MECHINERY AND
EQUIPMENT
EVALUATION
TECHNICAL KNOWLEDGE
To identify the costs normally charged to machinery
when purchased.
To know the accounting treatment of capital
expenditure and revenue expenditure.
To recognize additions, improvements or
betterments, replacements, repairs and
rearrangement cost.
MACHINERY
a. Purchase price
b. Freight, handling, storage and other cost related to the acquisition
c. Insurance while in transit
d. Installation cost, including site preparation and assembling
e. Cost of testing and trial run, and other cost necessary in preparing the machinery
for its intended use.
f. Initial estimate of cost of dismantling and removing the machinery and restoring
the site on which it is located and for which the entity has a present obligation as
required by law or contract.
g. Fee paid to consultants for advice on the acquisition of the machinery.
h. Cost of safety rail and platform surrounding machine.
i. Cost of water device to keep machine cool.
j. Cost of adjustment changes to the machine prior to use to make it operate more
efficiently.
Tools Patterns and dies
Tools are classified Patterns and dies are
as machine tools essential for designing
and hand tools and forging products.
Equipment Returnable containers
The term "equipment" Returnable containers are items
includes delivery equipment, like bottles, boxes, tanks, drums,
store equipment, office and barrels that buyers return to
equipment and furniture and the seller after using or
fixtures. consuming their contents.
CAPITAL EXPENDITURE AND REVENUE
EXPENDITURE
An expenditure that benefits only the current period is a revenue expenditure
and therefore reported as an expense.
RECOGNITION OF SUBSEQUENT COST
The subsequent cost of property, plant, and equipment is recognized using
the same criteria as the initial cost.
FUTURE ECONOMIC BENEFIT
In general, a subsequent cost on an item of property, plant and equipment
will benefit future periods or increase the future service potential of an asset
when:
Subsequent cost
a. Additions
[Link] or betterments
c. Replacements
d. Repairs
e. Rearrangement cost
Additions
Additions are modifications or alterations which increase the physical size or
capacity of the asset. Such expenditures are of two types, namely:
a. An entirely new unit
b. An expansion, enlargement or extension of the old asset
Improvements or betterments
Improvements or betterments are modifications or alternations which
increase the service life or the capacity of the asset.
Improvements may involve replacing an asset or a component with one of
better or superior quality. These expenditures are typically capitalized.
Replacements
Replacements also involve substitution but the new asset is not better than
the old asset when acquired.
An improvement replaces a superior quality item, while a replacement uses
an equal or lesser quality item, which can be categorized into three types.
Repairs
Repairs are expenditures incurred to restore asset to good operating
condition upon breakdown or replacement of broken parts. Repairs
may be classified as extraordinary repairs and ordinary repairs.
Repair and maintenance
Repair differs from maintenance in that repair restores an asset to
good operating condition, while maintenance keeps the asset in
good condition
Rearrangement cost
Rearrangement is the costs of relocating existing property, plant, and
equipment, or reorganizing part or all of an entity's operations, are not
capitalized but should be expensed as incurred.
Accounting for major replacement
The accounting treatment for a replacement depends on
whether the original asset's part is identifiable separately.
If separate identification is practicable, the major replacement
is debited to the asset account.
Accounting for major improvement
A major improvement that doesn't replace a part or extend the asset's
useful life is directly added to or debited to the asset account.
However, the major improvement that extends the useful life of the
asset may be debited to accumulated depreciation.
DEPRECIATION
METHOD
DEPRECIATION METHOD
The depreciation method shall reflect the pattern in
which the future economic benefits from the asset
are expected to be consumed by the entity.
The depreciation method shall be reviewed at least
at every year-end.
The depreciation method should be changed if there
is a significant shift in the expected pattern of future
economic benefits, and such a change is treated as a
change in accounting estimate.
Methods of depreciation
1. Equal or uniform charge methods
a. Straight line
b. Composite method
c. Group method
2. Variable charge or use-factor or activity methods
a. Working hours or service hours
b. Output or production method
3. Decreasing charge or accelerated or diminishing balance methods
a. Sum of years' digits
b. Declining balance method
c. Double declining balance
4. Other methods
a. Inventory method
b. Retirement method
c. Replacement method
Straight line method
Under the straight-line method, the annual depreciation charge is calculated by
evenly distributing the depreciable amount over the estimated useful life of the
asset.
The formula for the computation of the annual depreciation following the straight
line method is as follows:
cost minus residual value
Annuel depreciation=
Useful life in years
Cost minus residual value equals depreciable amount.
Straight line rate
Depreciable amount multiplied by the straight line rate of depreciation also
gives the amount of annual depreciation.
The straight line rate is determined by dividing 100% by the life of the asset
in years.
Rationale for straight line
The straight line method is adopted when the principal cause of
depreciation is passage of time.
The straight line approach considers depreciation as a function of time
rather than as a function of usage.
ILLUSTRATION
The following data relate to an equipment acquired at the beginning of the
first year:
Equipment at acquisition cost 105,000
Residual value 5,000
Useful life 5 YEARS
Depreciation table - straight line
100,000
Composite and group method
Large entities own various individual depreciable assets. For these entities, making
detailed depreciation computation for each individual asset referred to as unit
depreciation is time consuming and costly.
The two methods of depreciating various individual assets as a single asset are
composite method and group method.
Accounting procedures
a. Depreciation is reported in a single accumulated depreciation account. Thus, the
accumulated depreciation account is not related to any specific asset account.
b. The composite or group rate is multiplied by the total cost of the assets in the
group to get the periodic depreciation.
c. When an asset in the group is retired, no gain or loss is reported. The asset
ascount is credited for the cost of the asset retired and the accumulated
depreciation account is debited for the cost minus salvage proceeds.
d. When the asset retired is replaced by a similar asset, the replacement is recorded
by debiting the asset account and crediting cash or other appropriate account.
Composite method
The following computation is necessary in determining the composite life and
composite rate:
The composite life is determined by dividing the total depreciable amount by total annual
depreciation.
Thus, P900,000 divided by P90,000 equals 10 years.
The composite rate is determined by dividing the total annual depreciation by the total cost.
Thus, P90,000 divided by P1,000,000 equals 9% composite rate.
All of the assets in the group are acquired at the beginning of current year. The annual
depreciation for the current year is simply recorded.
Retirement of asset in the group
It the equipment is retired after four years and sold for P20,000:
Cash 20,000
Accumulated depreciation 110,000
Equipment 130,000
If there are no proceeds from the retirement of the equipment, the accumulated
depreciation is simply debited for the cost of the asset.
Accumulated depreciation 130,000
Equipment 130,000
Retirement of asset in the group
After the retirement of the equipment, the remaining cost of the assets in group is
P870,000.
Total cost 1,000,000
Cost of Equipment retired (130,000)
Remaining cost 870,000
Consequently, the annual depreciation is no longer P90,000. The annual
depreciation starting the fifth year would be P78,300, computed by
multiplying the composite rate of 9% by the remaining cost of P870,000.
Retirement and replacement of asset
Upon the retirement of the equipment, the same is replaced by a similar asset costing
P160,000. P1,030,000. Thus, the total cost of the assets in the group is now P1,030,000
Depreciation shall be discontinued when the same would result to a carrying amount of
the assets in the group below the residual value of the assets in the group.
Variable charge or activity methods
The variable or activity methods assume that depreciation is more a function of use
rather than passage of time.
There are two variable methods, namely:
a. Working hours method
b. Output or production method
Rationale for variable depreciation
The variable methods are adopted if the principal cause of depreciation is usage.
The use of these methods is based on the following:
a. Assets depreciate more rapidly if they are used full time or overtime.
b. There is a direct relationship between utilization of assets and realization of
revenue. If assets are used more intensively in production, greater revenue is
expected.
If assets are used more intensively in production, greater revenue is expected.
The major objection to these methods is that the units of output or service hours
which serve as the basis of depreciation may be difficult to estimate.
ILLUSTRATION
Machinery at cost 600,000
Residual value None
Estimated useful life
Year 5 Years
Service hours 60,000 hours
Output 150,000 units
Working hours method
Under this method, a depreciation rate per hour is computed by dividing the
depreciable amount by the estimated usefui life in terms of service hours.
Thus, the rate per hour is P10, computed by dividing P600,000 by 60,000 hours.
The depreciation rate per hour is then multiplied by the actua hours worked in one
period to get the depreciation for that period.
Depreciation Table - Working Hours Method
Output or production method
The output or production method results in a charge based on the expected use or
output.
Under this method, a depreciation rate per unit is computed by dividing the
depreciable amount by the estimated useful life in terms of units of output. Thus, the
rate per unit is P4, computed by dividing P600,000 by 150,000 units. The
depreciation rate per unit is then multiplied by the yearly output to get the annual
depreciation.
Depreciation Table - Output Method
Thank You
