Property, Plant, and Equipment, and Intangible Assets: Study Notes

Property, Plant, and Equipment, and Intangible Assets

Chapter Overview

This chapter discusses the accounting for long-lived assets, focusing on property, plant, and equipment (PP&E) and intangible assets. These assets are essential for business operations and are expected to provide economic benefits for more than one year. The chapter covers acquisition, depreciation/amortization, disposal, impairment, and the impact on financial statements.

Learning Objectives

• Explain how to account for the cost of property, plant, and equipment

• Explain how to account for depreciation of property, plant, and equipment

• Explain additional topics in accounting for long-lived tangible assets

• Explain how to account for intangible assets

• Analyze a company's return on assets

• Analyze the cash flow impact of long-lived asset transactions

Accounting for the Cost of Property, Plant, and Equipment

Types of Long-Lived Assets

• Tangible long-lived assets: Physical assets used in operations, such as land, buildings, machinery, and equipment.

• Intangible assets: Non-physical assets, such as patents, copyrights, trademarks, and goodwill.

Initial Measurement

• Assets are recorded at historical cost, which includes purchase price and all costs necessary to bring the asset to its intended use.

• Examples of costs included: purchase price, legal fees, installation, transportation, and site preparation.

Land, Buildings, and Equipment

• Land: Includes purchase price, legal fees, property taxes, and costs to prepare land for use.

• Buildings: Includes purchase price, construction costs, architect fees, permits, and interest during construction.

• Machinery/Equipment: Includes purchase price, delivery, installation, testing, and insurance during transit.

Land Improvements and Leasehold Improvements

• Land improvements: Expenditures for items that will deteriorate over time (e.g., fences, driveways, landscaping).

• Leasehold improvements: Improvements made to leased property; amortized over the shorter of the lease term or useful life.

Capital vs. Revenue Expenditures

• Capital expenditures: Costs that increase the asset's value or extend its useful life; capitalized on the balance sheet.

• Revenue expenditures: Costs for maintenance or repairs; expensed immediately.

Example Table: Determining Asset Costs

Item	Land	Building	Land Improvements	Equipment
Purchase price	$200,000	$400,000	$30,000	$50,000
Legal fees	$5,000
Architect fees		$10,000
Installation				$2,000
Landscaping			$5,000

Depreciation of Property, Plant, and Equipment

Depreciation Concepts

• Depreciation: The process of allocating the cost of a tangible asset over its useful life.

• Does not represent a decrease in market value, but rather allocation of cost.

Key Terms

• Useful life: Estimated period the asset will be used by the business.

• Residual value: Estimated value at the end of the asset's useful life.

• Depreciable cost: Asset cost minus residual value.

$\text{Depreciable Cost} = \text{Asset Cost} - \text{Residual Value}$

Depreciation Methods

• Straight-Line (SL) Method: Allocates equal depreciation expense each year.

  • $\text{Depreciation Expense} = \frac{\text{Depreciable Cost}}{\text{Useful Life}}$

• Units-of-Production (UOP) Method: Allocates expense based on usage or output.

  • $\text{Depreciation per Unit} = \frac{\text{Depreciable Cost}}{\text{Total Estimated Units}}$

  • $\text{Depreciation Expense} = \text{Depreciation per Unit} \times \text{Units Produced}$

• Double-Declining Balance (DDB) Method: Accelerated method; higher expense in early years.

  • $\text{DDB Rate} = 2 \times \text{Straight-Line Rate}$

  • $\text{Depreciation Expense} = \text{Book Value at Beginning of Year} \times \text{DDB Rate}$

Example Table: Depreciation Schedule

Year	Straight-Line	Units-of-Production	Double-Declining Balance
1	$10,000	$12,000	$20,000
2	$10,000	$8,000	$16,000
3	$10,000	$10,000	$12,800

Additional Topics in Accounting for Long-Lived Tangible Assets

Partial Period Depreciation and Asset Disposal

• Depreciation must be calculated for partial years if assets are acquired or disposed of during the year.

• When assets are sold, compare proceeds to carrying value to determine gain or loss.

$\text{Gain/Loss on Sale} = \text{Proceeds} - \text{Carrying Value}$

Impairment of Assets

• Occurs when carrying amount exceeds recoverable amount.

• Loss is recognized as:

  • $\text{Loss on Impairment} = \text{Carrying Amount} - \text{Recoverable Amount}$

Disclosure Guidelines

• Companies must disclose policies for measuring and depreciating PP&E, and details of major asset classes.

Accounting for Intangible Assets

Types of Intangible Assets

• Finite-life intangibles: Amortized over useful life (e.g., patents, copyrights).

• Indefinite-life intangibles: Not amortized, but tested for impairment (e.g., trademarks, goodwill).

Accounting for Intangibles

• Intangibles are recorded at cost and amortized if they have a finite life.

• Impairment is recognized if carrying amount exceeds recoverable amount.

• Research and development costs are generally expensed, except development costs meeting certain criteria (IFRS).

Analyzing a Company's Return on Assets

• Return on Assets (ROA) measures profitability relative to total assets.

$\text{ROA} = \frac{\text{Net Income}}{\text{Average Total Assets}}$

Cash Flow Impact of Long-Lived Asset Transactions

• Purchases and sales of long-lived assets appear in the investing section of the statement of cash flows.

• Depreciation expense is a non-cash item and does not affect cash flows directly.

• Capital expenditures reduce cash; asset sales increase cash.

IFRS and ASPE Differences

• IFRS and ASPE differ in some recognition and measurement rules for PP&E and intangibles.

Summary Table: Key Terms and Concepts

Term	Definition
Depreciation	Allocation of the cost of a tangible asset over its useful life
Amortization	Allocation of the cost of an intangible asset over its useful life
Impairment	Reduction in asset value when carrying amount exceeds recoverable amount
Capital Expenditure	Cost that increases asset value or extends useful life
Revenue Expenditure	Cost for maintenance or repairs; expensed immediately

Examples and Applications

• Calculating depreciation using different methods for a new machine

• Recording the sale of equipment and determining gain or loss

• Testing for impairment of a trademark

• Analyzing the impact of asset purchases on the statement of cash flows

Additional info: These notes expand on the provided outline with definitions, formulas, and examples for clarity and completeness.