7.1 Accounting for Property, Plant, and Equipment (PP&E)

Let's begin with this basic working rule for determining the cost of an asset:

The cost of any asset is the sum of all the costs incurred to bring the asset to its location and intended use. The cost of property, plant, and equipment includes its purchase price plus any taxes, commissions, and other amounts paid to make the asset ready for use. Because the specific costs differ for the various categories of property, plant, and equipment, we discuss the major groups individually.

What are Tangible and Intangible Assets?

Property, plant, and equipment consists of long-lived assets that are actively used in operations to generate future benefits beyond one year.

There are two categories of capital or long-lived assets: 

1. Tangible assets
2. Intangible assets

Property, plant, and equipment (PP&E) are tangible assets.

1. Tangible Assets

Tangible assets are resources with physical substance that are used in the operations of a business and are not intended for sale to customers. Tangible assets are also called PP&E, long-term assets, fixed assets, and capital assets. 

For example, buildings, equipment, land, and fixtures are all tangible assets.

Long-lived assets do not last forever and their usefulness decreases over time. Thus, the cost of these assets must be expensed over their useful lives (called depreciation). Land is an exception and is not depreciated because its usefulness does not decrease. But, land improvements (e.g., parking lots, fence) are depreciable.

Most long-lived assets have a related “expense” account to capture its contribution to the business, in-line with the matching principle.

2. Intangible Assets

Intangible assets are long-lived assets with no physical form. Intangible assets include rights from patents, copyrights, franchises, etc.

We will discuss intangible assets further in a later part of this unit.

Measuring the Acquisition Costs

The cost of a PP&E asset includes:

• Purchase price,
• Any taxes, 
• Commissions, and
• Other amounts paid to make the asset ready for use.

Let's look at how costs vary by type of PP&E.

Acquisition Cost of Land

The cost of land includes:

• Purchase price;
• Real estate commissions;
• Survey and legal fees;
• Back property taxes paid; and
• Grading and removing unwanted buildings.

Note: the cost of land does not include the cost of fencing, paving, security systems, and lighting. These are separate tangible assets—called land improvements—and they are subject to depreciation.

Let’s take a look at an example:

A business signs a $300,000 note payable to purchase land for a new production facility, and pays $10,000 in real estate commission, $8,000 in back property tax, $5,000 for removal of an old building, a $1,000 survey fee, and $260,000 to pave the parking lot.

What is the cost of the land?

(Harrison et al., 2018, p. 280)

Measuring the Acquisition Cost of Buildings

The cost of constructing a building includes: 

• Architectural fees, building permits, and contractors’ charges;
• Materials, labor, and overhead; and
• Interest on money borrowed to finance the construction.

The cost of purchasing an existing building (new or old) includes:

• Purchase price;
• Brokerage commission;
• Sales and other taxes paid; and
• All expenditures to repair and renovate the building for its intended purpose.

Acquisition Cost of Equipment

The cost of equipment includes:

• Purchase price (after discounts);
• Transportation;
• Insurance in transit;
• Non-refundable sales and other taxes;
• Purchase commission;
• Installation costs, and any expenditures to test the asset before it’s placed in service; and
• Special platform used to support the equipment.

After the asset is up and running, insurance, taxes, and maintenance costs are recorded as expenses, not as part of the asset’s cost.

Land Improvements and Leasehold Improvements

Land improvements: the cost for land improvement (e.g., parking lot pavement, driveways, signs, fences) is recorded in a separate account entitled land improvements. Although these assets are located on the land, they are subject to decay, and their cost should therefore be depreciated.

Leasehold improvements: companies often lease equipment or property. Then, they customize them for their special needs—leasehold improvements. The cost of leasehold improvements should be capitalized and depreciated over the term of the lease or the life of the asset, whichever is shorter.

Lump-Sum (Basket) Purchases of Assets

Businesses often purchase several assets as a group, or a “basket,” for a single lump-sum amount. For example, a business may pay one price for land and a building. The company must identify the cost of each asset. The total cost is divided among the assets according to their relative fair values.  

Let’s take a look at an example:

On January 1, WestJet purchased land and a building for $300,000 cash (acquisition cost).The appraised market values for the building and land are $189,000 and $126,000, respectively.

How much of the $300,000 purchase price will be charged to the building and land accounts?

© Course Author(s) and University of Waterloo

Corresponding journal entry:

Capital Assets vs. Immediate (In-Year) Expenditures

Long-lived assets usually require expenditures during their useful lives to enhance or maintain their productive capacity. Most companies expense small costs, say, below $1,000. Other expenditures can be capitalized as an asset and depreciated or immediately expensed based on the nature of the expense. This requires some judgment. In general, the following rules help differentiate between an asset and an expense.