Financial Accounting: PPE, Depreciation, and Intangible Assets Study Notes

Property, Plant, and Equipment (PPE) and Intangible Assets

Introduction

This study guide covers key topics in financial accounting related to Property, Plant, and Equipment (PPE), depreciation, asset disposal, natural resources, and intangible assets. These concepts are essential for understanding how companies account for long-lived assets and their consumption over time.

Fixed & Current Assets

Classification of Assets

• Fixed (Non-current) Assets: Assets intended for permanent ownership or use by the company, such as land, buildings, equipment, and machinery. Expected to be used for more than one period.

• Current Assets: Assets not fixed, typically converted into cash within 12 months (e.g., raw materials, finished goods, receivables, cash).

Balance Sheet Presentation

• Fixed assets are shown net of accumulated depreciation.

• Current assets are listed separately, reflecting liquidity.

Comparison: PPE, Intangibles, and Investments

	PPE	Intangibles	Investments
Physical Substance	Yes	No	No
Long-term Nature	Yes	Yes	Yes
Consumption/Depreciation	Depreciation/Depletion	Amortization/Impairment	Not depreciated

Measuring the Cost of PPE (IAS 16)

Initial Measurement

• Purchase Price: The amount paid to acquire the asset.

• Directly Attributable Costs: Costs necessary to bring the asset to its intended use (e.g., installation, legal fees, transportation).

Asset Recognition Criteria

• Probable future economic benefits will flow to the entity.

• Cost can be measured reliably.

Examples of Directly Attributable Costs

Asset	Costs Included
Land	Purchase price, commissions, survey/legal fees, property taxes, grading, removing unwanted buildings
Land Improvements	Fencing, paving, security systems, lighting
Building (Constructed)	Architectural fees, contractor charges, materials, labor, overhead, interest on borrowed funds
Building (Purchased)	Purchase price, broker's commission, taxes, repair/renovation costs
Equipment	Purchase price, transportation, insurance, installation, testing

Lump-Sum (Basket) Purchases

Allocation of Cost

• When multiple assets are purchased together, total cost is allocated based on relative market values.

• Example: If land and building are purchased for $2,800,000, and their market values are $300,000 and $2,700,000, respectively, allocate cost proportionally.

Subsequent Costs (IAS 16)

Capital Expenditures (CAPEX) vs. Expenses (OPEX)

• CAPEX: Increases capacity or extends useful life; added to asset account.

• OPEX: Maintains or restores working order; recorded as expense.

Depreciation

Definition and Purpose

• Depreciation: Systematic allocation of the cost of a fixed asset over its useful life.

• Not a valuation process or a fund for asset replacement.

• Charged to the income statement; cumulative amount is called Accumulated Depreciation.

Impact on Financial Statements

• Income Statement: Depreciation expense reduces net profit.

• Balance Sheet: Asset cost minus accumulated depreciation equals carrying amount.

Depreciation Methods

Overview

• All methods result in the same total depreciation over the asset's life.

• Choice of method should reflect the pattern of economic benefits consumed.

1. Straight-Line Method

• Equal expense each year.

• Formula: $\text{Depreciation Expense} = \frac{\text{Asset Cost} - \text{Residual Value}}{\text{Useful Life}}$

• Example: Asset cost DKK 75,000, residual value DKK 3,000, useful life 5 years: $\frac{75,000 - 3,000}{5} = 14,400$ DKK per year

2. Units-of-Production (UOP) Method

• Expense based on usage (units, miles, hours).

• Formula: $\text{Depreciation per unit} = \frac{\text{Depreciable Cost}}{\text{Total Expected Units}}$ $\text{Depreciation Expense} = \text{Depreciation per unit} \times \text{Units Used in Period}$

• Example: $\frac{19,000 - 2,800}{36,000} = 0.45$ per mile

3. Accelerated Depreciation Methods

• Higher expense in early years, suitable for assets that lose value quickly.

• Double-Declining-Balance (DDB): $\text{DDB Rate} = \frac{1}{\text{Useful Life}} \times 2$ $\text{Depreciation Expense} = \text{DDB Rate} \times \text{Book Value at Beginning of Year}$

• Residual value ignored until final year.

Additional Depreciation Methods

• Declining Balance: Similar to DDB but with a different rate.

• Sum-of-the-Years-Digits (SYD): Allocates higher expense in early years.

• Annuity Method: Based on present value concepts.

Impairment of PPE (IAS 36)

Definition

• An asset is impaired when its carrying value exceeds its recoverable amount.

• Recoverable amount: Higher of net realizable value and value-in-use.

Disposal of PPE

Steps in Disposal

1. Update depreciation to date of disposal.

2. Remove asset and accumulated depreciation from books.

3. Calculate gain or loss based on proceeds and book value.

Natural Resources and Depletion

Accounting for Natural Resources

• Includes assets like oil, timber, minerals.

• Expense recognized through depletion, similar to units-of-production depreciation.

• Journal Entry: Debit Depletion Expense, Credit Accumulated Depletion.

Intangible Assets and Amortization

Definition and Types

• No physical substance; carry special rights (patents, copyrights, trademarks, franchises).

• Finite lives: Amortization recorded.

• Indefinite lives: Tested for impairment, not amortized.

Accounting for Specific Intangibles

• Patents: Exclusive right to produce/sell invention; finite life.

• Copyrights: Exclusive right to reproduce/sell creative work; finite life.

• Trademarks/Trade Names: Distinctive identification; may have indefinite life.

• Franchises/Licenses: Right to sell product/service under specified conditions; may have indefinite life.

• Goodwill: Excess of purchase price over net asset value in acquisition; not amortized, subject to impairment.

Impairment of Intangible Assets

• Permanent decline in value requires impairment loss recognition.

• Goodwill impairment cannot be reversed.

Research & Development (R&D) Costs

• Research phase: Always expensed.

• Development phase: Capitalized if specific criteria are met (technical feasibility, intention to complete, ability to use/sell, future economic benefits, adequate resources, reliable measurement).

Summary Table: Depreciation Methods

Method	Formula	Best Use Case
Straight-Line	$\frac{\text{Cost} - \text{Residual Value}}{\text{Useful Life}}$	Assets with uniform usage
Units-of-Production	$\frac{\text{Cost} - \text{Residual Value}}{\text{Total Units}} \times \text{Units Used}$	Assets with variable usage
Double-Declining-Balance	$(\frac{1}{\text{Useful Life}} \times 2) \times \text{Book Value}$	Assets that lose value quickly

Key Terms

• PPE: Property, Plant, and Equipment

• Depreciation: Allocation of asset cost over useful life

• Amortization: Allocation of intangible asset cost

• Impairment: Reduction in asset value below carrying amount

• Depletion: Allocation of natural resource cost

• Residual Value: Estimated value at end of useful life