Topic 2

Assets I
Property, Plant, and Equipment
Fair Value Measurement
 Course Outline
Accounting Regulations and the Conceptual Framework (Topic 1)

Assets
(Topics 2/3)
Income Taxes Prior Period Accounting
(Topic 5) Issues (Topic 6) Balance
Liabilities Sheet
(Topic 4) A = L + OE
INPUTS

Leases

OUTPUTS
(Topic 8)

Owners’ Equity Statement of

(Topic 9) Changes in
Equity
Revenue & Expenses Statement of
Financial Statement
Comprehensive
Presentation (Topic 10)
Income
Statement of Cash Flows
(Topics 11/12)
 Topic 2 Resources
• Lecture Material
• Loftus, et al. (2015). Financial Reporting
– Chapter 1: Sections 1.7.1, 1.8.1, and 1.9
– Chapter 3: Sections 3.1 – 3.3
– Chapter 5: Sections 5.1 – 5.6 (p.132) and 5.7
• Conceptual Framework
• AASB 13 Fair Value Measurement
• AASB 116 Property, Plant, and Equipment
• Topic 2 non-gradable practice quiz
– Access through L@G

Note: Asset revaluation will be covered in-depth in Topic 6

 Learning Objectives
Property, Plant, and Equipment (AASB 116)
1. Discuss the nature of property, plant and equipment
2. Outline the recognition and measurement criteria for
initial recognition of property, plant and equipment
3. Explain the cost model of measurement and
understand the nature and calculation of depreciation
4. Briefly explain the revaluation model of measurement
5. Account for derecognition of assets
 Learning Objectives

Fair Value Measurement (AASB 13)

1. Identify the reasons for needing an accounting
standard on fair value measurement

2. Explain the definition of fair value

3. Understand how to measure the fair value of non-

financial assets
Property, Plant, and Equipment (PPE)
AASB 116
 Think about this!
https://app.secure.griffith.edu.au/journal/admin/

• What does an asset mean to you?

• What does an asset mean to a company?
• What assets does a business include on its Statement of
Financial Position?
 Assets Defined
An asset is defined as (Conceptual Framework , para 49):
• a resource controlled by the entity as a result of past events and from
which future economic benefits are expected to flow to the entity

Three essential characteristics:

1. Resource must contain future economic benefits
2. Entity must have control over the future economic benefits
3. There must have been a past event

The essential characteristics represent ‘Rules’ to:

• Select which assets are recorded in the financial statements, and
• Reduce overstatement of assets
 Asset Recognition

An asset should be recognised in the Statement of

Financial Position when (Conceptual Framework, para 89):
• It is probable that the future economic benefits will flow to the
entity, and
• The asset has a cost or other value that can be measured reliably

Both criteria must be satisfied!

Represent more ‘rules’ to reduce overstatement in the
financial statements
Woolworths Ltd
 Property, Plant, and Equipment
Why are they Important?
• Size of the Property, Plant, and Equipment (PPE) asset class
– Dependent upon the entity
– PPE can be a large proportion of an entity’s total asset base
– Woolworths Ltd
• 9,600.7 (PPE)/24,205.2 (Total Assets) = 39.66%

• Importance of valuing assets accurately

– Relevance, faithful representation, reliability, comparability
– Financial Ratios
 Property, Plant, and Equipment (PPE)
Nature
AASB 116 (para 6) defines property, plant & equipment as:
– Tangible items
– Assets with a specific use within the entity
– They are expected to be used during more than one period
• Non-current in nature
– Excludes assets held for sale

Normally divided into classes:

– Land
– Buildings
– Machinery
– Motor vehicles
 Property, Plant, and Equipment (PPE)
Initial Recognition
Cost of an item is recognised as an asset if (para 11):
1. It is probable that economic benefits will flow to the entity;
and
2. Cost can be reliably measured
• Where future economic benefits are not expected to flow
to the entity
– Costs incurred should be expensed

• Significant parts (with different useful lives) are required to

be separately accounted for (para 9).
– E.g. Aircraft, Lecture theatre
 Property, Plant, and Equipment (PPE)
Initial Measurement at Acquisition Date
Initially measured at cost which includes (para 16):
1. Purchase price (at fair value)
– Amount given up by the buyer to acquire the asset at
acquisition date
2. Directly attributable costs
– Are the costs directly attributable to bringing the asset to the
location and condition necessary for it to operate?
– If ‘yes’, capitalise cost; If ‘no’ expense.
3. Initial estimate of the costs of dismantling and removing the
item or restoring the location site
– E.g. Off-shore oil platform
 Let’s crunch some numbers…
Magpie Ltd (1)
Magpie Ltd uses many kinds of machines in its operations. It constructs some of these
machines itself and acquires others from the manufacturers. The following information
relates to two machines that it has recorded in the 2017–18 period. Machine A was
acquired, and Machine B was constructed by Magpie Ltd itself on 1 July 2017.
Machine A
Cash paid for equipment, including GST of $8000 $88 000
Costs of transporting machine — insurance and transport 3 000
Labour costs of installation by expert fitter 5 000
Labour costs of testing equipment 4 000
Insurance costs for 2017–18 1 500
Costs of training for personnel who will use the machine 2 500
Costs of safety rails and platforms surrounding machine 6 000
Costs of water devices to keep machine cool 8 000
Costs of adjustments to machine during 2017–18 to make it operate more efficiently 7 500
Machine B
Cost of material to construct machine, including GST of $7000 77 000
Labour costs to construct machine 43 000
Allocated overhead costs — electricity, factory space etc. 22 000
Costs of installation 12 000
Insurance for 2017–18 2 000
Profit saved by self-construction 15 000
Safety inspection costs prior to use 4 000
 Let’s crunch some numbers…
Magpie Ltd (2)
Requirement 1
Determine the amount at which each of these machines should be
recorded in the records of Magpie Ltd. For items not included in the cost
of the machines, note how they should be accounted for.
Cost of Machine A Cost of Machine B
$88,000 Equipment $77,000 Material to construct machine
(8,000) GST (7,000) GST
3,000 Transport 43,000 Labour
5,000 Installation 22,000 Overheads
4,000 Testing 12,000 Installation
6,000 Safety rails 4,000 Safety
8,000 Coolers $151,000
7,500 Adjustments
$113,500
Expense – Insurance and Training Expense – Insurance; Disregard profit saved
 Let’s crunch some numbers…
Magpie Ltd (3)
Requirement 2(a)
Prepare journal entries to record the cost of Machine A and Machine B

Date Details DR CR
1/7/15 Machine A (A↑) 113,500
Cash (A↓) 113,500
Record the cost of Machine A

Date Details DR CR
1/7/15 Machine B (A↑) 151,000
Cash (A↓) 151,000
Record the cost of Machine B
 Let’s crunch some numbers…
Magpie Ltd (4)

Record insurance and training expense

Date Details DR CR
1/7/15 Insurance expense (E↑) (1,500 + 2,000) 3,500
Training expense (E↑) 2,500
Cash (A↓) 6,000
Expense Insurance and Training costs
 Property, Plant, and Equipment (PPE)
Measurement Subsequent to Initial Recognition
AASB 116 (para 29) allows a choice of two possible measurement models:
1. Cost model
2. Revaluation model

• The choice of model is an accounting policy decision based primarily on

the relevance of information

• The policy that is chosen must be applied to a whole class of assets

• May change policy, but only if results in more relevant and/or reliable
information to users

Accounting policy choice allowed by the Standard-Setters at the level of the

financial report preparers (i.e. the company itself has a choice)
 Woolworths Ltd
Notes to the Financial Statements
Note 1 (G):
Property, Plant, and
Equipment (p. 108)

Does WOW use the

cost or revaluation
model?
 Cost Model
• AASB 116 requires that assets are carried at cost less any
accumulated:
– Depreciation
– Impairment losses (Note: Impairment Losses are covered in Topic 6)

• Repair and maintenance costs are expensed as incurred, not

capitalised (para 12)
– Why? These costs keep PPE in the required working condition

• Capitalisation requires increased probable future economic

benefit (at time of expenditure)
– Replacement of a car engine
 Cost Model
Depreciation (1)
AASB 116 (para 6) includes the following definitions:
• Depreciation:
– The systematic allocation of the depreciable amount of an asset
over its useful life
• Depreciable amount:
– The cost of an asset less its residual value
• Residual value:
– The estimated value that an entity would currently obtain from
disposal of the asset at the end of its useful life
• Useful life:
– The period over which an asset is expected to be available for
use by an entity
• Affected by expected usage, physical wear and tear, obsolescence
 Cost Model
Depreciation (2)
• Depreciation is a process of allocation
– Reflects the pattern in which the asset’s future economic benefits
are expected to be consumed by the entity (para 60)
• AASB 116 does not specify how this allocation process
should be undertaken
• Various depreciation methods are used in practice.
• Common methods include:
– Straight line method, Diminishing-balance method, and Units-of-
production method
Depreciation Expense (E↑) DR XXX
Accumulated Depreciation (Contra A↑) CR XXX
In all cases, depreciation expense is recognised with this journal entry
 The Cost Model
Depreciation (3)
• Straight-line method - Provides for the same amount of
depreciation expense for each year of the asset’s useful life
– Annual depreciation = (Cost – Residual Value)/Useful Life
• Diminishing Balance method - Results in a decreasing annual
charge over the useful life of an asset
(Where, n = Useful Life, r = Residual Value, c = Cost)
– If you have to use this method, you will be given the percentage rate
• Units of Production method - A depreciation charge is based on
the expected use or output of the asset
– Step 1: Depreciation per unit = (Cost – Residual Value)/Total units of
production
– Step 2: Depreciation expense = Depreciation per unit x Total units of
output produced
ONLY straight-line method will be examinable in 2102AFE
 Let’s crunch some more numbers…
Magpie Ltd (1)
Machine A has a useful life of 5 years and Machine B has a useful life
of 10 years. Both assets have zero residual value. Both assets are
depreciated on a straight-line basis.

Requirement 2(b):
Prepare journal entries to record depreciation expense for Machine
A and Machine B for the year ended 30 June 2018.

Straight-line depreciation = (cost – residual)/useful life

 Let’s crunch some more numbers…
Magpie Ltd (2)
Depreciation for Machine A
Date Details DR CR
30/6/18 Depreciation expense – Machine A (E↑) $22,700
Accumulated Depreciation expense – Machine A (Contra A↑) $22,700
Annual depreciation expense [($113,500 – 0/5)]

Depreciation for Machine B

Date Details DR CR
30/6/18 Depreciation expense – Machine B (E↑) $15,100
Accumulated Depreciation expense – Machine B (Contra A↑) $15,100
Annual depreciation expense [($151,000 – 0/10)]
 Let’s crunch some more numbers…
Magpie Ltd (3)
Requirement 3
• Where in Magpie Ltd’s annual financial report would you disclose
the value of the equipment?
• What amount would you show for the value of Machine A and
Machine B in that report?
Statement of Financial Position
Non-Current Assets:
Property, Plant & Equipment:
Machine A 113,500
Less: Accumulated Depreciation (22,700) 90,800
Machine B 151,000
Less: Accumulated Depreciation (15,100) 135,900
 The Revaluation Model (1)

• An alternative to the Cost Model

– Subsequent to initial recognition of the asset at cost

• What is an asset revaluation?

– Recognising a reassessment of the carrying amount of a non-
current asset to fair value as at a particular date
• Fair value measured in accordance with AASB 13

• Revaluation model to be used for classes of assets – Why?

1. Limits managements’ ability to ‘cherry-pick’ or select which assets
to revalue
2. Consistent measurement for the same type of assets in entity
 The Revaluation Model (2)
• Measurement basis is fair value (FV) (AASB 13)
– Any revaluation must be to Fair Value (AASB 116)

• Frequency of revaluations is not specified

– Must be performed with sufficient regularity such that the
carrying amount of assets is not materially different from
their FV (para 31)
• Revaluation performed on a class basis
• Accounting performed on an asset-by-asset basis

We will look at accounting for Revaluations in Topic 6

 Asset Derecognition

• Derecognition should occur (para 67):

– Disposal (such as the sale of an asset)
– Where no future economic benefits are expected

• Gain or loss from derecognition

– Included in the profit or loss for the period
– Gains are not classified as revenue (para 68)

• Calculating gain or loss from derecognition

– Difference between the net disposal proceeds from sale and
carrying amount of the asset (para 71)
 Derecognition
Cost Model
On sale of an item of PPE, the entity must:
1. Account for depreciation from the beginning of the period to the
date of sale
Depreciation Expense (E↑) DR XXX
Accumulated Depreciation (Contra A↑) CR XXX
To record depreciation expense from XX/XX/20XX to XX/XX/20XX

2. Account for the sale and recognise a gain or loss on sale

Cash (A↑) DR XXX
Accumulated Depreciation (Contra A↓) DR XXX
Loss on sale of Asset (if applicable) (E↑) DR XXX
Asset (A↓) CR XXX
Gain on sale of Asset (if applicable) (OCI↑) CR XXX
To record gain/loss on disposal of asset
 Derecognition – Cost Model
Magpie Ltd (1)

On 31st December 2018, Magpie Ltd sold Machine A

for $90,000.

Requirement 4:
Provide journal entries to record the sale of Machine A in
the accounts of Magpie Ltd
 Derecognition – Cost Model
Magpie Ltd (2)
Step 1: Account for depreciation from the beginning of the period to
the date of sale
Date Details DR CR
31/12/18 Depreciation expense – Machine A (E↑) $11,350
Accumulated Depreciation expense – Machine A (Contra A↑) $11,350
Record ½ year depreciation to date of sale (1/7/18 to 31/12/18)

Workings:
• How long has Magpie held Machine A for?
• 1.5 years (1/7/17 – 31/12/18)
• Accumulated depreciation on the date of sale:
• 1 year = $22,700 (already recorded), plus
• ½ year = $11,350 ($22,700/2) (not yet recorded)
• Need to update depreciation to date of sale
 Derecognition – Cost Model
Magpie Ltd (3)
Strategy:
1. Remove the balance from the Machine A account

2. Remove the balance from the Accumulated Depreciation

Machine A account

3. Record Gain or Loss on disposal of Machine A

4. Record receipt of cash on disposal

 Derecognition – Cost Model
Magpie Ltd (4)
Step 2: Account for the sale and recognise a gain or loss on sale
Cash (received for asset sold) (A↑) DR 90,000
Accumulated Depreciation (CA↑) DR 34,050
Machine A (A↓) (original cost of asset) CR 113,500
Gain on sale of Machine A (OCI↑) CR 10,550
To record gain on disposal of Machine A

Workings:
• Written down value on date of sale (cost less accumulated depreciation):
• $79,450 ($113,500 – [22,700 + 11,350])
• Gain/loss on sale of Machine A:
• $10,550 (Proceeds of sale $90,000 – Written down value $79,450)
 Fair Value Measurement
AASB13

Valuing Assets on the Statement of Financial Position

 The Need for a Standard on
Fair Value Measurement
• Fair value is used as a measure of assets at some point in
many accounting standards (AASBs)
• Corporate collapses and accounting scandals in the U.S.
involved irregularities in fair value numbers
• Prior to the introduction of AASB 13/IFRS 13 in 2011, many
standards defined fair value as:
‘the amount for which an asset could be exchanged, or a
liability settled, between knowledgeable, willing parties in
an arm’s length transaction’.

• Measurement is based on a hypothetical transaction

 New Definition of Fair Value

Fair value is defined as (Appendix A, AASB 13):

‘the price that would be received to sell an asset or paid to
transfer a liability in an orderly transaction between market
participants at the measurement date.’

Key Elements:
1. Exit Price
2. Orderly transactions
3. Market participants
 Fair Value Definition – Elements
1. Exit Price
Current Exit Price:
‘The price that would be received to sell an asset or paid to
transfer a liability’

Based on:
• The perspective of the entity that holds the asset or owes the
liability
• Expectations about future cash flows that will be generated by
the asset/liability subsequent to the sale/transfer
 Fair Value Definition – Elements
2. Orderly Transactions
‘a transaction that assumes exposure to the market for a
period before the measurement date to allow for marketing
activities that are usual and customary for transactions
involving such assets or liabilities’

Key issues:
• Refers to transactions made under normal market conditions
• Excludes sales made under liquidation or ‘fire sale’ conditions
• Excludes non-arms length sales
 Fair Value Definition – Elements
3. Market Participants
Buyers and sellers in the principal market for the asset

Criteria:
• Must be independent from each other
• Must be knowledgeable about the asset or liability
• Must have the ability to enter into the transaction
• Must not be forced or compelled
 Fair Value Definition – Elements
Transaction and Transportation Costs (1)
Transactions Costs:
• Transactions costs are incremental direct costs that would not
have been incurred had the decisions to sell the asset/transfer
the liability not been made

Transportation Costs:
• Transport costs are the costs incurred to transport an asset from
its current location to its principal market

Both affect the determination of fair value and are relevant in

determining the most advantageous market.
• However, the price used to measure Fair Value is NOT adjusted
for these costs
 Fair Value Definition – Elements
Transaction and Transportation Costs (2)
 Fair Value Measurement Process

Four step process in making a FV measurement:

1. Determine the asset that is to be measured
2. For a non-financial asset, determine the valuation
premise that is appropriate
3. Determine the principal or most advantageous market
4. Determine the appropriate valuation technique(s)
 Step 1
Determine the Asset to be Measured
Involves considering characteristics that market participants
would take into account when pricing an asset or liability
Relevant questions to consider include:
• What is the location of the asset?
• What is the condition of the asset?
• Are there any restrictions on sale or use of the asset?
• Is the asset or liability a stand-alone asset or it is a group of
assets?
 Step 2
Determine the Valuation Premise (1)
Fair value is measured by considering the highest and
best use of an asset:
‘...the use of a non-financial asset by market participants that
would maximise the value of the asset or the group of assets and
liabilities (e.g. a business) within which the asset would be used.’

• These uses must be physically possible, legally permissible, and

financially feasible
• The highest and best use is from the perspective of the market
participant, not the holder
 Step 2
Determine the Valuation Premise (2)
In-combination valuation premise:
• Where market participants would obtain maximum benefit principally
through using the asset in combination with other assets and
liabilities as a group
• Asset will be sold as an individual asset, not as a group
– Asset will be used by the market participant in conjunction with other
assets

Stand-alone valuation premise:

• Where market participants would obtain maximum benefit principally
through using the asset on a stand-alone basis
• The asset will not be used in combination with other assets
 Step 3
Determine the Principal or Most
Advantageous Market
FV measurement assumes that the transaction takes place in the principal
market or, in the absence of a principal market, the most advantageous
market
• Principal market:
– The market with the greatest volume and level of activity
• Most advantageous market:
– The market that would maximise the amount received/paid after deducting
transaction and transport costs
 Step 4
Determine the Appropriate
Valuation Technique
• Objective of the valuation technique selected:
– Estimate the price at which an orderly transactions would
take place between market participants under current market
conditions.
• Three possible valuation techniques exist:
1. Market approach
2. Cost approach
3. Income approach
• Judgement is required to select the most appropriate
technique for the situation
 Step 4
Determine the Appropriate Valuation
Technique - Inputs
When applying a technique the use of observable inputs
needs to be maximised and unobservable inputs minimised:
– Observable inputs
• Developed using market data, such as publicly available
information
– Unobservable inputs
• Those where market data is not available and are
developed using the best information available
• To achieve consistency and comparability AASB 13
provides a hierarchy of inputs
 Fair Value Hierarchy
The hierarchy shows which inputs are given higher priority in determining a
fair value measurement

Level 1 Inputs Level 2 Inputs Level 3 Inputs

Quoted prices Inputs other than quoted

(unadjusted) in active prices included within
markets for identical Level 1 that are Unobservable inputs
assets that the entity can observable for the asset, for the asset
access at the either directly or
measurement date indirectly

Financial assets, such Buildings held and Accounts receivable,

as shares used trademarks
 Fair Value of Assets
in the Real World
1. How reliable are the FV numbers?
2. Does past experience warn us against the extensive
use of FV?
3. Are the FV measures that are not based on directly
observable market prices costly to determine?
4. Should measures based on unobservable inputs be
called FV?

Article: “Charles Lee: Why Fair Value Accounting Isn’t Fair”

Next Week – Topic 3

Assets Part II
Intangible Assets