In accounting, PPE (Property, Plant, and Equipment) refers to tangible, long-term assets that are used by a company in its operations to generate revenue. These assets are not intended for resale but are used for production, administrative purposes, or service delivery.
Key Features of PPE
Tangible Assets: PPE includes physical items such as buildings, machinery, vehicles, land, and equipment.
Long-Term Assets: They are not consumed within a single accounting period and have a useful life of more than one year.
Used in Operations: PPE assets are used in the normal operations of the business, unlike inventory or investment properties.
Non-Current Assets: PPE is classified as non-current (fixed) assets on the balance sheet because of their long-term nature.
Components of PPE
Common examples of PPE include:
Land: Not depreciable (unless impaired).
Buildings: Offices, warehouses, factories, etc.
Machinery and Equipment: Tools, machines, and production equipment.
Vehicles: Company cars, delivery trucks, etc.
Furniture and Fixtures: Office furniture, shelving units, etc.
Accounting for PPE
- Initial Recognition: PPE is recorded at its cost, which includes:
Purchase Price: Net of discounts and rebates.
Direct Costs: Costs directly attributable to bringing the asset to its intended use, such as delivery fees, installation costs, legal fees, etc.
Dismantling Costs: Costs of removing or restoring the asset site (if required).
- Subsequent Measurement: After initial recognition, PPE can be measured using either:
Cost Model: Recorded at historical cost less accumulated depreciation and impairment losses.
Revaluation Model: Adjusted to fair value at periodic intervals.
- Depreciation: PPE (except land) is depreciated over its useful life to allocate the cost systematically:
Methods: Straight-line, diminishing balance, or units of production.
Example: A machine costing $50,000 with a 10-year useful life and no salvage value has an annual depreciation expense of $5,000 using the straight-line method.
Impairment: If the recoverable amount (fair value or value in use) of PPE is less than its carrying amount, the asset is impaired, and an impairment loss is recorded.
Derecognition: When PPE is sold or no longer provides economic benefits, it is removed from the books, and any gain or loss is recognized in the income statement.
Presentation in Financial Statements
Balance Sheet: PPE is shown under non-current assets as a single line item, often broken down into individual components in the notes to the accounts.
Income Statement:
Depreciation expense and impairment losses are charged to the income statement.
Gains or losses from the disposal of PPE are also reported.
Importance of PPE
Operational Efficiency: Represents the resources available to carry out business activities.
Financial Health: Indicates long-term investment in physical assets.
Depreciation Impact: Affects net income through non-cash charges.
Liquidity Analysis: Helps assess how capital-intensive the business is.
Example
A company purchases a machine for $100,000. The installation cost is $10,000, and the dismantling cost at the end of its life is estimated to be $5,000. The total cost of the machine is:
$100,000 (purchase price) + $10,000 (installation) + $5,000 (dismantling) = $115,000.
Depreciation is calculated based on this total cost over its useful life.
