Property, Plant and Equipment (including natural resources) The life cycle, including expense versus capitalize, front end costs, maintenance and overhaul, depreciation and depletion, exchange and sale. Topics include impairment and capitalization of interest.

Plant assets, fixed assets, operational assets– which is included in property, plant and equipment (PPE)? Tangible resources Expected to benefit more than one year of operations Needed to “run the business” and ultimately help generate revenue Historical cost valuation (objective, verifiability versus relevance) Cost or depreciated cost (depreciate no more than cost less salvage) Impairment write-down (no write-up later if circumstances change)

Front end costs –to expense or capitalize, that is the question! Expense or prepaid expense Capitalize (record as an asset) Insurance Repairs for unintended damage to new asset Annual fees that must be paid, like property taxes Necessary expenditures to obtain asset and get it ready for intended use Examples – installation, shipping, delinquent property taxes, title search fees, survey costs, tearing down original structures not needed on land Fix up costs on used assets to get them ready for 1st time use

Straight line depreciation –the most popular one Straight line depreciation –the most popular one! (& related depreciation methods) Straight-line method Group/Composite method Formula (cost-salvage)/useful life (time based) Record gain or loss when individual assets are sold If partial year, smaller amount of depreciation (or use nearest whole year or other convention) Based on STL depreciation Calculate rate as % of cost by doing STL for each asset in the batch when start with this method (continue rate if sell off, change if add new items) Materiality allows no gain/loss when selling assets from the pool (since assumed gains offset losses on sales of old items over time)

Depreciation methods-Accelerated ones Double declining balance (DDB) Sum of the year’s digits (SYD) Formula – (cost- accumulated depreciation) times 2/useful life Time based Most depreciation the first year Poor math! Once DDB amount less than STL, use STL to finish Formula – (cost- salvage) times the remaining useful life beginning of the year/SYD SYD = add up the numbers counted to reach useful life or n(n+1)/2 Time based Most depreciation the first year (though less than DDB) 1st year partial year – more complicated math

Units of Output/Production Depreciation method Activity-based, not time-based method Hours, miles, units produced, etc. Better matching to revenues probably when usage varies from period to period Extra work since must track the actual activity of an asset each period Not necessarily an “activity” identified for every PPE

Depreciation conventions and revisions Nearest whole month – 1st to 15th, depreciate that entire month, 16th to 31st, depreciate next month Nearest whole year convention – purchase in 1st 6 months of year, depreciate whole year; 2nd 6 months of year, depreciate next year One-half year convention – ½ year’s depreciation taken in year of acquisition and year of disposal on all assets If change in estimate –service life or salvage value – adjust in current and future year (prospectively) If add to original cost of PPE or decrease accumulated depreciation – adjust in current and future year (prospectively)

Capitalization of Interest During construction period only Must have debt (either project loan and/or other loans) Can’t exceed actual interest accrued/paid Need weighted average accumulated expenditure – for the year -# of months divided by 12 months that must finance an expenditure before project is completed (or average of total spent for the accounting period) Project loan borrowed just for PPE project –use first in calculations. Other loans can be used next – must calculate weighted average of interest (total interest expense/total principle of loans) Eventually, record increase to PPE ledger account and decrease to interest expense Interest capitalized will be expensed as part of depreciation over the life of PPE

Overhaul versus maintenance Change quality of usage (such as additions) or substantially extend useful life beyond original expectation – capitalize (add to asset or decrease accumulated depreciation) – “capital expenditure” Capital expenditure will impact future depreciation Keeping an asset in good working condition – expense or prepaid expense – “operating or revenue expenditure” Revenue expenditure will not impact future depreciation Immaterial – probably expense

Exchanges of PPE Swap assets – take off asset on books (cost and accumulated depreciation) and recognize new asset received Gain – if value of asset given up is less than fair market value of same asset Loss –if value of asset given up is greater than fair market value of same asset Cash received – if fair value of asset given up is greater than fair value of asset received Cash paid – if fair value of asset given up is less than fair value of asset received swapping solely to generate a gain with no economic substance (gain deferred and new asset value decreased)

Impairment of PPE If major technological or other change causes likelihood of vastly diminished future returns Test for impairment – book value versus estimated future benefit (add up expected future cash flows) Impaired ---book value > total future cash flows Not impaired – book value < total future cash flows Loss from impairment --- revised fair market value of PPE (present value of expected future flows) compared to book value Journalize --- close out cost and accumulated depreciation to date and replace with fair market value of impaired asset, recognize loss Conservative – picking the lower of two asset values

Disposal of property, plant and equipment Update depreciation until time of disposal Recognize “realized” gain or loss in journal entry (giving up versus receiving) Close out PPE asset ledger account and any accumulated depreciation If no compensation for disposal, book value becomes loss

Depletion of natural resources Timber, coal and mineral deposits, oil and gas Expensed as generate revenues – depletion Follows same basic rules as PPE –including units of output depreciation method often used Asset “capitalized costs”– includes acquisition, exploration costs (searching for natural resource reserves), development costs before production, asset retirement obligations (costs of restoring to natural state) Related PPE with useful life limited to life of the mine or deposit would be depreciated in same way as natural resource depleted