Property,PlantandEquipmentWhatCostsareIncludedinProperty,Plant,andEquipment?Property,Plant,andEquipmentisaseparatecategoryonaclassifiedbalancesheet.IttypicallyfollowsLong-termInvestments,andisoftentimesreferredtoas“PP&E.”Itemsappropriatelyincludedinthissectionarethephysicalassetsdeployedintheproductiveoperationofthebusiness,likeland,buildings,andequipment.Notethatidlefacilitiesandlandheldforspeculationaremoreappropriatelylistedinsomeothercategoryonthebalancesheet,likeLong-termInvestments.WithinthePP&Esection,itemsarecustomarilylistedaccordingtoexpectedlife.Landcomesfirst,followedbybuildings,thenequipment.Forsomebusinesses,theamountofPP&Ecanbesubstantial.Thisisthecaseforfirmsthathaveheavymanufacturingoperationsorsignificantrealestateholdings.Otherserviceorintellectual-basedbusinessesmayactuallyhaveverylittletoshowwithinthisbalancesheetcategory.BelowisanexampleofhowatypicalPP&Esectionofthebalancesheetmightappear.Inthealternative,somecompaniesmayrelegatethislevelofdetailintoanoteaccompanyingthefinancialstatements,andinsteadjustreportasinglenumberfor“property,plant,andequipment,netofaccumulateddepreciation”onthefaceofthebalancesheet.COSTASSIGNMENTThecorrectamountofcosttoallocatetoaproductiveassetisbasedonanassessmentofthoseexpendituresthatareordinaryandnecessarytogettheiteminplaceandinconditionforitsintendeduse.Suchamountsincludethepurchaseprice(lessanynegotiateddiscounts),permits,freight,ordinaryinstallation,initialsetup/calibration/programming,andothernormalcostsassociatedwithgettingtheitemreadytouse.Thesecostsaretermedcapitalexpenditures.Incontrast,otherexpendituresmayarisethatarenot“ordinaryandnecessary,”orbenefitonlytheimmediateperiod.Thesecostsshouldbeexpensedasincurred.Anexampleisrepairofabnormaldamagecausedduringinstallationofequipment.Toillustrate,assumethatPechlatCorporationpurchasedanewlathe.Thelathehadalistpriceof$90,000,butPechlatnegotiateda10%discount.Inaddition,Pechlatagreedtopayfreightandinstallationof$5,000.Duringinstallation,thelathe’sspindlewasbentandhadtobereplacedfor$2,000.Thejournalentrytorecordthistransactionis:INTERESTANDTRAININGCOSTInterestpaidtofinancethepurchaseofproperty,plant,andequipmentisexpensed.Anexceptionisinterestincurredonfundsborrowedtofinanceconstructionofplantandequipment.Suchinterestrelatedtotheperiodoftimeduringwhichactiveconstructionisongoingiscapitalized.Interestcapitalizationrulesarequitecomplex,andaretypicallycoveredinintermediateaccountingcourses.Theacquisitionofnewmachineryisoftentimesaccompaniedbyemployeetrainingregardingcorrectoperatingprocedures.Thenormalruleisthattrainingcostsareexpensed.Thelogicisthatthetrainingattachestotheemployeenotthemachine,andtheemployeeisnotownedbythecompany.Onrareoccasion,justificationforcapitalizationofveryspecializedtrainingcosts(wherethetrainingiscompanyspecificandbenefitsmanyperiods)ismade,butthisistheexceptionratherthantherule.LANDWhenacquiringland,certaincostsareordinaryandnecessaryandshouldbeassignedtoLand.Thesecostsincludethecostoftheland,plustitlefees,legalfees,surveycosts,andzoningfees.Alsoincludedaresitepreparationcostslikegradinganddraining,orthecosttorazeanoldstructure.Allofthesecostsmaybeconsideredordinaryandnecessarytogetthelandreadyforitsintendeduse.Somecostsarelandimprovements.Thisassetcategoryincludesthecostofparkinglots,sidewalks,landscaping,irrigationsystems,andsimilarexpenditures.Whyseparatelandandlandimprovementcosts?Theanswertothisquestionwillbecomeclearwhendepreciationisconsidered.Landisconsideredtohaveanindefinitelifeandisnotdepreciated.Alternatively,parkinglots,irrigationsystems,andsoforthdowearoutandmustbedepreciated.LUMP-SUMACQUISITIONAcompanymaybuyanexistingfacilityconsistingofland,buildings,andequipment.Thenegotiatedpriceisusuallya“turnkey”dealforallthecomponents.Whilethelump-sumpurchasepriceforthepackageofassetsisreadilydeterminable,assigningcoststotheindividualcomponentscanbecomeproblematic.Yet,foraccountingpurposes,itisnecessarytoallocatethetotalpurchasepricetotheindividualassetsacquired.Thismayrequireaproportionalallocationofthepurchasepricetotheindividualcomponents.Toillustrate,assumeDibitanzlacquiredamanufacturingfacilityfromMalloyfor$2,000,000.Assumethatthefacilityconsistedofland,building,andequipment.IfDibitanzlhadacquiredthelandseparately,itsestimatedvaluewouldbe$500,000.Theestimatedvalueofthebuildingis$750,000.Finally,theequipmentwouldcost$1,250,000ifpurchasedindependentofthe“package.”Thesumofthevaluesofthecomponentscomesto$2,500,000($500,000+$750,000+$1,250,000).Yet,theactualpurchasepricewasonly80%ofthisamount($2,500,000X80%=$2,000,000).Theaccountingtaskistoallocatetheactualcostof$2,000,000tothethreeseparatepieces,asshownbythefollowing:Theabovecalculationsformthebasisforthefollowingentry:JUDGMENTAccountingmayseemtobemechanical.However,thereisaneedfortheexerciseofjudgment.Professionaljudgmentwasrequiredtoestimatethevalueofthecomponentsforpurposesofmakingtheprecedingentry.Suchjudgmentsareoftentimesaninescapablepartoftheaccountingprocess.Notethatdifferentestimatesofvaluewouldhavecausedadifferentproportionofthe$2,000,000tobeassignedtoeachitem.Doestheallocationreallymatter?Itisactuallyveryimportantbecausetheamountassignedtolandwillnotbedepreciated.Amountsassignedtobuildingandequipmentwillbedepreciatedatdifferentrates.Thus,thefuturepatternofdepreciationexpense(andthereforeincome)willbealteredbythisinitialallocation.Investorspaycloseattentiontoincomeandproperjudgmentbecomesanimportantelementoftheaccountingprocess.MATERIALITYManyexpendituresareforlong-livedassetsofrelativelyminorvalue.Examplesincludetrashcans,telephones,andsoforth.Shouldthoseexpendituresbecapitalizedanddepreciatedovertheirusefullife?Or,doesthecostofrecordkeepingexceedthebenefit?Manybusinessessimplychoosetoexpensesmallcostsasincurred.Thereasonismateriality;nomatterwhichwayoneaccountsforthecost,itisnotapttobearonanyone’sdecision-makingprocessaboutthecompany.Thisagainhighlightsthedegreetowhichprofessionaljudgmentcomesintoplayintheaccountingprocess.ServiceLifeandCostAllocationCasually,peoplewillspeakofdepreciationasadeclineinvalueor“using-up”ofanasset.However,inaccountingjargon,thetermismeanttorefertotheallocationofanasset’scosttotheaccountingperiodsbenefited.Itisnotanattempttovaluetheasset.Thus,itisoftensaidthatdepreciationisaprocessof“allocation”not“valuation.”O(jiān)nceanasset’scostisdetermined,itnextbecomesnecessarytodeterminetheaccountingperiodsbenefited(i.e.,servicelife).Determiningtheservicelifeofanassetisanessentialfirststepincalculatingtheamountofdepreciationattributabletoaspecificperiod.Severalfactorsmustbeconsidered:Physicaldeterioration--“Wearandtear”willeventuallycausemostassetstosimplywearoutandbecomeuseless.Thus,physicaldeteriorationservestoestablishanouterlimitontheservicelifeofanasset.Obsolescence--Theshorteningofservicelifeduetotechnologicaladvancesthatcauseanassettobecomeoutofdateandlessdesirable.Inadequacy--Aneconomicdeterminantofservicelifewhichisrelevantwhenanassetisnolongerfastenoughorlargeenoughtofillthecompetitiveandproductiveneedsofacompany.Factorssuchasthesemustbeconsideredindeterminingtheservicelifeofaparticularasset.Insomecases,allthreefactorscomeintoplay.Inothercases,onefactoralonemaycontrolthedeterminationofservicelife.Importantly,servicelifecanbecompletelydifferentfromphysicallife.Forexample,computersareoftenreplacedeventhoughstillphysicallyfunctional.Recognizethatsomeassetshaveanindefinite(orpermanent)life.Oneprominentexampleisland.Accordingly,itisnotconsideredtobeadepreciableasset.DepreciationConceptsOncethecostandservicelifeofanassetaredetermined,itistimetomoveontothechoiceofdepreciationmethod.Thedepreciationmethodissimplythepatternbywhichthecostisallocatedtoeachoftheperiodsinvolvedintheservicelife.Therearemanymethodsfromwhichtochoose.Threepopularmethodsare:(1)straight-line,(2)units-of-output,and(3)double-decliningbalance.Whysomanychoices?Toexplain,beginbyassumingthata$100assetistobedepreciatedoverfouryears.Underthestraight-lineapproach,depreciationexpenseissimply$25peryear(showninredonthetopofthefacingpage).Thismayseemverylogicaliftheassetisuseduniformlyoverthefour-yearperiod.But,whatifmaintenancecosts(showningreen)arealsoconsidered?Asanassetages,itisnotuncommonformaintenancecoststoexpand.Assumethefirst-yearmaintenanceis$0,andriseseachyearasshown.Combiningthetwocoststogetherrevealsanincreaseintotalcost,eventhoughtheusageisdeemedtobeconstant.Withaccelerateddepreciation(shownonthebottomofthefacingpage),thecombinedamountofdepreciationandmaintenanceprovidesalevelmeasureoftotalcost.Thismayachieveabettermatchingoftotalcostsandbenefitsinthisparticularscenario.Doesthismeanthataccelerateddepreciationisbetter?Notnecessarily.Factscanvary,andthepointistoshowwhymultiplemethodsexistandcanbejustified.Straight-LineEffectsAcceleratedEffectsSOMEIMPORTANTTERMINOLOGYInanydiscipline,precisionisenhancedbyadoptingterminologythathasveryspecificmeaning.AccountingforPP&Eisnoexception.Anexactunderstandingofthefollowingtermsisparamount:Cost:Thedollaramountassignedtoaparticularasset;usuallytheordinaryandnecessaryamountexpendedtogetanassetinplaceandinconditionforitsintendeduse.

Servicelife:Theusefullifeofanassettoanenterprise,usuallyrelatingtotheanticipatedperiodofproductiveuseoftheitem.Salvagevalue:Alsocalledresidualvalue.Thisistheamountexpectedtoberealizedattheendofanasset’sservicelife;forexample,theanticipatedfuturesalesproceedsforusedequipment.Depreciablebase:Thecostminusthesalvagevalue.Depreciablebaseistheamountofcostthatwillbeallocatedtotheservicelife.

Bookvalue:Alsocallednetbookvalue.Thisreferstothebalancesheetamountatapointintimethatrevealsthecostminustheamountofaccumulateddepreciation(bookvaluehasothermeaningswhenusedinothercontexts,sothisdefinitionislimitedtoitsuseinthecontextofPP&E).Belowisanillustrationrelatingthesetermstothefinancialstatementpresentationforabuilding:Intheprecedingillustration,assumingstraight-linedepreciation,whatistheasset’sage?The$2,000,0000depreciablebase($2,300,000-$300,000)isevenlyspreadover20years.Thisproducesannualdepreciationof$100,000.Asaresult,theaccumulateddepreciationof$1,500,000suggestsanageof15years(15X$100,000).DepreciationMethodsTherearemanypossibledepreciationmethods,butstraight-lineanddouble-decliningbalancearethemostpopular.Inaddition,theunits-of-outputmethodisuniquelysuitedtocertaintypesofassets.Thefollowingdiscussioncoverseachofthesemethods.Intermediateaccountingcoursestypicallyintroduceadditionaltechniquesthataresometimesappropriate.THESTRAIGHT-LINEMETHODUnderthestraight-lineapproachtheannualdepreciationiscalculatedbydividingthedepreciablebasebytheservicelife.Anassetthathasa$100,000cost,$10,000salvagevalue,andafour-yearlifewouldproducethefollowingamounts:Foreachoftheaboveyears,thejournalentrytorecorddepreciationisasfollows:Theapplicabledepreciationexpensewouldbeincludedineachyear’sincomestatement(exceptinamanufacturingenvironmentwheresomedepreciationmaybeassignedtothemanufacturedinventory,aswillbecoveredinthemanagerialaccountingchapterslaterinthisbook).Theappropriatebalancesheetpresentationwouldappearasfollows(endofyear3inthiscase):

FRACTIONALPERIODDEPRECIATION(SL)Assetsmaybeacquiredatotherthanthebeginningofanaccountingperiod,anddepreciationmustbecalculatedforapartialperiod.Withthestraight-linemethodtheamountissimplyafractionoftheannualamount.Forexample,anassetacquiredonthefirstdayofAprilwouldbeusedforonlyninemonthsduringthefirstcalendaryear.Therefore,Year1depreciationwouldbe9/12oftheannualamount.Followingisthedepreciationtablefortheasset,thistimeassuminganApril1stacquisitiondate:THEUNITS-OF-OUTPUTMETHODTheunits-of-outputmethodinvolvescalculationsthatarequitesimilartothestraight-linemethod,butitallocatesthedepreciablebaseovertheunitsofoutputratherthanyearsofuse.Itislogicaltousethisapproachinthosesituationswherethelifeisbestmeasuredbyidentifiableunitsofmachine“consumption.”

Forexample,perhapstheengineofacorporatejethasanestimatedlifeof50,000hours.Or,aprintingmachinemayproduceanexpected4,000,000copies.Incaseslikethese,theaccountantmayoptfortheunits-of-outputmethod.Toillustrate,assumeDatNguyenPaintingCorporationpurchasedanairfiltrationsystemthathasalifeof8,000hours.Thefiltercost$100,000andhasa$10,000salvagevalue.Nguyenanticipatesthatthefilterwillbeused1,000hoursduringthefirstyear,3,000hoursduringthesecond,2,000duringthethird,and2,000duringthefourth.Accordingly,theanticipateddepreciationschedulewouldappearasfollowsTheformofjournalentryandbalancesheetaccountpresentationarejustlikethestraight-lineillustration,butwiththerevisedamountsfromthistable.THEDOUBLE-DECLININGBALANCEMETHODAsoneofseveralaccelerateddepreciationmethods,double-decliningbalance(DDB)resultsinrelativelylargeamountsofdepreciationinearlyyearsofassetlifeandsmalleramountsinlateryears.Thismethodcanbejustifiedifthequalityofserviceproducedbyanassetdeclinesovertime,orifrepairandmaintenancecostswillriseovertimetooffsetthedecliningdepreciationamount.Withthismethod,200%ofthestraight-linerateismultipliedtimestheremainingbookvalueofanasset(asofthebeginningofaparticularyear)todeterminedepreciationforaparticularyear.Astimepasses,bookvalueandannualdepreciationdecrease.

Toillustrate,againutilizetheexampleofthe$100,000asset,withafour-yearlife,and$10,000salvagevalue.Depreciationforeachofthefouryearswouldappearasfollows:Theamountsintheabovetabledeserveadditionalcommentary.Year1expenseequalsthecosttimestwicethestraight-linerate(four-yearlife=25%straight-linerate;25%X2=50%rate).Year2isthe50%rateappliedtothebeginningofyearbookvalue.Year3iscalculatedinasimilarfashion.Notethatsalvagevaluewasignoredinthepreliminaryyears’calculations.ForYear4,however,thecalculatedamount(($100,000-$87,500)X50%=$6,250)wouldcausethelifetimedepreciationtoexceedthe$90,000depreciablebase.Thus,inYear4,only$2,500istakenasexpense.ThisgivesrisetoanimportantgeneralruleforDDB:salvagevalueisinitiallyignored,butonceaccumulateddepreciationreachestheamountofthedepreciablebase,thendepreciationceases.Intheexample,only$2,500wasneededinYear4tobringtheaggregatedepreciationuptothe$90,000level.Anassetmayhavenosalvagevalue.ThemathematicsofDDBwillneverfullydepreciatesuchassets(sinceoneisonlydepreciatingapercentageoftheremainingbalance,theremainingbalancewouldnevergotozero).Inthesecases,accountantstypicallychangetothestraight-linemethodneartheendofanasset’susefullifeto“finishoff”thedepreciationoftheasset’scost.FRACTIONALPERIODDEPRECIATION(DDB)UnderDDB,fractionalyearsinvolveaverysimpleadaptation.Thefirstpartialyearwillbeafractionoftheannualamount,andallsubsequentyearswillbethenormalcalculation(twicethestraight-lineratetimesthebeginningofyearbookvalue).IftheexampleassetwaspurchasedonApril1stofYear1,thefollowingcalculationsresult:ALTERNATIVESTODDB150%and125%decliningbalancemethodsarequitesimilartoDDB,buttherateis150%or125%ofthestraight-linerate(insteadof200%aswithD