What is Property, Plant and Equipment (PPE)?
It is a non-current, tangible capital asset shown on the balance sheet of a business and is used to generate revenues and profits. PPE plays a key part in the financial planning and analysis of a company’s operations and future expenditures. This is especially true in relation to capital expenditures.
What Classifies as Property, Plant, and Equipment?
Property, plant, and equipment basically includes any of a company’s long-term, fixed assets. PP&E assets are tangible, identifiable, 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 equipment, and furnishings, among other things. Note that, of all these asset classes, land is one of the only assets that does not depreciate over time.
If a company produces machinery (for sale), that machinery is not classified as property, plant, and equipment but rather is classified as inventory. The same goes for real estate companies that hold buildings and land under their assets. Their office buildings and land are PP&E, but the houses or land they sell are inventory.
Recognition and Measurement of PPE
A company should only recognize PPE if:
It is probable that future economic benefits associated with the asset will flow to the entity over a period of more than one year; and
We can reliably calculate or estimate the cost of the asset.
The initial costs of a PPE item may include:
Its purchase price, any import duties, non-refundable taxes, sales discounts, and rebates.
Any costs directly attributable to bringing the asset to the location and condition necessary for it to be operational (such as installation expenses).
An estimated value of the costs of dismantling and removing the asset and restoring the site on which it is located. People commonly refer to this as an asset retirement obligation (ARO).
Depreciation of PPE
One major component of the PP&E formula is depreciation. Depreciation lowers the value of property, plant, and equipment on the balance sheet over time due to wear and tear. Depreciation also results in the reduction of their useful life. The depreciation expense is used to reduce the value of the net balance. It flows to the income statement as an expense.