💰Intermediate Financial Accounting I Unit 8 – Property, Plant & Equipment (PP&E)

Key Concepts and Definitions

• Property, Plant, and Equipment (PP&E) refers to tangible assets held for use in the production or supply of goods or services, for rental to others, or for administrative purposes
• PP&E assets are expected to be used for more than one accounting period (typically more than a year)
• Examples of PP&E include land, buildings, machinery, vehicles, and office equipment
• Historical cost is the original cost of acquiring an asset, which includes the purchase price and any directly attributable costs (installation, shipping)
• Useful life is the estimated period over which an asset is expected to be available for use by an entity
• Residual value (salvage value) is the estimated amount that an entity would currently obtain from the disposal of an asset, after deducting the estimated costs of disposal, if the asset were already of the age and in the condition expected at the end of its useful life
• Carrying amount (book value) is the amount at which an asset is recognized in the balance sheet after deducting accumulated depreciation and accumulated impairment losses

Initial Recognition and Measurement

• PP&E is initially recognized at its cost, which includes the purchase price and any directly attributable costs necessary to bring the asset to its intended use
• Directly attributable costs may include costs of site preparation, initial delivery and handling, installation, and testing
• If payment for PP&E is deferred beyond normal credit terms, the difference between the cash price equivalent and the total payment is recognized as interest expense over the period of credit
• When PP&E is acquired in exchange for a non-monetary asset (asset swap), it is measured at fair value unless the transaction lacks commercial substance or the fair value cannot be reliably measured
• If an asset is self-constructed, its cost includes materials, labor, and overhead costs directly attributable to the construction
• Borrowing costs (interest) directly attributable to the acquisition or construction of a qualifying asset are capitalized as part of the asset's cost

Depreciation Methods and Calculations

• Depreciation is the systematic allocation of the depreciable amount of an asset over its useful life
• Depreciable amount is the cost of an asset less its residual value
• Three common depreciation methods are straight-line, diminishing balance (declining balance), and units of production
• Straight-line depreciation allocates an equal amount of depreciation expense each period over the useful life of the asset
  • Formula: $Depreciation per period = \frac{Cost - Residual Value}{Useful Life}$
• Diminishing balance method (declining balance) allocates a higher depreciation expense in the earlier years and less in later years
  • Formula: $Depreciation = Book Value at Beginning of Period \times Depreciation Rate$
• Units of production method allocates depreciation based on the expected use or output of the asset
  • Formula: $Depreciation per period = \frac{Cost - Residual Value}{Total Estimated Production} \times Units Produced$

Subsequent Costs and Revaluations

• Subsequent costs related to PP&E are capitalized only if they enhance the economic benefits of the asset (increased capacity, improved quality, or extended useful life)
• Costs incurred for repairs and maintenance to maintain the asset's original condition are expensed as incurred
• Revaluation of PP&E is permitted under certain circumstances, where the asset's carrying amount is adjusted to its fair value
• When an asset is revalued, any accumulated depreciation at the date of revaluation is either restated proportionately with the change in the gross carrying amount or eliminated against the gross carrying amount
• Increases in an asset's carrying amount due to revaluation are credited to other comprehensive income and accumulated in equity under the heading "revaluation surplus"
• Decreases in an asset's carrying amount due to revaluation are recognized as an expense, except to the extent that it reverses a previous revaluation increase

Impairment of Assets

• An asset is impaired when its carrying amount exceeds its recoverable amount
• Recoverable amount is the higher of an asset's fair value less costs of disposal and its value in use
• Value in use is the present value of the future cash flows expected to be derived from an asset
• At the end of each reporting period, an entity assesses whether there is any indication that an asset may be impaired (external sources, internal sources, dividends)
• If any indication of impairment exists, the entity estimates the recoverable amount of the asset
• An impairment loss is recognized in profit or loss for the amount by which the asset's carrying amount exceeds its recoverable amount
• After the recognition of an impairment loss, the depreciation charge for the asset is adjusted in future periods to allocate the asset's revised carrying amount over its remaining useful life

Derecognition and Disposal

• An item of PP&E is derecognized upon disposal or when no future economic benefits are expected from its use or disposal
• The gain or loss arising from the derecognition of an item of PP&E is included in profit or loss when the item is derecognized
• The gain or loss is calculated as the difference between the net disposal proceeds (if any) and the carrying amount of the asset
• Compensation from third parties for items of PP&E that were impaired, lost, or given up is included in profit or loss when the compensation becomes receivable

Financial Statement Presentation and Disclosure

• PP&E is presented as a separate line item on the balance sheet, typically under the heading "Non-current assets"
• The notes to the financial statements should disclose, for each class of PP&E:
  • Measurement bases used for determining the gross carrying amount
  • Depreciation methods used and useful lives or depreciation rates
  • Gross carrying amount and accumulated depreciation at the beginning and end of the period
  • A reconciliation of the carrying amount at the beginning and end of the period, showing additions, disposals, revaluations, impairment losses, and other movements
• The financial statements should also disclose the existence and amounts of restrictions on title and PP&E pledged as security for liabilities
• If PP&E is stated at revalued amounts, additional disclosures are required, such as the effective date of the revaluation and whether an independent valuer was involved

Real-World Applications and Examples

• A manufacturing company purchases a new production line for $1,000,000 with an estimated useful life of 10 years and a residual value of$100,000. The company uses the straight-line depreciation method.
  • Annual depreciation expense = ($1,000,000 -$100,000) / 10 years = $90,000
• A delivery company acquires a fleet of vehicles for $500,000. The vehicles are expected to have a useful life of 5 years and a residual value of$50,000. The company uses the diminishing balance method with a depreciation rate of 30%.
  • Year 1 depreciation = $500,000 × 30$150,000
  • Year 2 depreciation = ($500,000 -$150,000) × 30% = $105,000
• A mining company purchases a drill for $800,000. The drill is expected to extract 500,000 tons of ore over its useful life. The company uses the units of production method. In the first year, the drill extracts 100,000 tons of ore.
  • Year 1 depreciation = ($800,000 / 500,000 tons) × 100,000 tons =$160,000
• A company owns a building with a carrying amount of $2,000,000. Due to a change in market conditions, the recoverable amount of the building is estimated to be$1,500,000. The company recognizes an impairment loss of $500,000.