natural
Resources

Intangible
Assets
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Characteristics of Plant Assets

Fixed (plant) Assets – are tangible long-lived
resources that are used in the operation of
the business. Plant assets include: land,
buildings, equipment, etc.
Unique features of PPE include:
 Acquired for use not for re-sale
 Long term in nature and subjected to depreciation
 Posses physical substance
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Acquisition costs of Plant Assets
The cost of a plant asset is the amount of all
expenditures incurred to acquire the asset and make it
ready for use.
Cost of land includes: purchase price, closing costs,
costs incurred in getting the land in condition for
its intended use, assumption of any liens on the
land.
NB:- the salvage value of the old building removed
from the land is deductible while determining cost of
land.
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Acquisition costs…cont’d

Costs of building include: purchase price,
professional fees that means, the costs architect fees
to design the building, construction costs incurred
from excavation to completion and costs of building
permits.
Costs of machineries and equipment include:
purchase price, shipping costs like freight, handling
charges and insurance on the equipment while in
transit, installation, assembly and installation and set
up costs or costs of conducting trial runs.
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Special Considerations while determining
cost of PPE
A. Cash Discounts: discount amount is not part of
cost of plant asset
B. Deferred payments: when PPE acquired by
issuing long term debt, cost of the asset is present
value of future cash payment.
Suppose that ABC Company purchased land by
issuing a Br. 500,000, 5-year noninterest bearing
note on January 1 of year 1 when the market rate of
interest was 10%; the note is to be repaid in 5 equal
installments of Br. 100,000 on December 31 of year
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1, year 2, year 3, year 4 and Year 5.

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Cont’d…
C. Issuance of securities: the cost of the plant asset
is equal to either the fair market value of the
securities issued or the fair market value of the
plant assets themselves provided that the fair
market value of the securities is not determinable.
Example: Mega Corporation purchased machinery
by issuing 2,000 shares of common stock with a
par value of Br. 40 and a fair market value of
Br. 75. Suppose that the fair market value of
the machinery was Br. 154,000
Cost of the machinery= 2000*75= 150,000
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Cont’d…
D. Lump-sum purchase: refers to a situation where
group of assets acquired at a single price. In such cases,
the single price is allocated to each asset based on
weight of each asset determined from market value of
assets.

Example: ABC Company purchased an existing factory
for a single sum of Birr 2,100,000. This price includes
the costs of title to the land, factory building and
equipment. An independent appraisal estimated the
market values of the assets (if these would be purchased
separately) at Birr 800,000 for the land, Birr 1,000,000
for the factory and Birr 700,000 for the building.
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Cont’d…
Step 1: Determine the percentage of the market value of each
asset to the total sum.
Assets
Market value
Percentage
Land
Br. 800,000
32%
Factory
1,000,000
40%
Building
700,000
28%
2, 500, 000
100%
Step 2: Multiply the percentage of each asset’s market value by

lump sum price
Land (0.32 × Br. 2,100,000)....................672,000
Factory (0.40 × Br. 2,100,000).................840,000
Building (0.28 × Br. 2,100,000)...............588,000
Cash.................................................................2,100,000
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Cont’d…
E. Donated assets: Assets donated by unrelated
parties should be recorded at their fair value
based on either an available market price or an
appraisal value. Example: XYZ Manufacturing
Company a corporation received land with a fair
market value of Br. 790,000 from a city with the
stipulation that a factory be built on the land; the
corporation incurred legal fees of Birr 20,000 to
obtain title to the land.
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Cont’d…
Cost of Land = Br. 790,000, Contribution Revenue =
Br. 790,000 – Br20,000 = Br. 770,000
Journal entry
Land………………………….790,000

contribution revenue……………..770,000
cash………………………………..20,000

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Cont’d…
F. Self constructed Assets: when determining
costs of self constructed assets, problem arises in
allocation of indirect costs. Direct costs can easily
be traced to cost object but indirect costs are not.
These indirect costs might be handled in one of
two ways.
a. Allocate no fixed indirect costs.
b. Allocate portion of indirect costs (fixed and
variable).
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Cont’d…
G. Interest costs during construction: there are
three approaches for treatment of interests during
construction.
a. Capitalize no interest charges during
construction.
b. Charge construction with all costs of funds

employed, whether identifiable or not.
c. Capitalize only the actual interest costs
incurred during construction.
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Depreciation of Plant Asset
• Depreciation is the process of allocating the cost
of a plant asset over its useful (service) life in a
rational and systematic manner.
Causes of depreciation:
a. Physical Deterioration – occurs from wear &
tear while in use as well as from the action of
the weather (exposure to sun, wind, and other
climatic factors)
b. Obsolescence (Function Depreciation) - is the
process of becoming out of date before the
assets physically wears out.
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Cont’d
• Methods of calculating depreciation
1.Straight line method
2.Units of output method
3.Declining balance method

4.Sum-of-the-years’-digits method
5.Interest method of computing depreciation
6.Composite
method
of
computing
depreciation

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Cont’d
Interest method of depreciation: under this
method, plant asset is considered as a bundle of
future service to be received periodically over the
economic life of the asset. The cost of such an
asset is viewed as the present value of the equal
periodic rents of services discounted at a rate of
interest consistent with the risk factors identified
with the investment in the plant asset.
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Cont’d

Interest method

of depreciation
Annuity
method
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Sinking fund
method
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Cont’d
a. Annuity method: appropriate when periodic depreciation
of the asset is assumed to be equal to expired cost and
implicit interest on unrecorded investment in the asset.
SV
(1  i) n
Deprciatio n 
1  (1  i) -n
i
AC 

Where: AC= stands for acquisition cost
SV= stands for salvage value
i =stands for market interest rate
n =stands for useful life
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Cont’d…
Example: Assume a machine with an economic
life of five years and a net residual value of Br.
67,388 is acquired by ABC Company for Br.
800,000. If the fair rate of interest for this type of
investment is 10% compounded annually, the
yearly depreciation is computed as follows under
annuity method.
Br.67,388
(1  0.1) 5
Br.200,000
1  (1  0.1)  5
0.1

Br.800,000 
Deprciatio n 

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