Information Sheet OAcc-413-10

PROPERTY, PLANT & EQUIPMENT

Learning Objectives:
After reading this INFORMATION SHEET, YOU MUST be able to:
1. Identify processes involved in the acquisition of property, plant & equipment.
2. Understand the different methods of computing for depreciation.

RAIZA AND NOEMI

Property, Plant, and Equipment – PP&E

What Is Property, Plant, and Equipment – PP&E?

Property, plant, and equipment (PP&E) are long-term assets vital to business
operations and not easily converted into cash. Property, plant, and
equipment are tangible assets, meaning they are physical in nature or can be
touched. The total value of PP&E can range from very low to extremely high
compared to total assets. It is important to note when calculating equity.

PP&E Formula and Calculation

Analyst and others will use the PP&E of a company to determine if it is on a
sound financial footing and utilizing funds in the most efficient and effective
manner.

Net PPE=Gross PPE+Capital Expenditures−ADwhere:AD=Accumulated depreciation

To calculate PP&E add the amount of gross property, plant, and equipment,
listed on the balance sheet, to capital expenditures. Next, subtract accumulated
depreciation from the result.
As a reminder, accumulated depreciation is the total amount of a company's cost
allocated to depreciation expense since the asset was put into
use. Depreciation is the process of allocating the cost of a tangible asset over
its
useful life and is used to account for declines in value. In most cases,
companies
will list their net PP&E on their balance sheet when reporting financial results,
so the calculation has already been done.

✓ KEY TAKEAWAYS
• Property, plant, and equipment are also called fixed assets, meaning they
are physical assets that a company cannot easily liquidate.
• PP&E are long-term assets vital to business operations and the long-term
financial health of a company.
• Purchases of PP&E are a signal that management has faith in the longterm
outlook and profitability of its company.
RAIZA AND NOEMI
Information From PP&E

Property, plant, and equipment are also called fixed assets, meaning they are
physical assets that a company cannot easily liquidate.

PP&E falls under the category of noncurrent assets, which are the long-term
investments or assets of a company. Noncurrent assets like PP&E have a useful
life of more than one year. Typically, noncurrent assets last many years and are
considered illiquid, meaning they can't be easily liquidated into cash.
Noncurrent assets are the opposite of current assets. Current assets are short-
term assets,
which are assets on the balance sheet that is likely to be converted into cash
within one year.

Investing in PP&E
A company investing in PP&E is a good sign for investors. A fixed asset is a
sizable investment in a company's future. Purchases of PP&E are a signal that
management has faith in the long-term outlook and profitability of its company.
PP&E are physical, tangible assets expected to generate economic benefits and
contribute to revenue for many years.

Investment in PP&E is also called a capital investment. Industries or businesses

that require a large number of fixed assets like PP&E are described as capital
intensive.

Liquidating PP&E
PP&E may be liquidated when they are no longer of use or when a company is
experiencing financial difficulties. Of course, selling property, plant, and
equipment to fund business operations is a signal that a company might be in
financial trouble. It is important to note that regardless of the reason a
company
has sold some of its property, plant, or equipment, it's unlikely the company
didn't realize a profit from the sale.

Accounting for PP&E

PP&E is recorded on a company's financial statements, specifically on the
balance sheet. PP&E is initially measured according to its historical cost, which
is the actual purchase cost and the costs associated with bringing assets to its
intended use.
For example, when purchasing a building for retail operations, the historical
cost could include the purchase price, transaction fees, and any improvements
made to the building to bring it to its destined use. The value of PP&E is
adjusted
routinely as fixed assets generally see a decline in value due to use and
depreciation.

Amortization is used to devalue these assets as they are used. However, the land
is not amortized because of its potential to appreciate in value. Instead, it is
represented at its current market value. The balance of the PP&E account is
remeasured every reporting period, and, after accounting for historical cost and
amortization, is called the book value. This figure is reported on the balance
sheet.

There are essentially four key areas when accounting for property, plant, and
equipment that you must ensure that you are familiar with:
• initial recognition
• depreciation
• revaluation
• derecognition (disposals)
FRISM AND ANNALYN

Depreciation
Depreciation of fixed assets must be calculated to account for the wear and
tear on business assets over time. As depreciation is a non-cash expense, the
amount must be estimated. Each year a certain amount of depreciation is
written off and the book value of the asset is reduced.
What is Depreciation?

In accounting terms, depreciation is defined as the reduction of recorded cost

of a fixed asset in a systematic manner until the value of the asset becomes
zero or negligible.

An example of fixed assets are buildings, furniture, office equipment,

machinery, etc. The land is the only exception that cannot be depreciated as
the value of land appreciates with time.

Depreciation allows a portion of the cost of a fixed asset to the revenue

generated by the fixed asset. This is mandatory under the matching principle
as revenues are recorded with their associated expenses in the accounting
period when the asset is in use. This helps in getting a complete picture of the
revenue generation transaction.

An example of Depreciation – If a delivery truck is purchased a company with

a cost of Rs. 100,000 and the expected usage of the truck are 5 years, the
business might depreciate the asset under depreciation expense as Rs. 20,000
every year for a period of 5 years.

How to calculate depreciation in small business?

These three methods commonly used to calculate depreciation. They are:
1. Straight-line method
2. Unit of production method
3. Double-declining balance method

Three main inputs are required to calculate depreciation:

1. Useful life – this is the time period over which the organization considers
the
fixed asset to be productive. Beyond its useful life, the fixed asset is no
longer cost-effective to continue the operation of the asset.
2. Salvage value – Post the useful life of the fixed asset, the company may
consider selling it at a reduced amount. This is known as the salvage value
of the asset.
3. The cost of the asset – this includes taxes, shipping, and preparation/setup
expenses.

Unit of production method needs the number of units used during production.
Let’s take a look at each type of Depreciation method in detail.

Types of depreciation
1) Straight-line depreciation method
This is the simplest method of all. It involves a simple allocation of an even
rate
of depreciation every year over the useful life of the asset. The formula for
straight-line depreciation is:
Annual Depreciation expense = (Asset cost – Residual Value) / Useful life of the
asset
Example – Suppose a manufacturing company purchases machinery for Rs.
100,000 and the useful life of the machinery are 10 years and the residual
value of the machinery is Rs. 20,000
Annual Depreciation expense = (100,000-20,000) / 10 = Rs. 8,000
Thus the company can take Rs. 8000 as the depreciation expense every year
over the next ten years as shown in the depreciation table below.

2) Unit of Production method

This is a two-step process, unlike the straight line method. Here, equal expense
rates are assigned to each unit produced. This assignment makes the method
very useful in assembly for production lines. Hence, the calculation is based on
the output capability of the asset rather than the number of years.
The steps are:

Step 1: Calculate per unit depreciation:

Per unit Depreciation = (Asset cost – Residual value) / Useful life in units of
Production
Step 2: Calculate the total depreciation of actual units produced:
Total Depreciation Expense = Per Unit Depreciation * Units Produced

Example: ABC company purchases a printing press to print flyers for Php.
40,000 with a useful life of 180,000 units and a residual value of Php 4000. It
prints 4000 flyers.

Step 1: Per unit Depreciation = (40,000-4000)/180,000 = Php 0.2

Step 2: Total Depreciation expense = Rs. 0.2 * 4000 flyers = Php. 800

So, the total Depreciation expense is Php. 800 which is accounted. Once the
per-unit depreciation is found out, it can be applied to future output runs.

3) Double declining method

This is one of the two common methods a company uses to account for the
expenses of a fixed asset. This is an accelerated depreciation method. As the
name suggests, it counts expense twice as much as the book value of the asset
every year.

The formula is:

Depreciation = 2 * Straight-line depreciation percent * book value at the

beginning of the accounting period

Book value = Cost of the asset – accumulated depreciation

Accumulated depreciation is the total depreciation of the fixed asset
accumulated up to a specified time.

Example: On April 1, 2012, company X purchased equipment for Rs. 100,000.

This is expected to have 5 useful life years. The salvage value is Php. 14,000.

Company X considers depreciation expense for the nearest whole month.

Calculate the depreciation expenses for 2012, 2013, 2014 using a declining
balance method.

Useful life = 5
Straight line depreciation percent = 1/5 = 0.2 or 20% per year
Depreciation rate = 20% * 2 = 40% per year
Depreciation for the year 2012 = Php 100,000 * 40% * 9/12 = Php 30,000
Depreciation for the year 2013 = (Php. 100,000-Rs. 30,000) * 40% * 12/12 =
28,000
Depreciation for the year 2014 = (Php 100,000 – 30,000 – 28,000) * 40% * 9/12
= 16,800

Depreciation for 2016 is Rs. 1,120 to keep the book value the same as salvage
value.
Rs. 15,120 – Rs. 14,000 = Rs. 1,120 (At this point the depreciation should
stop).
Why should small businesses care to record depreciation?
Over the useful life of the fixed asset, the cost is moved from balance sheet to
income statement. Alternatively, it is just an allocation process as per the
matching principle instead of a technique that determines the fair market value
of the fixed asset.
Accounting entry – DEBIT depreciation expense account
and CREDIT accumulated depreciation account

If we do not use depreciation in accounting, then we have to charge all assets

to expense once they are bought. This will result in huge losses in the following
transaction period and high profitability in periods when the corresponding
revenue is considered without an offset expense. Hence, companies that do not
use the depreciation expense in their accounts will incur front-loaded expenses
and highly variable financial results.
Final Notes
Depreciation is an important part of accounting records which helps companies
maintain their income statement and balance sheet properly with the right
profits recorded. Using good business accounting software can help you record
the depreciation correctly without making manual mistakes.
You can try Profit Books. It is simple accounting software which lets you create
professional invoices,
JASMIN AND ERA

How Do Tangible and Intangible Assets Differ?

There are two types of categories of assets called tangible and intangible
assets. Tangible assets are typically physical assets or property owned by a
company, such as a computer equipment. Tangible assets are the main type of
assets that companies use to produce their product and service.

Intangible assets don't physically exist, yet are they have a monetary value
since
they represent potential revenue. A type of intangible asset could be a copyright
to a song. The record company that owns the copyright would get paid a royalty
each time the song is played.

There are various types of assets that could be considered tangible or

intangible, Some of which are short-term or long-term assets.

✓ KEY TAKEAWAYS
• Tangible assets are typically physical assets or property owned by
a company, such as equipment, buildings, and inventory.
• Tangible assets are the main type of assets that companies use to
produce their product and service.
• Intangible assets are non-physical assets that have a monetary
value since they represent potential revenue.
• Intangible assets include patents, copyrights, and a company's
brand.

There are various types of assets that could be considered tangible or

intangible,
some of which are short-term or long-term assets.

✓ KEY TAKEAWAYS
• Tangible assets are typically physical assets or property owned by a
company, such as equipment, buildings, and inventory.
• Tangible assets are the main type of assets that companies use to
produce their product and service.
• Intangible assets are non-physical assets that have a monetary value
since they represent potential revenue.
• Intangible assets include patents, copyrights, and a company's brand.
Understanding How Tangible and Intangible Assets Differ
Tangible assets form the backbone of a company's business by providing the
means to which companies produce their goods and services. Tangible assets
can be damaged by naturally occurring incidence since they are physical assets.
Intangible assets are the non-physical assets that add to a company's future
value or worth and can be far more valuable than tangible assets. Both of these
types of assets are initially recorded on the balance sheet, which helps
investors, creditors, and banks assess the value of the company.

Tangible Assets

Tangible assets are physical and measurable assets that are used in a company's
operations. Assets like property, plant, and equipment, are tangible assets.
These assets include:
• Land
• Vehicles
• Equipment
• Machinery
• Furniture
• Inventory
• Securities like stocks, bonds, and cash

There are two types of tangible assets:

1. Current Assets
Current assets include items such as cash, inventory, and marketable securities.
These items are typically used within a year and, thus, can be more readily sold
to raise cash for emergencies.

2. Fixed Assets
Fixed assets are non-current assets that a company uses in its business
operations for more than a year.

They are recorded on the balance sheet as Property, Plant, and

Equipment (PP&E), and include assets such as trucks, machinery, office
furniture, buildings, etc. The money that a company generates using tangible
assets is recorded on the income statement as revenue. Fixed assets are needed
to run the business continually.

Intangible Assets

Intangible assets are typically nonphysical assets used over the longterm.
Intangible assets are often intellectual assets, and as a result, it's difficult
to assign a value to them because of the uncertainty of future benefits.
Intangible assets are intellectual property that includes:
• Patents, which provide property rights to an inventor
• Trademarks, which are a recognizable phrase or symbol that denotes a
specific product and differentiates a company
• Franchises, which are a type of license that a party (franchisee) buys to
allow them to have access to a company's brand and sell goods under
their name
• Goodwill, which represents the value above and beyond a target
company's assets that another company pays to acquire them
• Copyrights, which represents intellectual property that's protected from
being duplicated by non-authorized parties

How are fixed assets reported on the balance sheet?

A company's fixed assets are reported in the noncurrent (or longterm) asset
section of the balance sheet in the section described as property,
plant, and equipment.
The fixed assets except for land will be depreciated and their accumulated
depreciation will also be reported under property, plant, and equipment