“The more the division of labor and the application of machinery extend, the more does competition extend among the workers, the more do their wages shrink together.”
- Karl Marx
Meaning of Property, Plant and Equipment
The physical/tangible assets held for a long period of time i.e. more than 1 year are termed as Property, Plant and Equipment. It includes the following:
The other name of Property, Plant and Equipment is “Fixed Asset”. Steel, oil, automobiles etc are some of the companies that rely heavily on capital intensive methods of production and manufacturing. They use heavy machinery for it.
Property, Plant and Equipment is listed on the financial statements of the companies under the heading PP&E. Big investors and analysts usually refer to the amount of Property, Plant and Equipment as to figure out the capital expenditure of the company.
Investments done in such assets help in figuring out how companies raise finance for funding their needs. These long term assets are vital for companies as they help in business operations and determine the long term financial health of the company.
When the company decides to invest in fixed assets then it is a proof that it is looking ahead in terms of scalability and profits. Fixed assets have a defined life span. It means that the economic life of property, plant and equipment is finite. Once the life is over, these assets will not provide any future economic benefit to the entity.
There is a fixed percent deducted from fixed assets each year. It is called depreciation. This fixed value is based on the salvage value of the asset. Another term used for salvage value is scrap value.
Companies that want to scale their business and expand it must make capital investments. These investments will have a key effect on the financial position of the firm.
We know that Property, Plant and Equipment are non-current assets. But it is important to understand that not every non-current asset is Property, Plant and Equipment. Intangible assets are also long term assets.
But intangible assets are not Property, Plant and Equipment. Assets like Goodwill, Trademarks, Patents and Copyrights are intangible assets and can be held for more than one year. But since they are intangible, they do not account for Property, Plant and Equipment.
Long term investments like bonds and notes are also non-current. But they have neither Property, Plant or Equipment. In short, PP&E includes specified non-current and tangible assets that were listed above.
Measurement and Recognition of Property, Plant and Equipment
There are certain conditions, fulfillment of which will lead to recognition of assets in the financial statement of a company.
When it is certain that once the asset is installed, it will cause future economic benefits to the entity in future.
The cost of the tangible fixed asset can be measured certainly.
There are certain expenses which will be included in the cost of the PP&E like:
Purchase price of the asset plus import duties, any non-refundable taxes, discounts on sale or rebates.
Any Costs that are incurred to bring the asset to site or location and costs expended for the installation of the asset to make it operational.
Any kind of dismantling costs or costs incurred while removing the asset from the site. Restoration costs are also included in the cost price of the asset.
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AS-10 vs IND AS 16
Both these Accounting Standards deal with Property, Plant and Equipment. IND AS16 is more extensive and wider in scope than AS10. There are some key differences between both like:
Real Estate Accounting
In IND AS-16, Real Estate Accounting is not included. Whereas in AS-10, Real estate related costs are excluded explicitly. In AS-10, it is specifically mentioned.
According to IND AS-16, inspection costs must be capitalized and de-recognized later on. Whereas in AS-10, capitalization concept is not dealt with.
In IND AS-16 it is specifically mentioned that any abnormal or unused costs related to labor, material or any resource required for construction should not be included in the costs of the asset. Whereas, in AS-10 self constructed asset costs are not dealt with. There is no specific mention of the same.
The concept of Joint Ownership is not dealt with in IND AS-16. In fact, IND AS-31 deals with Joint Ownership. But in AS-10 there is specific mention of Joint Ownership and all fixed assets that are jointly owned have a specific treatment.
Assets for sale and retired from Use
In AS-10 you will find treatment for both assets held for sale as well as the assets retired from use. But in IND AS-16 no treatment is given with regards to Assets held for sale. IND AS-105 which is about Assets for sale and Discontinued Operations deals with this issue.
So, you can see both these Accounting Standards deal with Property, Plant and Equipment but the scope and context of both of them is different. There are many cases that are covered in IND AS-16 that are not included in AS-10
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Formula to Compute the Value of Property, Plant and Equipment
For companies it is important to compute the exact value of the fixed costs as it will be reflected in the financial statements at the end of the year. Moreover, these financials will be reviewed by the stakeholders of the company.
These stakeholders include the investors and analysts which will take decisions related to investing money further. When the asset is purchased, when it is sold, when it is taken on hire/lease or any other case, it is important to find the cost of the asset.
Formula of PP&E
Fixed assets depreciate overtime and sometimes companies face difficulties when converting them to cash. All these situations must be taken into account while computing the final WDV of the asset.
The formula to compute the cost of Property, plant and Equipment is as follows:
Net PP&E = Gross PP&E + Capital Expenditure - Accumulated Depreciation
In order to calculate the Net PP&E we have to understand the three terms given on the right hand side of the formula. Now let us look at each term individually.
Capital Expenditure in short CapEx are expenses that company incurs to maintain, upgrade or install the physical assets including Property, plant, equipment, buildings or even technology.
Repairing the roof or building a new factory are also capital expenditures. These expenditures are done when a company wants to expand the business or improve its business operations.
Industries that are capital intensive tend to have more capital expenditure. You can use the balance sheet to calculate the capital expenditure done on Property, Plant and Equipment.
To find out the amount of capital expenditure, you need to check the prior balance sheet of the firm and compare the values of Property, Plant and Equipment in prior and current balance sheets.
You have to add the change in current value of PP&E and the depreciation expense to calculate the current CapEx of the company.
Accumulated Depreciation is the total value of the depreciation in the useful life of the asset or up to a particular point. Every year the amount of depreciation expense is added to the opening of an accumulated depreciation account.
The amount of accumulated depreciation is shown in the balance sheet just below the capitalized fixed asset. The amount of accumulated depreciation increases over time as depreciation is recorded.
To find out the WDV of the asset you need to minus the accumulated depreciation from the historical cost of the asset.
Gross Property, Plant & Equipment
Whatever amount is written on the balance sheet with respect to Property, Plant and Equipment without any adjustment is simply the Gross value of PP&E. Under the head Investment, there is a sub-head of PP&E.
Here you will find all the fixed assets that are to be included under Property, Plant and Equipment. Take all the values and add them. The resultant will be Gross Value of PP&E.
Now that all the individual terms are clear we can analyze the formula better. So, in order to calculate the Net Value of Property, Plant and Equipment you need to add the gross values of all the fixed and tangible assets under PP&E.
Then add the total gross value to the Capex. The next step is to minus the accumulated depreciation. You will find that most firms use Net Value of Property, Plant and Equipment on their financial statements.
Therefore, they must have already used the said formula to reach the net values.
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Limitations of Property, Plant and Equipment
For a company’s success Property, plant and Equipment play a vital role. But we cannot forego the fact that they are capital intensive. Companies are sometimes forced to sell some of their assets in order to raise funds and increase their net profit.
Therefore, it becomes necessary to audit the investments or sales of the company in terms of Property, Plant and Equipment.
Another limitation of Property, Plant and Equipment is the fact that it only includes tangible assets and ignores the intangible assets like Copyrights, Patents etc. For example- Coca-cola has established a huge brand name. Brand name is an intangible asset.
If the investors and analysts only look at the tangible assets to assess the profitability and true value of any company then they will be mistaken. Ignoring such a huge brand is a big mistake. We need to accept the fact that PP&E only accounts for a certain portion of the company.
There are other relevant expenditures and assets that can be analyzed to judge the true value of the firm.
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A company’s PP&E can be used as a measure to figure out its true value in the market. But we cannot ignore other aspects as well.