How is Property, Plant, and Equipment (PPE) Recorded in Accounting?

Introduction to PPE

Property, Plant, and Equipment (PPE) forms a critical component of a company’s balance sheet. It includes long-term physical assets like buildings, machinery, office furniture, land, vehicles, and more. Unlike current assets, which are consumed or converted into cash within a year, PPE assets have a useful life that typically extends beyond one year and are used in the normal course of business operations to generate revenue.

Understanding how to properly record and manage PPE in accounting is essential for accurate financial reporting and ensuring compliance with accounting standards such as Generally Accepted Accounting Principles (GAAP) or International Financial Reporting Standards (IFRS). This tutorial delves into the detailed process of recording PPE in accounting, covering acquisition, depreciation, revaluation, impairment, disposal, and relevant journal entries.

What is Included in PPE?

Before diving into the specifics of recording PPE in accounting, it is essential to know what qualifies as PPE. Here are the primary categories:

Land – Includes land owned by the business used for operations (excluding investment properties).
Buildings – Office spaces, factories, warehouses, and other facilities owned by the business.
Machinery and Equipment – Tools and equipment used in production or business operations.
Vehicles – Cars, trucks, or other means of transportation owned by the business.
Office Furniture and Fixtures – Desks, chairs, shelving, etc.
Leasehold Improvements – Modifications made to leased properties to suit the business’s needs.
Computers and Technology – Servers, computers, printers, and related hardware used for business operations.

These assets typically represent significant investments and are capitalized on the balance sheet instead of being immediately expensed on the income statement.

Initial Recognition of PPE

When a company acquires PPE, it records the asset at its cost. This cost includes not just the purchase price but all the necessary expenditures to bring the asset to its intended use. Let’s break this down:

Purchase Price – The amount paid to acquire the asset.
Installation Costs – Costs incurred to install the asset or make it operational, such as assembly, testing, or employee training on how to use a new machine.
Freight and Handling – Costs associated with shipping and delivering the asset to the business premises.
Legal Fees and Permits – Any legal costs or permits related to acquiring or installing the asset, such as the cost to obtain environmental permits for land or construction permits for buildings.
Demolition Costs – If a new facility replaces an old one, the cost of demolishing the old structure to make room for the new one can be included in the cost of the asset.

Journal Entry for Initial Acquisition

Let’s assume your company buys a new piece of machinery for $100,000, incurs installation costs of $5,000, and pays $2,000 in shipping and handling. The total cost to bring the machinery to its intended use is $107,000. The journal entry to record the purchase would be:

Date: [Date of Purchase]

Machinery (PPE)                       $107,000
    Cash/Accounts Payable                     $107,000

The machinery account is debited (increased) by $107,000, and cash or accounts payable (if payment is deferred) is credited (decreased or increased, respectively) by $107,000.

Depreciation of PPE

Since PPE represents long-term assets, they are subject to depreciation. Depreciation allocates the cost of an asset over its useful life. The idea is that assets lose value due to wear and tear, obsolescence, or age, and this loss should be reflected in the financial statements over time. The only major PPE asset not subject to depreciation is land, as it typically doesn’t lose value over time.

There are several methods for calculating depreciation, but the most commonly used ones are:

Straight-Line Depreciation – Allocates the asset’s cost evenly over its useful life.
Declining Balance Method – Applies a higher depreciation expense in the earlier years of the asset’s useful life and reduces the expense over time.
Units of Production – Depreciation is based on the asset’s usage, so depreciation varies depending on how much the asset is used each year.

Straight-Line Depreciation Example

Assume the machinery acquired for $107,000 has a useful life of 10 years and an estimated salvage value of $7,000 at the end of its life. The annual depreciation expense under the straight-line method is calculated as follows:

Depreciable Amount = Cost - Salvage Value
                   = $107,000 - $7,000
                   = $100,000

Annual Depreciation Expense = Depreciable Amount / Useful Life
                            = $100,000 / 10 years
                            = $10,000 per year

Journal Entry for Depreciation

Each year, the depreciation expense is recorded with the following journal entry:

Date: [End of Year]

Depreciation Expense                  $10,000
    Accumulated Depreciation – Machinery     $10,000

Here, Depreciation Expense is an expense account that shows up on the income statement, reducing net income, while Accumulated Depreciation is a contra-asset account that reduces the book value of the asset on the balance sheet.

After the first year, the net book value of the machinery would be:

Net Book Value = Cost - Accumulated Depreciation
               = $107,000 - $10,000
               = $97,000

Impairment of PPE

Sometimes, assets lose their value due to unforeseen circumstances, such as damage, obsolescence, or significant changes in market conditions. This decline in value is known as impairment. If an asset’s carrying amount (the amount recorded on the balance sheet) exceeds its recoverable amount (the higher of fair value less costs to sell or value in use), it must be written down.

Example of Impairment

Let’s assume the machinery is now impaired due to technological obsolescence, and the recoverable amount is only $50,000, while its carrying value is $97,000. The journal entry to record the impairment loss would be:

Date: [Impairment Date]

Impairment Loss                       $47,000
    Accumulated Impairment – Machinery       $47,000

Impairment Loss is an expense on the income statement, and Accumulated Impairment reduces the carrying value of the asset on the balance sheet.

Revaluation of PPE

Certain assets, particularly land and buildings, may appreciate in value over time. Under IFRS, companies have the option to revalue their PPE at fair value rather than maintaining them at cost. This is known as the revaluation model. Any increase in value is credited to a revaluation surplus, which is part of equity, and any decrease is expensed.

Example of Revaluation

Let’s say your company revalues a building originally purchased for $500,000, and its fair value is now $600,000. The journal entry for revaluation is:

Date: [Revaluation Date]

Building (PPE)                        $100,000
    Revaluation Surplus – Building            $100,000

This increase does not impact the income statement; instead, it increases equity through the revaluation surplus account.

Disposal of PPE

Eventually, PPE assets are disposed of—whether sold, scrapped, or donated. The process for recording the disposal involves removing the asset’s cost and accumulated depreciation from the books and recognizing any resulting gain or loss.

Example of Disposal

Let’s say the company sells the machinery for $30,000 at the end of its useful life. At that point, the machinery’s cost is $107,000, and accumulated depreciation is $100,000, so the carrying value is $7,000. The journal entry for disposal would be:

Date: [Disposal Date]

Cash                                  $30,000
Accumulated Depreciation             $100,000
    Machinery (PPE)                          $107,000
    Gain on Sale of Machinery                 $23,000

The difference between the selling price ($30,000) and the carrying value ($7,000) results in a gain of $23,000, which is recorded as a gain on the sale of machinery on the income statement.

Presentation on Financial Statements

PPE is presented under the Non-Current Assets section of the balance sheet. It appears at cost less accumulated depreciation (or at fair value in the case of revalued assets). Accumulated depreciation is shown as a deduction from the historical cost of the asset.

On the Income Statement, depreciation is recorded as an expense, often under operating expenses. Any impairment losses or gains on the sale of PPE are also recorded on the income statement.

Important Notes on PPE in Accounting

Capitalization Threshold – Companies often set a minimum value threshold for capitalization, meaning only assets exceeding a certain amount are capitalized as PPE. Smaller purchases are expensed immediately.
Component Depreciation – When different parts of a single asset have different useful lives (e.g., a roof vs. a building), these components should be depreciated separately.
Depreciation Method Consistency – While different methods of depreciation can be used, companies must apply their chosen method consistently from period to period, ensuring comparability in financial statements.

Conclusion

Recording and managing Property, Plant, and Equipment (PPE) in accounting is crucial for accurate financial reporting and ensuring compliance with established accounting standards. From acquisition to disposal, each step involves thoughtful calculation and attention to detail, whether it be in calculating depreciation, recognizing impairment, or revaluing assets. Understanding these processes ensures that a company’s financial statements accurately reflect the true value of its long-term investments in physical assets, providing a clear picture of its financial health to stakeholders.

Whether you’re an accountant, business owner, or finance professional, a solid grasp of PPE accounting empowers you to make informed decisions about your company’s assets, fostering better financial management and long-term success.