Property, Plant and
Equipment
(including natural resources)
The life cycle, including expense versus capitalize, front end costs,
maintenance and overhaul, depreciation and depletion, exchange
and sale. Topics include impairment and capitalization of interest.
Plant assets, fixed assets, operational assets–
which is included in property, plant and equipment (PPE)?
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Tangible resources
Expected to benefit more than one year of operations
Needed to “run the business” and ultimately help generate revenue
Historical cost valuation (objective, verifiability versus relevance)
Cost or depreciated cost (depreciate no more than cost less salvage)
Impairment write-down (no write-up later if circumstances change)
Front end costs –to expense or capitalize,
that is the question!
Expense or prepaid expense
• Insurance
• Repairs for unintended damage
to new asset
• Annual fees that must be paid,
like property taxes
Capitalize (record as an asset)
• Necessary expenditures to
obtain asset and get it ready for
intended use
• Examples – installation,
shipping, delinquent property
taxes, title search fees, survey
costs, tearing down original
structures not needed on land
• Fix up costs on used assets to
get them ready for 1st time use
Straight line depreciation –the most popular one!
(& related depreciation methods)
Straight-line method
Group/Composite method
• Formula (cost-salvage)/useful
life (time based)
• Record gain or loss when
individual assets are sold
• If partial year, smaller amount
of depreciation (or use nearest
whole year or other convention)
• Based on STL depreciation
• Calculate rate as % of cost by
doing STL for each asset in the
batch when start with this
method (continue rate if sell off,
change if add new items)
• Materiality allows no gain/loss
when selling assets from the
pool (since assumed gains offset
losses on sales of old items over
time)
Depreciation methods-Accelerated ones
Double declining balance (DDB)
Sum of the year’s digits (SYD)
• Formula – (cost- accumulated
depreciation) times 2/useful life
• Time based
• Most depreciation the first year
• Formula – (cost- salvage) times the
remaining useful life beginning of
the year/SYD
• SYD = add up the numbers
counted to reach useful life or
n(n+1)/2
• Time based
• Most depreciation the first year
(though less than DDB)
• 1st year partial year – more
complicated math
• Poor math!
• Once DDB amount less than
STL, use STL to finish
Units of Output/Production Depreciation
method
• Activity-based, not time-based method
• Hours, miles, units produced, etc.
• Better matching to revenues probably when usage varies from period
to period
• Extra work since must track the actual activity of an asset each period
• Not necessarily an “activity” identified for every PPE
Depreciation conventions and revisions
• Nearest whole month – 1st to 15th, depreciate that entire month, 16th
to 31st, depreciate next month
• Nearest whole year convention – purchase in 1st 6 months of year,
depreciate whole year; 2nd 6 months of year, depreciate next year
• One-half year convention – ½ year’s depreciation taken in year of
acquisition and year of disposal on all assets
• If change in estimate –service life or salvage value – adjust in current
and future year (prospectively)
• If add to original cost of PPE or decrease accumulated depreciation –
adjust in current and future year (prospectively)
Capitalization of Interest
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During construction period only
Must have debt (either project loan and/or other loans)
Can’t exceed actual interest accrued/paid
Need weighted average accumulated expenditure – for the year -# of
months divided by 12 months that must finance an expenditure before
project is completed (or average of total spent for the accounting period)
Project loan borrowed just for PPE project –use first in calculations.
Other loans can be used next – must calculate weighted average of interest
(total interest expense/total principle of loans)
Eventually, record increase to PPE ledger account and decrease to interest
expense
Interest capitalized will be expensed as part of depreciation over the life of
PPE
Overhaul versus maintenance
• Change quality of usage (such as additions) or substantially extend
useful life beyond original expectation – capitalize (add to asset or
decrease accumulated depreciation) – “capital expenditure”
• Capital expenditure will impact future depreciation
• Keeping an asset in good working condition – expense or prepaid
expense – “operating or revenue expenditure”
• Revenue expenditure will not impact future depreciation
• Immaterial – probably expense
Exchanges of PPE
• Swap assets – take off asset on books (cost and accumulated depreciation)
and recognize new asset received
• Gain – if value of asset given up is less than fair market value of same asset
• Loss –if value of asset given up is greater than fair market value of same
asset
• Cash received – if fair value of asset given up is greater than fair value of
asset received
• Cash paid – if fair value of asset given up is less than fair value of asset
received
• swapping solely to generate a gain with no economic substance (gain
deferred and new asset value decreased)
Impairment of PPE
• If major technological or other change causes likelihood of vastly
diminished future returns
• Test for impairment – book value versus estimated future benefit
(add up expected future cash flows)
• Impaired ---book value > total future cash flows
• Not impaired – book value < total future cash flows
• Loss from impairment --- revised fair market value of PPE (present
value of expected future flows) compared to book value
• Journalize --- close out cost and accumulated depreciation to date
and replace with fair market value of impaired asset, recognize loss
• Conservative – picking the lower of two asset values
Disposal of property, plant and equipment
• Update depreciation until time of disposal
• Recognize “realized” gain or loss in journal entry (giving up versus
receiving)
• Close out PPE asset ledger account and any accumulated depreciation
• If no compensation for disposal, book value becomes loss
Depletion of natural resources
• Timber, coal and mineral deposits, oil and gas
• Expensed as generate revenues – depletion
• Follows same basic rules as PPE –including units of output
depreciation method often used
• Asset “capitalized costs”– includes acquisition, exploration costs
(searching for natural resource reserves), development costs before
production, asset retirement obligations (costs of restoring to natural
state)
• Related PPE with useful life limited to life of the mine or deposit
would be depreciated in same way as natural resource depleted