What is Property Plant and Equipment (PP&E)?
Property plant and equipment (PP&E) are long-term tangible assets that are physical in nature. These are non-current assets that are used in the company’s operations for a longer part of the time. They are also called as the fixed assets of the company as it cannot be easily liquidated.
Property plant and equipment is considered a long-term capital investment and its purchase shows that the management has a belief in the long-term outlook and profitability in the company. PP&E assets are expected to generate economic benefits.
Examples of PP&E include Machinery, Equipment, Vehicles, Buildings, Land, Office Equipment, Furniture, Fixtures, etc.
INC Corp. owns machinery with a gross value of $ 10 million. Accumulated depreciation recorded so far was at $5 million. Due to the wear and tear of the machinery, the company purchased new equipment at the cost of $ 2 million.
Net PPE = $ 7 Million ($ 10 Million+ $ 2 Million – $ 5 Million)
Recognition of Property Plant and Equipment (PP&E)
The cost of PP&E shall be recognized as an asset only if it is probable that future economic benefits will flow to the entity, and the cost of it can be reliably measured.
PP&E that qualifies for recognition shall be measured at its cost. The initial cost may include the following:
- Employee costs directly attributable to construction or acquisition of PP&E; the cost of site preparation; initial delivery and handling costs; installation and assembly costs; the cost of testing assets’ functionality; professional fees, etc.;
- If payment for an item of PP&E is deferred beyond standard credit terms, the difference between the cash price equivalent and the total cash outflow is recognized as interest over the credit period unless the interest is capitalized.
- If the asset is acquired in exchange for another asset, the cost will be measured at its fair value unless there is an absence of commercial element or the fair value of both the asset received and the asset given is not quantifiable. If the asset obtained via exchange transaction is not recorded at the fair value, then it’s the cost determined based on the carrying amount of the asset given.
- Subsequent cost or capital expenditure to PP&E can be added if the investment is made either in updating and maintaining existing equipment or purchasing new additional equipment.
PP&E Calculation Example
Sigma Inc. acquires a new asset. The purchase price of the asset is $ 800,000. Also, the company incurs the following costs:
- Custom Clearance: 400
- Rent of lorry (Note 1): 100
- Site preparation and planning: 200
- Labour Charges (Note 2): 100
- Installation Charges: 50
- A lorry has been acquired on rent and used by the business for transporting anything and not specifically obtained for this asset.
- Include $ 20,000 salaries of entity’s own employees working full time
Measurement after Recognition of Property Plant and Equipment
#1 – Cost Model
The Asset is measured at its cost reduced by accumulated depreciation and impairment loss, if any.
#2 – Revaluation Model
The Asset is recorded as per the revalued amount. I.e., the fair value of the asset at the time of revaluation, less depreciation, and impairment, as long as the fair value of the asset can be measured.
- Under this, the revaluation of property plant and equipment should be carried out regularly to ensure that the carrying amount does not differ materially from its fair value at the balance sheet date. If an item is revalued, then the entire class of assets should be revalued.
- If the revaluation of assets increases in value, the same should be credited to other comprehensive income and accumulated in equity under the revaluation surplus. However, the increase shall be recognized in P&L A/c to the extent that it reserves a revaluation decrease of the same asset previously recognized in P&L.
- A decrease arising as a result of revaluation should be recognized as the expense to the extent that it exceeds any amount previously credited to the revaluation surplus relating to the same asset.
- When the revalued asset is retired or disposed of, the revaluation surplus shall be transferred to retained earnings.
Depreciation of PP&E
The depreciation amount should be allocated on a systematic basis over the asset’s useful life. The residual value and the useful life of an asset should be annually and, if expectations differ from previous estimates, the changes shall be accounted for as a change in an accounting estimate.
- The depreciation method can be considered based on the pattern in which the asset’s future economic benefits are expected.
- The depreciation method shall be reviewed annually; has there been a significant change in the expected pattern of consumption of future economic benefits; the depreciation pattern should be changed prospectively as a change in estimate.
- Depreciation shall be recognized in profit or loss unless it is included in the carrying amount of another asset.
- There are various methods of depreciation like the Straight line method, WDV method, accelerated depreciation method, double declining method, etc.
Impairment of PP&E
Property plant and equipment should not be valued higher than it’s the recoverable amount. Recoverable amount is higher of an asset’s fair value reduced by its selling cost, and it’s utility. Compensation from the third party for PP&E impairment shall be included in P&L when compensation is receivable.
Derecognition of Property Plant and Equipment
The carrying amount of PP&E shall be derecognized on disposal; or when no future economic benefits are expected from its use or disposal. The Gain or loss arising from derecognition shall be included in profit or loss.
The Financial statements shall disclose for each class of PP&E its the basis for measuring its carrying amount; depreciation methods used; the useful lives or depreciation rates; the gross carrying amount and it’s accumulated depreciation; reconciliation of the carrying amount at the beginning, and the end of the period.
- It shall also disclose restrictions on title and items pledged as security for liabilities; expenditures to construct PP&E during the period; contractual commitments to acquire assets. Compensation from third parties for impairment.
- In case of revaluation – the effective date of revaluation; whether an independent valuer is involved; for every revalued class of PP&E, the carrying amount at which the asset would have been recorded under the cost model and the revaluation gain, including changes in the same during the reporting period and any limitation on paying out the balance to shareholders.
Property plant and equipment represents only one portion of the company’s assets. It is essential to monitor a company’s investment in PP&E, as it is vital for long-term success. The importance of PP&E varies from company to company based on the nature of the industry.
This article has been a guide to what is Property Plant and Equipment. Here we discuss how to recognize PP&E along with practical examples, calculations, and formulas. You may learn more about accounting from the following articles –