PP&E (Property, Plant and Equipment)

Fixed, tangible assets

What is PP&E (Property, Plant and Equipment)?

Property, Plant and Equipment (PP&E) are non-current capital assets on the balance sheet of a business used to generate revenues and profits.  PP&E plays a key part in the financial planning and analysis of a company’s operations and future expenditures, especially with regards to capital expenditures.

 

PP&E

 

The PP&E account is often denoted as net of accumulated depreciation. This means that, if a company does not purchase new equipment (capital expenditures is zero), Net PP&E should slowly decrease in value every period due to depreciation. This can be better determined through the depreciation schedule.

PP&E, as a fixed asset account, is generally very illiquid. A company can sell its equipment, but not as easily as its inventory. The value of PP&E between companies will vary with the operations. For example, a construction company will generally have a higher property, plant and equipment balance than an accounting firm.

 

What Classifies as Property, Plant and Equipment?

Property, plant and equipment will include any of a company’s long-term, fixed assets. PP&E assets are tangible, identifiable, physical and expected to generate an economic return for the company for more than one year, or one operating cycle (whichever is longer). The account can include machinery, equipment, vehicles, buildings, land, office space, office equipment, and furnishings, among others. Note that, of all these asset classes, land is generally one of the only assets that do not depreciate over time.

If a company produces machinery (for sale), that machinery does not classify as property, plant and equipment. The machinery used to produce the machinery for sales is PP&E, but the machinery for sale will be classified as inventory. The same goes for real estate companies that hold building and land under their assets. Their office buildings and land are PP&E, but the apartments they sell are inventory.

 

PP&E Formula

Net PP&E = Gross PP&E + Capital Expenditures  – Accumulated Depreciation

To illustrate:

In May 2017, Factory Corp. owned machinery with a gross value of $5,000,000. Accumulated depreciation for the same machinery was at $2,100,000. Due to the wear and tear of the machinery, the company decided to purchase another $1,000,000 in new equipment. For this period, the depreciation expense for all old and new equipment is $150,000.

Thus, the ending balance is $3,750,000. This is found by taking $5,000,000 + $1,000,000 – $2,100,000 – $150,000.

 

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Capital Expenditures

As the above formula shows, capital expenditures are what add to the net property, plant and equipment balance on the balance sheet.  When the company spends money investing in either (1) updating and maintaining existing equipment, or (2) purchasing new additional equipment, this adds to the total balance on the balance sheet.

 

Recognition and Measurement of PP&E

PP&E should be recognized by a company only if:

  1. It is probable that future economic benefits associated with asset will flow to the entity; and
  2. The cost of the asset can be measured reliably.

The initial costs of a PP&E item may include:

  1. Its purchase price, any import duties, non-refundable taxes, sales discounts, and rebates;
  2. Any costs directly attributable to bringing the asset to the location and condition necessary for it to operational; and
  3. An estimated value of the costs of dismantling and removing the asset and restoring the site on which it is located. This is commonly referred to as an asset retirement obligation (ARO).

 

Repairs and Replacement of PP&E

The nature of PP&E assets is that some of these assets need to be regularly fixed or replaced to prevent equipment failures or to adopt a more sophisticated technology. For example, it is normal for companies to repair or replace old factories or automobiles with new assets when necessary. The general rule in accounting for repairs and replacements is that repairs and maintenance work are expensed while replacements of assets are capitalized. Repairs are easy to record; it is simply a debit to repair or maintenance expense and a credit to cash. Replacements, however, are a bit more complicated. For replacements, the old cost of the asset is derecognized from the company’s books and the new cost of the replacement is recorded/recognized.

 

Depreciation of PP&E

The other major component of the PP&E formula above is depreciation and amortization.  Depreciation reduces the value of property, plant, and equipment on the balance sheet as the value of assets are lowered over time due to wear and tear and the reduction of their useful life.  The depreciation expense is used to reduce the value of the net balance and it flows to the income statement as an expense.

 

Learn more about the Balance Sheet!

We hope this has been a helpful guide to understanding property, plant and equipment.  To keep learning and advancing your career, we highly recommend these additional resources below: