Ch5. Property, Plant & Equipment and Depreciation — From Acquisition to Disposal

What Is Property, Plant & Equipment?

Property, Plant & Equipment (PP&E) Tangible assets held for use in the production of goods, provision of services, rental, or administrative purposes. Expected to be used for more than one year and to generate future economic benefits.

Examples: Land, buildings, machinery, vehicles, furniture and fixtures, assets under construction

Determining Acquisition Cost

Cost Model: The sum of all costs incurred to acquire the asset.

Acquisition Cost = Purchase Price + Direct Costs of Acquisition
                   (freight, installation, initial testing included)

Note: Post-acquisition training costs, advertising costs, etc. are excluded.

Land: Not depreciated (permanent asset)

Depreciation

The systematic allocation of a tangible asset’s acquisition cost over its useful life.

Basic Depreciation Concept:
Acquisition Cost − Salvage Value = Depreciable Amount
→ Allocated over the useful life

Straight-Line Method

The same amount is expensed each period.

Annual Depreciation = (Acquisition Cost − Salvage Value) / Useful Life

Example: Cost $100,000, Salvage Value $10,000, Useful Life 5 years
→ Annual Depreciation = (100,000 − 10,000) / 5 = $18,000

Declining Balance Method

A fixed rate is applied to the carrying (book) value each period. More is expensed in early years.

Depreciation = Beginning Book Value × Depreciation Rate

Example: Cost $100,000, Rate 40%
Year 1: 100,000 × 40% = $40,000
Year 2:  60,000 × 40% = $24,000
Year 3:  36,000 × 40% = $14,400

Units of Production Method

Depreciation is proportional to actual output. Well-suited for machinery and mines.

Depreciation Per Unit = (Acquisition Cost − Salvage Value) / Total Estimated Production
Annual Depreciation = Depreciation Per Unit × Actual Units Produced

Capital Expenditures vs. Revenue Expenditures

Category	Capital Expenditure	Revenue Expenditure
Meaning	Spending that increases asset value or extends useful life	Spending that maintains the current condition
Accounting treatment	Capitalized as an asset (not expensed immediately)	Expensed in the current period
Examples	Installing an elevator, major expansions	Repainting, routine supplies replacement
Effect on income	Increases income in the short term	Decreases income in the current period

Practical judgment: If future economic benefits increase, it’s a capital expenditure.

Asset Impairment

When the recoverable amount of an asset (the higher of its value in use or fair value less costs to sell) falls below its carrying amount, an impairment loss must be recognized.

Impairment Loss = Carrying Amount − Recoverable Amount

Examples of impairment indicators: Sharp decline in market value, technological obsolescence, deteriorating business conditions, physical damage

Key Concept Cards

Straight-Line vs. Declining Balance ★★★★★ : Straight-line = same amount expensed each year. Declining balance = more expensed in early years (accelerated). Tax regulations often permit the declining balance method. Memory tip: Straight-line = uniform, Declining balance = front-loaded

Capital Expenditure ★★★★★ : Spending that increases an asset’s future economic benefits → capitalized. Must be distinguished from revenue expenditures (maintenance and repairs). Memory tip: Improves value = capital expenditure, maintains status quo = revenue expenditure

Depreciation as a Non-Cash Expense ★★★★☆ : An expense recorded without any cash outflow. Therefore, it is added back to operating income when analyzing EBITDA or cash flows. Memory tip: Depreciation = non-cash expense → added back in cash flow analysis

Practice Quiz

Q. Waterproofing work on the exterior of a building costs $10,000. Is this a capital or revenue expenditure?

If the purpose is to extend the building’s useful life or increase its value, it is a capital expenditure. If it is simply routine maintenance, it is a revenue expenditure. When the judgment is ambiguous, consider the materiality (the amount) and whether future benefits increase.

Q. Equipment is purchased for $50,000, with a salvage value of$ 5,000 and a useful life of 5 years, depreciated straight-line. What is the book value after 3 years?

Annual depreciation = (50,000 − 5,000) / 5 = $9,000. Accumulated depreciation after 3 years =$ 27,000. Book value = 50,000 − 27,000 = $23,000.

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