Property, Plant, and Equipment
I. Characteristics of Fixed Assets
a. Fixed assets are acquired for use in operations and not for resale.
b. Long term in nature and subject to depreciation.
c. Possess physical substance.
II. Classification of Fixed Assets
a. The following assets are shown separately on the balance sheet at original
(historical) cost.
i. Land (Property)
ii. Buildings (Plant)
iii. Equipment – may include machinery, tools, furniture, & fixtures
1. Net Book Value – net of Accumulated Depreciation
iv. Accumulated Depreciation (Contra-Asset)
1. May be combined for two or more asset categories:
a. Accumulated Depreciation – Building
b. Accumulated Depreciation – Machine
b. Fixed Assets are Nonmonetary Assets
i. Monetary Assets (Liabilities) – fixed in dollars regardless of changes in
specific prices or changes in the general price level.
1. Cash, Accounts and Notes Receivable, etc.
ii. Nonmonetary Assets (Liabilities) – not fixed in dollars and instead
fluctuates with changes in the price level.
1. Inventory, Property, Plant, Equipment, etc.
III. Valuation of Fixed Assets—U.S. GAAP
a. Purchased
i. Historical cost is the basis for valuation.
ii. Cash or cash equivalent price of obtaining the asset and bringing it to the
location and condition necessary for its intended use.
b. Donated Fixed Assets
i. Record at FMV along with incidental costs incurred.
ii. Journal Entry:
1. Fixed Asset (FMV)
Gain on nonreciprocal transfer
IV. Valuation of Fixed Assets—IFRS—Fixed assets are initially recognized at cost to
acquire the asset. Subsequent to acquisition, fixed assets can be valued using the
cost model or the revaluation model.
a. Cost Model—FA are reported at historical cost adjusted for accumulated
depreciation and impairment.
b. Revaluation Model—a class of FA is revalued to FV and then reported at FV less
subsequent accumulated depreciation and impairment. Revaluations must be
made frequently enough to ensure that carrying amount does not differ materially
from FV at the end of the reporting period. When FV differs materially from CV,
a further revaluation is required. Revaluation must be applied to all items in a
class of FA, not to individual FA. Land and buildings, machinery, furniture and
fixtures, and office equipment are examples of FA classes. When FA are reported
at FV, the historical cost equivalent must be disclosed.
i. Revaluation Losses—FV<CV; report on the income statement.
ii. Revaluation Gains—FV>CV; report in other comprehensive income and
accumulated in equity as revaluation surplus.
iii. Impairment—If revalued FA subsequently become impaired, the
impairment is recorded by first reducing any revaluation surplus to zero
with further impairment losses reported on the income statement.
V. Cost of Equipment
a. Include:
i. All Expenditures related directly to their acquisition or construction
1. Invoice Price
a. LESS Cash Discounts and other discounts
b. PLUS Freight-in, Installation Charges (Testing and
Preparing for Use), Sales and Federal Excise Taxes, and
Interest during construction
b. Capital Vs. Expense – Proper accounting is determined based upon the purpose of
the disbursement.
1. Additions – Improve the quantity of fixed assets and are charged to
“cost of fixed assets.”
a. Journal Entry:
Asset (machinery, etc.)
Cash/Accounts Payable
2. Improvements (betterments) – improve the quality of fixed assets
and are charged to “cost of fixed assets” account.
3. Replacements – involves a determination of what the unit of
depreciation is.
a. Composite – if the entire unit is the unit of depreciation,
expense the replacement as a repair.
b. Component – if units of the fixed asset are separated,
remove original cost and related accumulated depreciation
of the component from the account and capitalize the
replacement.
4. Repairs
a. Ordinary repairs should be expensed as repair and
maintenance
b. Extraordinary repairs should be capitalized
i. Charge the cost account if fixed asset efficiency is
improved
ii. Charge the A/D account if fixed asset life is
extended
VI. Cost of Land - When land has been purchased for the purpose of constructing a building,
all costs incurred up to excavation for the new building are considered land costs.
a. Land Cost Includes:
i. Purchase Price, Brokers’ Commissions, Title and Recording Fees, Legal
Fees, Draining of Swamps, Clearing of Brush and Trees, Site
Development, Existing obligations assumed by buyer (including
mortgages and back taxes), demolition of existing building,
ii. LESS: Proceeds from sale of existing buildings, standing timber, etc.
b. Land Improvements (Depreciable)
i. Fences, Water Systems, Sidewalks, Paving, Landscaping, Lighting
c. Interest Cost – Interest cost during construction period may be added to cost of
land improvement based on weighted average of accumulated expenditures.
VII.
Cost of Buildings
a. Cost Includes:
i. Purchase Price, All Repair charges neglected by the previous owner
(deferred maintenance), Alternations and improvements, and Architects
fees.
VIII. “Basket Purchase” of Land and Building – allocate the purchase price based on the
ratio of appraised values of individual items.
IX. Investment Property—IFRS Only
a. Under IFRS, land or building held by an entity or by a lessee under a finance
(capital) lease to earn rentals or for capital appreciation are classified and reported
as investment property. The investment property designation includes property
under construction or development for future use as investment property. U.S.
GAAP does not include a specific definition or set of accounting rules for
investment property. Investment property does not include owner-occupied
property, property held for sale in the ordinary course of business, or property
being constructed or developed, unless the property is under construction or
development for future use as an investment property.
b. Cost of Investment Property
i. Purchase Price
ii. Expenses directly related to purchase, including legal services,
professional fees, property transfer taxes and other taxes.
c. Capitalize vs. Expense—Capitalize the following:
i. Costs incurred to subsequently add to the property
ii. Cost to replace part of the property
iii. Cost to service the property; does not include cost of day-to-day servicing,
repairs, and maintenance costs, labor or minor parts.
d. Investment Property Measurement Models—after initial recognition, investment
property can be reported under two different models:
i. Cost Model: investment property is reported on the B/S at cost less
accumulated depreciation (if appropriate). When the cost model is used,
the FV of the investment property must be disclosed.
ii. FV Model: investment property is reported on the B/S at FV and is not
depreciated. The best evidence for FV is current prices in an active
market for similar property in the same location and condition. FV
reflects market conditions at the end of the accounting period. Once
adopted, FV measurement must be applied consistently until the asset is
disposed of or can no longer be classified as investment property b/c it is
owner-occupied or will be developed for sale in the ordinary course of
business.
1. Gains and Losses: the investment property should be revalued
with regularity so that the CV does not differ materially from FV.
A g/l arising from a change in the FV of investment property is
recognized in earnings in the period in which it arises.
X. Fixed Assets Constructed by a Company
a. Direct materials and direct labor
b. Repairs and maintenance expenses which add value to fixed asset.
c. Overhead, including direct items of overhead
d. Do not include profit
XI. Capitalization of Interest Costs
a. Construction Period Interest – should be capitalized (based on weighted average
of accumulated expenditures) as part of the historical cost of acquiring fixed
assets such as:
b.
c.
d.
e.
i. Buildings, machinery, or land improvements
ii. Fixed assets intended for sale or lease and constructed as discrete projects
iii. Land Improvements – if a structure is in place on the land, charge the
interest cost to the structure (and not the land)
Interest Cost – Interest cost is based on interest obligations having:
i. Stated (explicit) interest rate, or if not stated, use Imputed interest rates per
APBO #21 (interest on receivables and payables) or Imputed interest rate
per FASB #13 (leases).
Do NOT Capitalize Interest Cost
i. On inventory routinely manufactured
ii. On assets held before or after construction period
iii. During intentional delays in construction
ONLY Capitalize Interest on Borrowing Necessary for That Project
i. Computing Capitalized Cost
1. Weighted Average Amount of Accumulated Expenditures –
capitalized interest costs for a particular period are determined by
applying an interest rate to the average amount of accumulated
expenditures for the qualifying asset during the period
2. Interest Rate on Borrowings – the interest rate paid on borrowings
(used for asset construction) during a particular period should be
used to determine the amount of interest costs, which should be
capitalized for the period.
3. Interest Rate on Excess Expenditures (Weighted Average) – if the
average accumulated expenditure outstanding exceeds the amount
of the related specific new borrowing, interest cost should be
computed on the excess. The interest rate that should be used on
the excess is the weighted average interest rate for other
borrowings of the company.
ii. Not to Exceed Actual Interest Costs – total capitalized interest costs for
any particular period may not exceed the total interest costs actually
incurred by an entity during that period.
iii. Do NOT reduce Capitalizable Interest – Do not reduce capitalizable
interest by income received on the unexpended portion of the loan.
Capitalization of Interest Period
i. Begins when three conditions are present:
1. Expenditures for the asset have been made
2. Activities that are necessary to get the asset ready for its intended
use are in progress
3. Interest cost is being incurred
ii. Continues as long as the three conditions are present.
iii. Ends when the asset is substantially complete and ready for the intended
use.
f. Disclose in Financial Statements
i. Total interest cost incurred during the period.
ii. Capitalized interest cost for the period.
Summary
Before
During
After
Construction Construction Construction
Borrowed funds (not use)
Expense
Expense
Expense
Borrowed funds (weighted average of
accumulated expense)
N/A
Capitalize
Expense
Excess (above amount borrowed)
expenditures (weighted average
interest rate)
N/A
Capitalize
Expense
XII.
Depreciable Assets and Depreciation – The basic principle of matching revenue and
expenses is applied to long-lived assets that are not held for sale in the ordinary
course of business. The systematic and rational allocation used to achieve
“matching” is usually accomplished by depreciation, amortization, or depletion,
according to the type of long-lived asset involved.
a. Kinds of Depreciation
i. Physical Depreciation – related to an assets deterioration and wear over a
period of time.
ii. Functional Depreciation – arises from obsolescence or inadequacy of the
asset to perform efficiently. Obsolescence may result from diminished
demand for the product that the depreciable asset produces or from the
availability of a new depreciable asset that can perform the same function
for substantially less cost.
b. Terms
i. Salvage Value – salvage or residual value is an estimate of the amount that
will be realized at the end of the useful life of a depreciable asset.
Frequently, depreciable assets have little or no scrap value at the end of
their estimated useful life and, if immaterial, the amounts may be ignored
in calculating depreciation.
ii. Estimated Useful Life – period of time over which an asset’s cost will be
depreciated. It may be revised at any time but any revision must be
accounted for prospectively, in current and future periods only.
XIII. Depreciation Methods – The goal of a depreciation method should be to provide for
a reasonable, consistent matching of revenue and expense by systematically
allocating the cost of the depreciable asset over its estimated useful life. The actual
accumulation of depreciation in the books is accomplished by using a contra account,
such as accumulated depreciation or allowance for depreciation. The amount subject
to depreciation is the difference between the cost and residual or salvage value and is
called the depreciable base.
XIV. Composite (Entire Unit) vs. Component Depreciation
a. Advantages of Component Depreciation Over Composite Depreciation
i. Depreciation expense for the year would be more accurate because each
component item would be depreciated over its useful life.
ii. Repair and maintenance expense would be more accurate because
replacements of components would be excluded from expense and
capitalized.
b. Component Depreciation – is not available for MACRS recovery property for tax
purposes because depreciation expense under the component method is generally
higher and MACRS is already high. However, it does appear to be available
when straight-line depreciation is elected.
c. Composite (Dissimilar Assets) or Group (Similar Assets) Depreciation – the
process of averaging the economic lives of a number of property units and
depreciating the entire class of assets over a single life, thus simplifying record
keeping of assets and depreciation calculations.
i. No gain or loss is recognized when one asset in the group is retired – when
a group or composite asset is sold or retired, the accumulated depreciation
is treated differently than the accumulated depreciation of a single asset.
If the average service life of the group of assets has not been reached when
an asset is retired, the gain or loss that results is absorbed in the
accumulated depreciation account. The accumulated depreciation account
is debited (credited) for the difference between the original cost and the
cash received.
d. The methods can use Straight-line, Sum-of-the-Years Digits, or Declining
Balance methods of Depreciation for GAAP purposes.
EX: Composite (Group) Depreciation
Machine A
Machine B
Machine C
Total Cost
$550,000
$200,000
$40,000
Estimated
Salvage
$50,000
$20,000
$0
Depreciable
Cost
$500,000
$180,000
$40,000
Totals
$790,000
$70,000
$720,000
Estimated Life
in Years
20
15
5
Annual
Depreciation
$25,000
$12,000
$8,000
$45,000
Average composite life = $720,000 / $45,000 = 16 years
Average composite rate = $45,000 / $790,000 = 5.7%
Disposal: Machine A is sold in 10 years for $260,000 (Loss is not recognized, however
accumulated depreciation must be reduced)
Cash
Accumulated Depreciation
Machine A
XV.
$260,000
$290,000
$550,000
Basic Depreciation Methods
a. Straight-line
i. Depreciation per period = (Cost – Salvage) / Estimated Useful Life
ii. Advantages: Simple to compute, applies to virtually all assets, consistent
from year to year, and wide acceptability
iii. Disadvantages: does not reflect difference in usage of asset from year to
year and does not always match costs with revenue
b. Sum-of-the-Years Digits – one of the accelerated methods of depreciation that
provides higher depreciation expense in the early years and lower charges in the
later years.
i. Formula: (Remaining Life/Sum of the Years Digits) * Depreciable Base
ii. S= (N * (N + 1)) / 2 = Denominator
iii. The numerator is the remaining life of the asset at the beginning of the
current year
iv. EX: An asset cost $11,000 with a $1,000 salvage value and estimated life
of four years.
1. First year: 4/10 * $10,000 = $4,000
2. Second year: 3/10 * $10,000 = $3,000
3. Third year: 2/10 * $10,000 = $2,000
4. Fourth year: 1/10 * $10,000 = $1,000
c. Declining Balance – most common accelerated method is the double declining
balance method.
i. Calculation – the first years depreciation is double the straight-line rate.
In succeeding years, the same percentage is applied to the remaining book
value.
ii. Salvage Value – no allowance is made for salvage value because the
method always leaves a remaining balance, which is treated as salvage
value. However, the asset should not be depreciated below the estimated
salvage value.
iii. Advantages: matches costs to revenues since greater utility is reflected in
greater depreciation during earlier years; as the amount of depreciation
decreases, repairs and maintenance charges increase thereby tending to
balance out one another.
iv. Disadvantages: Does not reflect changes in the activity of the asset,
computation can be complex, greater disparity in the amount of
depreciation between earlier years and later years which is inconsistent,
and there is a possibility that with decreasing depreciation and increasing
repairs and maintenance that income is artificially smoothed over the
years.
d. Units of Production (Productive Output) – the unit-of-production method relate
depreciation to the estimated production capability of an asset and are expressed
in a rate per unit or hour.
i. (Cost – Salvage Value) / Estimated units or hours = rate per unit or hour
ii. Rate per unit or hour * Units or Hours = Depreciation
iii. Advantages: Matches costs with revenues and reflects activity of the
enterprise.
iv. Disadvantages: if no activity, no depreciation expensed, cannot be used for
all assets, and can be complex because it requires clerical work and
records
e. Partial Year Depreciation – when an asset is placed in service during the year, the
depreciation expense is taken only for the portion of they year that the asset is
used.
f. Disposals
i. Sale of an asset during its useful life – Debit Cash and Accumulated
Depreciation; Credit Asset at Cost AND difference is Gain or Loss
ii. Write off fully depreciated asset – Debit Accumulated Depreciation and
Credit asset at full cost
iii. Total and Permanent Impairment – Debit Accumulated Depreciation and
Loss Due to Impairment; Credit asset at full cost
iv. Partial Impairment – Debit Loss Due to Impairment and Credit
Accumulated Depreciation
g. Disclosure – allowances for depreciation and depletion should be deducted from
the assets to which they relate. The following disclosures of depreciable assets
and depreciation should be made in the financial statements or notes:
i. Depreciation expense for the period
ii. Balance of major classes of depreciable assets by nature or function
iii. Accumulated depreciation allowances by classes or in total
iv. The methods uses, by major classes, in computing depreciation
XVI. Depletion – allocation of the cost of wasting assets such as oil, gas, and minerals to
production
a. Terms
i. Purchase Cost – includes any expenditure necessary to purchase and then
prepare the land for the removal of resources.
ii. Residual Value – similar to salvage value; monetary worth of a depleted
asset after the resources have been removed.
iii. Depletion Base (Cost – Residual Value)
iv. Methods
1. Cost Depletion (Unit Depletion Rate)
2. Percentage Depletion (Not GAAP – Tax Only)
a. Based on a percentage of sales; allowed by Congress as a
tax deduction to encourage exploration in a very risky
business; Usually exceeds cost depletion; Limited to 50%
of net income from the depletion property computed before
the percentage depletion allowance.
b. Unit Depletion Rate (Depletion per Unit) – unit depletion is the amount of
depletion recognized per unit extracted.
i. Calculation:
1. Depletion Base: Cost to Purchase Property PLUS Development
costs to prepare the land for extraction PLUS any estimated
restoration costs LESS Residual Value of land after the resources
are extracted.
2. Depletion per unit = Depletion Base / Estimated Removable Units
ii. Total depletion is calculated by multiplying the unit depletion rate times
the number of units extracted. If all units extracted are not sold, then
depletion must be allocated between COGS and Inventory. The amount of
depletion to be included in COGS is calculated by multiplying the unit
depletion rate by the number of units sold. Depletion applicable to units
extracted but not sold is allocated to inventory as direct materials.