Presenting a concise summary of the most important elements of Property, Plant and equipment (PPE) describing depreciation, the PPE definition and the 2 models (cost and revaluation) employed to recognize PPE. The notes are primarily intended for a beginner to intermediate level.
Property, plant and equipment represents a major line item for many companies. Investment in this
account is normally considered healthy for a business.
Property refers to land and buildings. Plant to machinery. And equipment…well to equipment.
Depreciation specifics
But what exactly is depreciation and what causes it? Depreciate means for something to lose value as
the condition gets worse. This can happen as the asset is used and can refer to things such as surface
damage, rust (wear and tear. There may be causes of depreciation independent of usage such as
technological obsolescence which may cause a loss in value if after a short period of time a newer
and more improved version of the product is released.
The depreciation process involves writing off the cost of the initial investment. The initial investment
is capitalized on the balance sheet. Depreciation is the writing off of the initial investment over the
useful life. For example, assume a PPE asset is bought for R200 000. The expected useful life is 4
years. Depreciation will be R50 000 each year assuming straight line method is employed.
The reason why the R200 000 investment is not immediately expensed is so that the “cost” of the
PPE asset can be matched against revenues earned from using the machine as the useful life is the
amount of time the PPE asset is going to be used by the entity.
Cost is anything sacrificed in order to obtain/acquire an asset. The fair value of the consideration
given to acquire an asset is referring to a non-monetary asset given up in order to acquire the desired
asset or cash or cash equivalents (a monetary asset). A non-monetary asset could be an item of PPE
on our books.
Carrying amount is described as Cost less accumulated depreciation. An alternative way to think
about carrying amount is that it represents the amount still to be depreciated in future i.e there is
expected to be more revenues to be matched against related future depreciation
The standard defines depreciation as being a systematic allocation. Depreciation is described in this
way as the method for handling depreciation is not to recognize the total cash cost of the asset
acquired as an expense in the income statement at the time when you first bought the asset. The
asset’s cost is rather spread/amortized over the useful life of the asset. (As explained above)
How you allocate depreciation will also depend on the nature of the asset itself. For example, some
assets depreciate faster than others in the early life of the asset while depreciation occurs more
evenly for other assets. The diminishing balance method would be more appropriate to use where
an item depreciates quickly in the beginning of it’s life. This is particularly true for say production
machinery which is used most heavily when new and entity can gain more output. Straight line
method would be appropriate for administrative PPE such as office equipment which are often used
more gradually and tend to last longer.
PPE definition
The definition of PPE states that it is held for use in the production process i.e a factory building or
production machinery as above used to produce inventory.
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