Accounting for acquisition of PPE

Once the cost is determined, entity will make the required accounting entries to record the asset. Entity may buy the asset on:

  1. Cash basis; paying for asset in cash or cash equivalent
  2. Credit basis; payment is delayed for certain period, usually less than year, thus creating a liability at the time of acquisition
  3. Exchange basis or trade-in basis; giving up old asset as part or complete payment for in exchange of newer asset and may or may involve additional cash payment at the time of acquisition or later.
  4. Lump-sum basis; acquiring multiple asset against a single payment
  5. Deferred payment basis; where payment is deferred for a period longer than one accounting period or simply more than a year’s time.

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1 Accounting – Cash basis acquisition of PPE

If item of property, plant and equipment is acquired on cash basis then its a simple transaction of one asset increasing and the other decreasing.

For example entity bought a machinery of $100,000 paying by cash then journal entry will be as follows:

Machinery a/c 100,000
Cash a/c 100,000

Similarly, if asset is bought paying by cheque then bank account will be credited. For example if entity bought printer to be used in head office for $2,000 and paid the supplier via cheque then journal entry will be:

Office equipment a/c 2,000
Bank a/c 2,000

2 Accounting – PPE acquired on credit basis

Entity may acquire an asset on credit basis meaning that payment will be made at a later date. This will create a liability at the time of acquisition which is recorded by crediting an account with appropriate title which is usually the name of supplier.

For example a building is acquired by business worth $20,000 and promised to pay the full amount in 2 months time to Momhil Plc. This will be recorded as follows:

Building a/c 20,000
Momhil Plc a/c 20,000

3 Accounting – PPE acquired on exchange basis

Sometimes entity acquires a new asset in exchange of old one. As new asset is coming in and old asset is going out therefore it is acquisition and disposal of asset at the same time. As the value of outgoing asset and incoming asset are connected, it sometimes get tricky and care must be taken in calculating the values.

We must know either the value of new asset or the disposal consideration of old asset and we can work out the other easily.

For example a new asset worth 10,000 is acquired and no payment is made to supplier except that entity gave and old asset in exchange. In this case disposal consideration of old asset is 10,000

Another example can be where entity acquired new asset that has a fair value of 15,000. Entity paid 7,500 in cash and also gave a used asset as part of purchase consideration. In this case the disposal value of old asset can be found using this simple formula:

New asset value = Cash + Old asset sales value
15,000 = 7,500 + Old asset sales value
15,000 – 7,000 = Old asset sales value
Old asset sales value = 7,500

We will discuss the journal entries for this case later in the section Disposal of property, plant and equipment

4 Accounting – PPE acquired on Lump-sum basis

If multiple assets are acquired as part of one deal for which a single payment is made it is called lump-sum purchase.

For example entity has acquired land, building and installed machinery for 200,000. Although all assets are acquired under one deal, we still have to recognize the assets separately in the statement of financial position thus we need to know the values of each individual assets.

To allocate the purchase consideration entity use relative fair values of asset and divide the total consideration on pro-rata basis. If it is not possible to determine the fair values of assets then there are other allocation basis available like future income basis, replacement cost basis. Entity is required to use such basis of allocation that render true and fair values of assets.

Example – Lump-sum purchase of property, plant and equipment

Rush Inc. has acquired new assets to expand its business to northern areas of Pakistan. Assets acquired include building, office equipment and piece of land. A single payment of 200,000 was made.

Fair values of similar type of assets in the region are as follows:

Building 81,000
Land 100,000
Office Equipment 50,000
231,000

Give the journal to record the assets in books of Rush Inc.

Solution:

First we need to find the values of each asset from total purchase value using relative fair values of asset. Following table shows the working:

Fair value % fair value % Cost Value
Building 81,000 81,000 / 231,000 200,000 x 0.35 70000
Land 100,000 100,000 / 231,000 200,000 x 0.43 86000
Office Equipment 50,000 50,000 / 231,000 200,000 x 0.22 44000
231,000 200000

The journal entry to recognize assets will be:

Building a/c 70,000
Land a/c 86,000
Office equipment a/c 44,000
Cash a/c 200,000

5 Accounting – PPE acquired on Deferred payment basis

Entities may acquire asset on such contracts where payment has been delayed for significant period of time. Unlike credit basis purchase where payment is made in few months time, in deferred payment contracts actual cash outflow may occur after 5 years or 10 years of actual purchase.

Under such contracts, the deferred portion of consideration will be recorded on present value basis in the cost of assets. However, unwinding charge will be treated as finance cost for the period and recorded in the income statement instead of being capitalized as cost of the asset.

To make proper calculations, discount rate to be used for present value calculation must be known and the period over which payment is deferred must also known with certainty. Usually it is written as part of contract or a separate instrument is used like bond.

Example – Purchasing PPE on deferred payment basis

Miyar & Co works on restoration of glaciers around the world. In order to dig a tunnel to reach one remote glacier in Hopar valley, company has acquired a digger that cost $1.5 million at the first day of the year.

Under the contract Miyar will pay $1 million upfront whereas $500,000 will be paid after 5 years from today. Applicable discount rate is found to be 10%.

Give the journal entries to record above transaction

Solution:

First we have to calculate the cost of asset to be recognized. For that we need to calculate the present value (PV) of $500,000 which can be done using a formula or discount table.

Formula for PV calculation is: 1/(1+r)n

where “r” is discount rate and “n” is the number of years. Following table shows the calculation:

Cash payment1,000,000
Deferred payment: 500,000

Present value:
= 500,000 / (1+0.1)5
= 500,000 / 1.61051
= 310,461





310,461
Total1,310,461

Journal entry at the time of acquisition will be:

Machinery a/c 1,310,461
Cash a/c 1,000,000
Deferred payment liability a/c 310,461

Journal entry at the end of the year:

As the asset is acquired at the start of the year therefore, by the end of first year, entity will have to record to unwinding of long term liability i.e. reversal of discount recorded but only that pertains to first year as follows:

Deferred payment liability 310,461
Add: unwinding of discount treated as interest expense
(310,461 x 0.1 = 31,046)
31,046
341,057