This chapter covers accounting for property, plant, and equipment (PPE), nonmonetary exchange, interest capitalization, disposition of plant assets at gain or loss.

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Chapter 10 presents a discussion of the basic accounting problems associated with the incurrence of costs related to property, plant, and equipment; and the accounting methods used to retire or dispose of these costs. These assets, also referred to as fixed assets, are of a durable nature and include land, building structures, and equipment. Fixed assets are an important part of the operations of most business organizations. They provide the major means of support for the production and/or distribution of a company’s product or service.

Property, plant, and equipment possess certain characteristics that distinguish them from other assets owned by a business enterprise. These characteristics may be expressed as follows: (a) acquired for use in operations and not for resale, (b) long-term in nature and usually depreciated, and (c) possess physical substance. An asset must be used in the normal business operations to be classified as a fixed asset. These assets last for a number of years and their costs must be allocated to the periods which benefit from their use.

Acquisition of Property, Plant, and Equipment

Property, plant and equipment are valued in the accounts by most companies at their historical cost. Historical cost is measured by the cash or cash equivalent price of obtaining the asset and bringing it to the location and condition necessary for its intended use. Thus, charges associated with freight costs and installation are considered a part of the asset’s cost.

Subsequent to acquisition, companies should not write up property, plant, and equipment to reflect fair value when it is above cost because (a) historical cost involves actual, not hypothetical transactions and so is the most reliable, and (b) gains and losses should not be anticipated, but should be recognized only when the asset is sold.

The assets normally classified on the balance sheet as property, plant, and equipment include land, buildings, and various kinds of machinery and equipment. The cost of each item includes the acquisition price plus those expenditures incurred in getting the asset ready for its intended use.

The cost of land, cost typically includes

  1. purchase price
  2. closing costs such as title to the land, attorneys’ fees, and recording fees
  3. costs of grading, filling, draining, and clearing the property
  4. assumption of any liens, mortgages, or encumbrances on the property
  5. any additional land improvements that have an indefinite life
  6. costs of removing an old building from land purchased for the purpose of constructing a new building

When improvements that have a limited life (fences, driveways, etc.) are made to the land they should be set up in a separate Land Improvements account so they can be depreciated over their estimated useful life.

Building costs include materials, labor, and overhead costs incurred during construction. Any fees such as those incurred for building permits or the services of attorneys and architects are included in acquisition cost. In general, all costs incurred from excavation of the site to the completion of the building are considered part of the building costs.

With respect to equipment, cost includes the purchase price plus all expenditures related to the purchase that occur subsequent to acquisition but prior to actual use. These related costs would include such items as freight charges, insurance charges on the asset while in transit, assembly and installation, special preparation of facilities, and asset testing costs.

Interest Costs During Construction

Capitalization of interest costs incurred in connection with financing the construction or acquisition of property, plant, and equipment generally follows the rule of capitalizing only the actual interest costs incurred during construction. While some modification to this general rule occurs, its adoption is consistent with the concept that the historical cost of acquiring an asset includes all costs incurred to bring the asset to the condition and location necessary for its intended use.

To qualify for interest capitalization, assets must require a period of time to get them ready for their intended use. Assets that qualify for interest cost capitalization include assets under construction for a company’s own use (such as buildings, plants, and machinery) and assets intended for sale or lease that are constructed or otherwise produced as discrete projects (like ships or real estate developments). The period during which interest must be capitalized begins when three conditions are present: (a) expenditures for the asset have been made; (b) activities that are necessary to get the asset ready for its intended use are in progress; and (c) interest cost is being incurred.