What is Property Plant and Equipment (PP&E)?
Property plant and equipment (PP&E) are long-term tangible assetsTangible AssetsAny physical assets owned by a firm that can be quantified with reasonable ease and are used to carry out its business activities are defined as tangible assets. For example, a company's land, as well as any structures erected on it, furniture, machinery, and equipment. that are physical in nature. These are non-current assetsNon-current AssetsNon-current assets are long-term assets bought to use in the business, and their benefits are likely to accrue for many years. These Assets reveal information about the company's investing activities and can be tangible or intangible. Examples include property, plant, equipment, land & building, bonds and stocks, patents, trademark. 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 companyFixed Assets Of The CompanyFixed assets are assets that are held for the long term and are not expected to be converted into cash in a short period of time. Plant and machinery, land and buildings, furniture, computers, copyright, and vehicles are all examples. as it cannot be easily liquidated.
Property plant and equipment is considered a long-term capital investmentCapital InvestmentCapital Investment refers to any investments made into the business with the objective of enhancing the operations. It could be long term acquisition by the business such as real estates, machinery, industries, etc. 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 recordedAccumulated Depreciation RecordedThe accumulated depreciation of an asset is the amount of cumulative depreciation charged on the asset from its purchase date until the reporting date. It is a contra-account, the difference between the asset's purchase price and its carrying value on the balance sheet. 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 capitalizedInterest Is CapitalizedCapitalized interest is the cost of borrowing incurred to acquire or construct the long term asset to be used in the business and is added in the asset's value to be shown in the balance sheet, instead of showing it as an interest expense in the company's income statement..
- 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 expenditureCapital ExpenditureCapex or Capital Expenditure is the expense of the company's total purchases of assets during a given period determined by adding the net increase in factory, property, equipment, and depreciation expense during a fiscal year. 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 assetsThe Revaluation Of AssetsAssets revaluation is an adjustment made in the carrying value of the fixed asset, either upwards or downwards, depending upon the fair market value of the fixed asset. Its purpose includes selling the asset to another business unit, merger and acquisition. 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 earningsRetained EarningsRetained Earnings are defined as the cumulative earnings earned by the company till the date after adjusting for the distribution of the dividend or the other distributions to the investors of the company. It is shown as the part of owner’s equity in the liability side of the balance sheet of the company..
Depreciation of PP&E
The depreciation amount should be allocated on a systematic basis over the asset’s useful life. The residual valueResidual ValueResidual value is the estimated scrap value of an asset at the end of its lease or useful life, also known as the salvage value. It represents the amount of value the owner will obtain or expect to get eventually when the asset is disposed. 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 methodStraight Line MethodStraight Line Depreciation Method is one of the most popular methods of depreciation where the asset uniformly depreciates over its useful life and the cost of the asset is evenly spread over its useful and functional life. , WDV methodWDV MethodThe Written Down Value method is a depreciation technique that applies a constant rate of depreciation to the net book value of assets each year, resulting in more depreciation expenses recognized in the early years of the asset's life and less depreciation recognized in the later years of the asset's life., accelerated depreciation methodAccelerated Depreciation MethodAccelerated depreciation is a way of depreciating assets at a faster rate than the straight-line method, resulting in higher depreciation expenses in the early years of the asset's useful life than in the later years. The assumption that assets are more productive in the early years than in later years is the main motivation for using this method. , double declining methodDouble Declining MethodThe Double Declining Balance Method is one of the accelerated methods used for calculating the depreciation amount to be charged in the company's income statement. It is determined by multiplying the book value of the asset by the straight-line method's rate of depreciation and 2, etc.
Impairment of PP&E
Property plant and equipment should not be valued higher than it’s the recoverable amountRecoverable AmountThe recoverable amount of an asset is the present value of the expected cash flows that will result from the asset's sale or use, and is determined as the greater of two amounts: the asset's fair value as reduced by related selling costs, and the asset's value in use.. 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 statementsFinancial StatementsFinancial statements are written reports prepared by a company's management to present the company's financial affairs over a given period (quarter, six monthly or yearly). These statements, which include the Balance Sheet, Income Statement, Cash Flows, and Shareholders Equity Statement, must be prepared in accordance with prescribed and standardized accounting standards to ensure uniformity in reporting at all levels. 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 amountCarrying AmountThe carrying amount or book value of asset is the cost of tangible, intangible assets or liability recorded in the financial statements, net of accumulated depreciation or any impairments or repayments. Accordingly, the carrying amount may differ from the market value of assets. 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 periodReporting PeriodA reporting period is a month, quarter, or year during which an organization's financial statements are prepared for external use uniformly across a period of time in order for the general public and users to interpret and evaluate the financial statements. 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 –