FAR EASTERN UNIVERSITY – MANILA

INSTITUTE OF ACCOUNTS, BUSINESS AND FINANCE

NICANOR REYES SR. ST., SAMPALOC, MANILA
APPLIED AUDITING

AUDIT OF PROPERTY, PLANT, AND EQUIPMENT,.

WASTING ASSETS,.
AND INTANGIBLE ASSETS.

PAS 16 - PROPERTY, PLANT, AND EQUIPMENT

❖ DEFINITION

- Tangible
- Used in business
- To be used > 1 year

✓ Land
✓ Land Improvements
✓ Building
✓ Machinery
✓ Delivery Equipment
✓ Store and Office Equipment
✓ Furniture and Fixtures
✓ Leasehold Improvements
✓ etc.

❖ MEASUREMENT

✓ Initial – Cost
✓ Subsequent – either (for an entire class):
- Cost model
- Revaluation model

❖ ACQUISITION

✓ Cash basis
- Cash
- Lump sum/basket price – allocate on the basis of relative fair value
✓ On account
- Invoice price minus cash discount, whether taken or not
✓ Installment method
- Cash price equivalent
- Present value if no cash price equivalent
✓ Issuance of share capital
1. FV of property received
2. FV of share capital
3. Par value or stated value of share capital
✓ Issuance of bonds payable
1. FV of BP
2. FV of property received
3. Face value of BP
✓ Exchange
o With commercial substance
▪ No cash involved
1. FV of property given up
2. FV of property received
3. CA of property given up
▪ With cash involved
- FV of property given up + cash paid (payor)
- FV of property given up - cash received (recipient)
o No commercial substance – no gain/loss on exchange
- CA of property given up
- Cash paid is still added; cash received is still deducted
o Trade in
- FV of property given up + cash paid
- Trade in value of property given up + cash paid (in effect FV of property received)
✓ Donation - FV
- From shareholders – donated capital
- From nonshareholders – income if unconditional; inititally unearned income if conditional
✓ Construction
- DM + DL + FOH

Handout – Audit of PPE, WA, and IA /RANNIE O. MEDINA, CPA, MBA 1

❖ DEPRECIATION

✓ Straight line
➢ Annual depreciation = (Cost - Residual value) / Life in years
Annual depreciation = Depreciable amount x rate
➢ Rate = 1 / Life

✓ Sum of the years’ digits (SYD)

➢ SYD = n(n+1)/2
➢ Depreciation for a certain year = Original depreciable amount x (Beg. remaining life / SYD)

✓ Declining balance method

➢ Rate =

➢ Depreciation for a certain year = CA x rate (RV is ignored)

➢ Depreciate only until CA = RV

o Double (200%) declining balance method

➢ Rate = 2 / Life

o 150% declining balance method

➢ Rate = 1.5 / Life

✓ Working (service) hours / output or production method

➢ Depreciation for a certain year = Depreciable amount / Life in service hours or units of output

✓ Composite/group method – Group is treated as one unit

➢ Depreciation for a certain year
= (Original cost + Subsequent acquisitions’ cost – Subsequent disposals’ cost) x Composite rate
➢ Composite rate = Total annual depreciation / Total cost

✓ etc.

o Leasehold improvements
➢ In computing depreciation expense, use the shorter of 2) the life of the improvements or 2) the lease
term,
and ignore residual value

❖ REVALUATION
Cost Replacement cost Appreciation
Asset xxx) xxx) xxx) - Increase in cost
Accumulated depreciation (proportional) (xxx) (xxx) (xxx) - Increase in AD
*xxx) **xxx) xxx) - Revaluation Surplus

* CA before revaluation
** Sound value / Fair value / Depreciated replacement cost / CA after revaluation

o Piecemeal realization of RS pertaining to depreciable assets

- RS / Life of the asset

Revaluation surplus xxx

Retained Earnings xxx

- Transfer the entire balance of RS to RE if the asset is derecognized

PAS 20 - GOVERNMENT GRANTS

✓ Related to income (presented as income or deduction from related expense)

o Compensation for expenses/losses already incurred with no further related costs
- Income immediately
o For specific expenses to be incurred
- Income over the period of the related expenses
- In proportion to the expenses incurred

✓ Related to asset (deferred income or deduction from related asset)

o Related to depreciable/nondepreciable asset
- Income in proportion to the depreciation of the related asset

Handout – Audit of PPE, WA, and IA /RANNIE O. MEDINA, CPA, MBA 2

PAS 23 - BORROWING COSTS

✓ Specific borrowing
➢ Loan principal x rate (of each SB)
Less: Interest income from investment of proceeds

✓ General borrowing
➢ Average expenditures
x Average rate (Total GB annual interest / Total GB principal)

✓ Both SB and GB
➢ Average expenditures
Less: SB principal
Amount related to GB
x Average rate
GB borrowing cost
Add: SB borrowing cost
Total capitalizable borrowing cost

✓ SB used partly for working capital purposes

- Entire borrowing is treated as GB

PAS 36 - IMPAIRMENT

- If RA < CA, IL should be recognized (IL = CA - RA).

- If RA > CA, the increase is ignored
- RA = FV-CTS or VIU, higher
- VIU = discounted net future cash flows
- Gain on reversal of impairment = CA (as if not impaired) or RA, lower - CA (before reversal)

PFRS 6 - WASTING ASSETS

❖ DEPLETION

❖ WASTING ASSET PROPERTY

- ex. mineral mine, coal mine, limestone quarry, land with removable deposits
✓ Acquisition cost (allocable to land is RV)
✓ Exploration cost (included as wasting asset property cost, if silent)
✓ Development cost (only those intangible)
✓ Estimated restoration cost (PV = FV of obligation)

Exploration – to locate
✓ acquisition of rights to explore
✓ topographical, geological, geochemical, geophysical studies
✓ exploratory drilling
✓ trenching
✓ sampling
✓ activities in relation to evaluating the TF and CV of extracting a mineral resource
✓ GA costs directly attributable to exploration and evaluation activities

Development – to prepare for extraction/exploitation

✓ intangible
o drilling
o sinking mine shaft
o construction of wells
✓ tangible (PPE, depreciated over life of PPE or life of WA property, whichever is lower)
o production
o tunnels, roads, bunker, mine shaft and other infrastructures
o bunk houses and other buildings constructed on the WA property
o “WA property improvements”

❖ WASTING ASSET DOCTRINE

RE
+ Accumulated depletion
- Capital liquidated
- Unrealized depletion in EI
Maximum dividend

RE
Capital liquidated
Dividends payable

Handout – Audit of PPE, WA, and IA /RANNIE O. MEDINA, CPA, MBA 3

PAS 38 - INTANGIBLE ASSETS

❖ SPECIFIC INTANGIBLE ASSETS

✓ Patent
- Legal life = 20 years
- “Technology-based” intangible asset

✓ Copyright
- Term of protection = During the life of the author and for 50 years after his death
- “Artistic-related” intangible asset

✓ Franchise
- May be granted for a definite period or an indefinite period
- “Contract-based” intangible asset

✓ Trademark
- Legal life = 10 years (But may have an indefinite life)
- “Market-based” intangible asset

✓ Leasehold
- Amount paid to obtain right to the lease
- Amortized over the life of the lease

✓ Computer software

✓ License

✓ Customer list

✓ etc.

o Organization (start-up) costs (e.g., incorporation fees and stock issuance costs) are expensed when
incurred.

❖ MEASUREMENT

✓ Initial – Cost
✓ Subsequent – either:
- Cost model
- Revaluation model

o Subsequent expenditures on an intangible asset are expensed outright, if silent.

❖ AMORTIZATION

✓ With limited/finite life – over legal life or useful life, shorter

✓ With indefinite life – not amortized; only tested for impairment at least annually

o Use straight line method, if silent.

Amortization Expense xxx

Patent Account xxx

Handout – Audit of PPE, WA, and IA /RANNIE O. MEDINA, CPA, MBA 4

 EXERCISES

PROBLEM 1

The property, plant and equipment section of White Corporation’s balance sheet at December 31, 2017
included the following items:

Land P 2,500,000
Land improvements 560,000
Building 3,600,000
Machinery and equipment 6,600,000

During 2018 the following data were available to you upon your analysis of the accounts:

Cash paid on purchase of land P 10,000,000

Mortgage assumed on the land bought, including interest at 16% 16,000,000
Realtor’s commission 1,200,000
Legal fees, realty taxes and documentation expenses 200,000
Amount paid to relocate persons squatting on the property 400,000
Cost of tearing down an old building on the land 300,000
Amount recovered from the salvage of the building demolished 600,000
Cost of fencing the property 440,000
Amount paid to a contractor for the building erected 8,000,000
Building permit fees 50,000
Excavation expenses 250,000
Architect’s fee 100,000
Interest that would have been earned had the money used during
the period of construction been invested in the money market 600,000
Invoice cost of machinery acquired 8,000,000
Freight, unloading, and delivery charges 240,000
Customs duties and other charges 560,000
Allowances, hotel accommodations, etc., paid to foreign
technicians during instillation and test run of machines 1,600,000
Royalty payment on machines purchased (based on units
produced and sold) 480,000

Based on the above and the result of your audit, compute for the following as of December 31, 2018:

1. Land
2. Land improvements
3. Building
4. Machinery and equipment
5. Total depreciable property, plant and equipment

PROBLEM 2

You obtain the following information pertaining to Red Co.’s property, plant, and equipment for 2018 in
connection with your audit of the company’s financial statements.

Audited balances at December 31, 2017:

Debit Credit
Land P 3,750,000
Buildings 30,000,000
Accumulated depreciation – buildings P 6,577,500
Machinery and equipment 22,500,000
Accumulated depreciation –
Machinery and Equipment 6,250,000
Delivery Equipment 2,875,000
Accumulated Depreciation –
Delivery Equipment 2,115,000

Depreciation Data:
Depreciation Method Useful Life
Buildings 150% declining balance 25 years
Machinery and Equipment Straight-line 10 years
Delivery Equipment Sum-of-the-years’-digits 4 years
Leasehold Improvements Straight-line -

Transactions during 2018 and other information are as follows:

a. On January 2, 2018, Red purchased a new truck for P500,000 cash and traded-in a 2-year-old truck with a
cost of P450,000 and a book value of P135,000. The new truck has a cash price of P600,000; the market
value of the old truck is not known.

b. On April 1, 2018, a machine purchased for P575,000 on April 1, 2013 was destroyed by fire. Red recovered
P387,500 from its insurance co.

c. On May 1, 2018, cost of P4,200,000 were incurred to improve leased office premises. The leasehold
improvements have a useful life of 8 years. The related lease terminates on December 31, 2013.
Handout – Audit of PPE, WA, and IA /RANNIE O. MEDINA, CPA, MBA 5
d. On July 1, 2018, machinery and equipment were purchased at a total invoice cost of P7,000,000; additional
cost of P125,000 for freight and P625,000 for installation were incurred.

e. Red determined that the delivery equipment comprising the P2,875,000 balance at January 1, 2018, would
have been depreciated at a total amount of P450,000 for the year ended December 31, 2018.

The salvage values of the depreciable assets are immaterial. The policy of the Red Co. is to compute
depreciation to the nearest month.

Based on the above and the result of your audit, answer the following:

1. How much is the Accumulated depreciation – Buildings as of December 31, 2018?

2. How much is the Accumulated depreciation – Machinery and Equipment as of December 31, 2018?
3. How much is the Accumulated depreciation – Delivery Equipment as of December 31, 2018?
4. How much is the Accumulated depreciation – Leasehold Improvements as of December 31, 2018?
5. How much is the net gain (loss) from disposal of assets for the year ended December 31, 2018?

PROBLEM 3

The following are independent situations:

The Machinery account of PAKO COMPANY contains the following entries during the year:

Date Item Debit Credit

2017
Jan. 1 Balance P1,800,000
June 30 Purchased four new machines 1,080,000
Installation cost of new machines 48,000
Sept. 30 Proceeds from sale of old machine, cost
P150,000; accumulated depreciation, P105,000 P 66,000
Oct. 31 Repairs of machinery 75,000
Dec. 1 Cash paid for trade-in of old machines—cost,
P90,000; accumulated depreciation, P36,000.
Cash price of new machine, P270,000 225,000
Dec. 31 Balance 3,162,000
Total P3,228,000 P3,228,000

1. What is the correct balance of the Machinery account on December 31, 2017?
2. Assuming depreciation is recorded on a monthly basis at 10% a year, how much was the depreciation charge
for 2017?

PROBLEM 4

On January 1, 2018, BC Corp. contracted with Mega Construction Company to construct a building for
P40,000,000 on land that BC purchased several years ago. The contract provides that BC is to make five
payments in 2018, with the last payment scheduled for the date of completion. The building was completed on
December 31, 2018.

BC made the following payments during 2018:

January 1 P 4,000,000
March 31 8,000,000
June 30 12,200,000
September 30 8,800,000
December 31 7,000,000
Total P 40,000,000

BC had the following debt outstanding at December 31, 2018:

a) A 12%, 4-year note dated January 1, 2018, with interest compounded quarterly. Both principal and interest
are payable on December 31, 2021. This loan relates specifically to the building project. P17,000,000.

b) A 10%, 10-year note dated December 31, 2014, with simple interest; interest payable annually on December
31. P12,000,000.

c) A 12%, 5-year note dated December 31, 2015, with simple interest; interest payable annually on December
31. P14,000,000.

1. The amount of interest to be capitalized during 2018 is

2. The amount of interest that would be expensed for 2018 is

Handout – Audit of PPE, WA, and IA /RANNIE O. MEDINA, CPA, MBA 6

PROBLEM 5

On January 1, 2016, SAMSON MFG. CO. began construction of a building to be used as its office headquarters.
The building was completed on June 30, 2017.

Expenditures on the project were as follows:

January 3, 2016 P2,500,000

March 31, 2016 3,000,000
June 30, 2016 4,000,000
October 31, 2017 3,000,000
January 31, 2017 1,500,000
March 31, 2017 2,500,000
May 31, 2017 3,000,000

On January 3, 2016, the company obtained a P5 million construction loan with a 10% interest rate. The loan was
outstanding all of 2016 and 2017. The company’s other interest-bearing debts included a long-term note of P25
million with an 8% interest rate, and a mortgage of P15 million on another building with an interest rate of 6%. Both
debts were outstanding during all of 2016 and 2017. The company’s fiscal year-end is December 31.

1. What is the amount of capitalizable interest in 2016?

2. What is the amount of capitalizable interest in 2017?
3. What amount of interest should be expensed in 2016?
4. What amount of interest should be expensed in 2017?
5. What is the total cost of the building (including the interest capitalized in 2016 and 2017)?

PROBLEM 6

In connection with your audit of the Josef Mining Corporation for the year ended December 31, 2018, you noted
that the company purchased for P10,400,000 mining property estimated to contain 8,000,000 tons of ore. The
residual value of the property is P800,000.

Building used in mine operations costs P800,000 and have estimated life of fifteen years with no residual value.
Mine machinery costs P1,600,000 with an estimated residual value P320,000 after its physical life of 4 years.

Following is the summary of the company’s operations for first year of operations.

Tons mined 800,000 tons

Tons sold 640,000 tons
Unit selling price per ton P4.40
Direct labor 640,000
Miscellaneous mining overhead 128,000
Operating expenses (excluding depreciation) 576,000

Inventories are valued on a first-in, first-out basis. Depreciation on the building is to be allocated as follows: 20%
to operating expenses, 80% to production. Depreciation on machinery is chargeable to production. Based on
the above and the result of your audit, answer the following: (Disregard tax implications)

1. How much is the depletion for 2018?

2. Total inventoriable depreciation for 2018?
3. How much is the Inventory as of December 31, 2018?
4. How much is the cost of sales for the year ended December 31, 2018?
5. How much is the maximum amount that may be declared as dividends at the end of the company’s first year
of operations?

PROBLEM 7

In 2001, Kieso Corporation acquired a silver mine in Benguet. Because the mine is located deep in the Benguet
mountains, Kieso was able to acquire the mine for the low price of P50,000. In 2002, Kieso constructed a road to
the silver mine costing P5,000,000. Improvements to the mine made in 2002 cost P750,000. Because of the
improvements to the mine and the surrounding land, it is estimated that the mine can be sold for P600,000 when
the mining activities are complete.

During 2003, five buildings were constructed near the mine site to house the mine workers and their families. The
total cost of the five buildings was P1,500,000. Estimated residual value is P250,000. In 2001, geologists estimated 4
million tons of silver ore could be removed from the mine for refining. During 2004, the first year of operations, only
5,000 tons of silver ore were removed from the mine. However, in 2005, workers mined 1 million tons of silver. During
that same year, geologists discovered that the mine contained 3 million tons of silver ore in addition to the original
4 million tons. Improvements of

P275,000 were made to the mine early in 2005 to facilitate the removal of the additional silver. Early in 2005, an
additional building was constructed at a cost of P225,000 to house the additional workers needed to excavate
the added silver. This building is not expected to have any residual value.

In 2006, 2.5 million tons of silver were mined and costs of P1,100,000 were incurred at the beginning of the year for
improvements to the mine.

Handout – Audit of PPE, WA, and IA /RANNIE O. MEDINA, CPA, MBA 7

Based on the above and the result of your audit, determine the following: (Round off depletion and depreciation
rates to two decimal places)

1. Depletion for 2004

2. Depletion for 2005
3. Depreciation for 2005
4. Depletion for 2006
5. Depreciation for 2006

PROBLEM 8

On December 31, 2017, Silver Corporation acquired the following three intangible assets:

• A trademark for P300,000. The trademark has 7 years remaining legal life. It is anticipated that the trademark
will be renewed in the future, indefinitely, without problem.

• Goodwill for P1,500,000. The goodwill is associated with Silver’s Hayo Manufacturing reporting unit.

• A customer list for P220,000. By contract, Silver has exclusive use of the list for 5 years. Because of market
conditions, it is expected that the list will have economic value for just 3 years.

On December 31, 2018, before any adjusting entries for the year were made, the following information was
assembled about each of the intangible assets:

a) Because of a decline in the economy, the trademark is now expected to generate cash flows of just
P10,000 per year. The useful life of trademark still extends beyond the foreseeable horizon.

b) The cash flows expected to be generated by the Hayo Manufacturing reporting unit is P250,000 per year for
the next 22 years. Book values and fair values of the assets and liabilities of the Hayo Manufacturing
reporting unit are as follows:

Book values Fair values

Identifiable assets P2,700,000 P3,000,000
Goodwill 1,500,000 ?
Liabilities 1,800,000 1,800,000

c) The cash flows expected to be generated by the customer list are P120,000 in 2019 and P80,000 in 2020.

Assume that the appropriate discount rate for all items is 6%.

Based on the above and the result of your audit, determine the following:

1. Total amortization for the year 2018

2. Impairment loss for the year 2018
3. Carrying value of Trademark as of December 31, 2018
4. Carrying value of Goodwill as of December 31, 2018
5. Carrying value of Customer list as of December 31, 2018

PROBLEM 9

Transactions during 2018 of the newly organized Pink Corporation included the following:

Jan. 2 Paid legal fees of P150,000 and stock certificate costs of P83,000 to complete organization of the
corporation.

15 Hired a clown to stand in front of the corporate office for 2 weeks and hound out pamphlets and candy
to create goodwill for the new enterprise. Clown cost, P10,000; pamphlets and candy, P5,000.

Apr. 1 Patented a newly developed process with costs as follows:

Legal fees to obtain patent P 429,000

Patent application and licensing fees 63,500
Total P 492,500

It is estimated that in 6 years other companies will have developed improved processes, making the
Pink Corporation process obsolete.

May 1 Acquired both a license to use a special type of container and a distinctive trademark to be printed on
the container in exchange for 6,000 shares of Pink’s no-par common stock selling for P50 per share. The
license is worth twice as much as the trademark, both of which may be used for 6 years.

July 1 Constructed a shed for P1,310,000 to house prototypes of experimental models to be developed in
future research projects.

Dec. 31 Incurred salaries for an engineer and chemist involved in product development totaling P1,750,000 in
2018.

Handout – Audit of PPE, WA, and IA /RANNIE O. MEDINA, CPA, MBA 8

Based on the above and the result of your audit, determine the following:

1. Cost of patent
2. Cost of licenses
3. Cost of trademark
4. Carrying amount of Intangible Assets
5. Total amount resulting from the foregoing transactions that should be expensed when incurred

PROBLEM 10

You gathered the following information related to the Patents account of the Lady Han Cookie Corporation in
connection with your audit of the company’s financial statements for the year 2006.

In 2005, Lady Han developed a new machine that reduces the time required to insert the fortunes into its fortune
cookies. Because the process is considered very valuable to the fortune cookie industry, Lady Han patented the
machine. The following expenses were incurred in developing and patenting the machine:

Research and development laboratory expenses P1,000,000

Metal used in the construction of the machine 320,000
Blueprints used to design the machine 128,000
Legal expenses to obtain patent 480,000
Wages paid for the employees’ work on the research, development, and
building of the machine (60% of the time was spent in actually building
the machine) 1,200,000
Expense of drawing required by the patent office to be submitted with the
patent application 68,000
Fees paid to the government patent office to process application 100,000

During 2006, Lady Han paid P150,000 in legal fees to successfully defend the patent against an infringement suit
by Cookie Monster Corporation.

It is the company’s policy to take full year amortization in the year of acquisition.

Based on the above and the result of your audit, determine the following:

1. Cost of patent
2. Cost of machine
3. Amount that should be charged to expense when incurred in connection with the development of the
patented machine
4. Carrying amount of patent as of December 31, 2006

Handout – Audit of PPE, WA, and IA /RANNIE O. MEDINA, CPA, MBA 9