Property, Plant &

Equipment

Prepared by Jayadev S.R

What are Property, Plant & Equipment
• Property, Plant, and Equipment (PP&E) are Fixed, tangible capital asset
shown on the balance sheet of a business and is used in its core business
operations to generate revenues and profits.
• PPE are used for more than one accounting period (hence they are Fixed or
Non Current Assets)
• The value of PP&E between companies varies substantially according to the
nature of its business.
• For example, a construction company will generally have a significantly
higher property, plant, and equipment balance than an accounting firm does.
• Examples of PPE are machinery, equipment, vehicles, buildings, land, office
equipment, and furnishings
• Note that, of all these asset classes, land is the only asset that does not
depreciate over time (Quarries, sites used for land refill does not belong to this
category)
• If a company produces machinery (for sale), that machinery is not classified
as property, plant, and equipment, but rather is classified as inventory.
• The same goes for real estate companies that hold buildings and land under
their assets. Their office buildings and land are PP&E, but the houses or land
they sell are inventory.
PPE – is recognized when :-
• It is probable that future economic benefits associated with the asset will
flow to the entity over a period of more than one year; and
• The cost of the asset can be calculated or estimated reliably.
Debit : Property, Plant & Equipment
Credit : Cash/Bank
‘The future economic benefit embodied in an asset is the potential to contribute,
directly or indirectly, to the flow of cash and cash equivalents to the entity’
Initial Recognition : Cost of PPE
• Its purchase price, any import duties, non-refundable taxes, sales discounts,
and rebates.
• Any costs directly attributable to bringing the asset to the location and
condition necessary for it to be operational (such as installation expenses).
• An estimated value of the costs of dismantling and removing the asset and
restoring the site on which it is located. This is commonly referred to as an
asset retirement obligation (ARO). For e.g Cost of decommissioning Nuclear
Plants, Oil rigs
• Estimate Value = Present Value of Future dismantling Costs
Land Cost
Purchase Price
Broker, Legal Fees etc.
Cost to demolish an old
existing building
Cost of Site development-
getting land ready for
intended use
Land Improvement Costs
are not part of Land Cost.
E.g Cost of Fencing,
Sidewalk, Water system etc.
Building Cost Equipment Cost
Purchase Price Purchase Price Less
Discounts
Architect Fees Sales & Excise Taxes
Alterations & Legal Fees, Transportation
improvements Charges
Capitalized Interest (Self Capitalized Interest (Self
constructed Asset) constructed Asset)
Repair Charges neglected
by the previous owner now
incurred
Costs incurred after Acquisition
• Revenue Expenses – These are normal and recurring expenses mainly
repairs and maintenance expenses to keep an asset in or restore an asset to its
normal operation condition.
• If they are incurred :
– On Factory Machine – add to Cost of Goods Sold
– On head quarters – add to General & Administrative Expenses
– On delivery truck – add to Selling Expenses
• Repairs & Maintenance Cost are generally charged to Income Statement.
• Capital Expenses (CapEx) – These are not normal and non-recurring
expenses which increases the Carrying Value of the Asset.
• These expenses have a benefit of more than 1 year by making the asset
Bigger, Better and Longer.
 Bigger - Extension, expansion, enlargement of an existing facility
thereby increasing the production capacity
 Better – Reinstallations & rearrangements improving efficiency (e.g
less fuel consumption) and productivity (more output)
 Longer – Major or extraordinary repairs extends the useful life of an
asset. (may increase the efficiency and productivity as well)
• For Asset replacements, the old cost of the asset is derecognized from the
company’s books and the cost of the new replacement is recognized.
Presentation of PPE in Balance Sheet
• The PP&E account is often denoted as net of accumulated depreciation in the
Balance Sheet
Depreciation
• Depreciation allocates the Cost of an Asset to the period benefitted in line
with the Matching Concept. I.e. Matching Revenue generated in a period
with its related expenses
• Depreciation Expense is the systematic allocation of depreciable amount of an
asset over its useful economic life. (Depreciable Amount = Cost of Asset Less
Scrap Value of the Asset)
• Depreciation expenses are charged to Income Statement under 2 heads COGS
and Selling, General & Administrative Expenses.
• Depreciation is a Non-Cash expense, meaning no Cash flows out of the entity.
Depreciation Methods
• Straight Line Method (SLM) is used if the asset give equal benefit each year.
This is subjective and needs managerial judgment.
• Accelerated Method charges increased depreciation in the initial years as the
productivity of the asset declines over its useful life(Buying Cars).
– Double Declining Balance (used for Tax purposes)
– Sum of Years Digit

• Activity Method is used when the asset is depreciated based on usage

– Based on Units of Production or number of hours used.

• Changes in Depreciation rate, Useful Life and Salvage Value are changes in
accounting estimates – accounted prospectively
Straight Line Depreciation Example
• Consider a machine that costs $25,000, with an estimated total unit production of 100 million
and a $0 salvage value.

• Depreciation Expense = ($25,000 – $0) / 8 = $3,125 per year

• Depreciation Expense is Debited and Accumulated Depreciation is Credited being Contra
Asset Account.
• The Carrying Value of Asset at 3rd year end is $ 25000 Less Accumulated Depreciation of ($
3125 x 3) = $ 15,625
Common Accounting Mistakes
• Not Depreciating when the asset is idle – Depreciation begins when you
place an asset in service and it ends when you take an asset out of service or
when you have expensed its cost (minus any salvage value), whichever comes
first.
• Capitalizing Repairs & Maintenance – repair charges incurred
to maintain existing / restore operating condition of an asset. Even if the cost
is very large, repairs and maintenance must be expensed
• Not depreciating land with a finite life such as quarries and sites used for
landfill (Land is generally considered to have an unlimited useful life, and is
therefore not depreciated)
• Failing to separately identify significant components of assets and depreciate
them using specific useful lives. For example, an aircraft body may have a
longer useful life than the engines and the seats. (IFRS). This is not required in
US GAAP – Composite Depreciation is Computed as an alternative.
• Failing to include depreciation expense as part of the cost of inventories and
Intangible assets.
• For e.g, depreciation of machinery used to manufacture a widget will be
capitalized as a conversion cost under IAS 2 Inventories, and if used to
produce an intangible asset, will be included as part of the cost under IAS
38 Intangible Assets.
• Failing to Capitalize freight in charges, Legal and broker’s fees, site
preparation fees etc. Failing to do this will understate Assets in Balance Sheet
and Depreciation expenses.
Thank You