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Part 2. Property, Plant and Equipment

6. What Costs are Included in Property, Plant, and Equipment

Items of property, plant, and equipment are included in a separate category on a classified balance sheet. Property, plant, and equipment typically follows the Long-term Investments section, and is oftentimes simply referred to as "PP&E." Items appropriately included in this section of the balance sheet are the physical assets deployed in the productive operation of the business, like land, buildings, and equipment. Note that idle facilities or land held for speculation may more appropriately be listed in some other category on the balance sheet (like long-term investments) since these items are not in productive use. Within the PP&E section, the custom is to list PP&E according to expected life - meaning that land (with an indefinite life) comes first, followed by buildings, then equipment. For some businesses, the amount of PP&E can be substantial. This is the case for firms that have heavy manufacturing operations or significant real estate holdings. Other businesses, say those that are service or intellectual based, may actually have very little to show within this balance sheet category. Below is an example of how a typical PP&E section of the balance sheet might appear. In the alternative, some companies may relegate this level of detailed disclosure into a note accompanying the financial statements, and instead just report a single number for "property, plant, and equipment, net of accumulated depreciation" on the face of the balance sheet.

Property, Plant & Equipment

Land

$ 1,000,000

Buildings

Less: Accumulated depreciation

$ 2,300,000 (1,500,000)

800,000

Equipment

Less: Accumulated depreciation

$ 4,000,000 (1,800,000)

2,200,000

$ 4,000,000

6.1. Cost to Assign to Items of Property, Plant, and Equipment

The correct amount of cost to allocate to PP&E is based on a fairly straight-forward rule - to identify those expenditures which are ordinary and necessary to get the item in place and in condition for its intended use. Such amounts include the purchase price (less any negotiated discounts), permits, freight, ordinary installation, initial setup/calibration/programming, and other normal costs associated with getting the item ready to use. These costs are termed "capital expenditures." In contrast, other expenditures may arise which were not "ordinary and necessary," or benefit only the immediate period. These costs should be expensed as incurred. An example is repair of abnormal damage caused during installation of equipment.

To illustrate, assume that Pechlat Corporation purchased a new lathe. The lathe had a list price of $90,000, but Pechlat negotiated a 10% discount. In addition, Pechlat agreed to pay freight and installation of $5,000. During installation, the lathe's spindle was bent and had to be replaced for $2,000. The journal entry to record this transaction is:

3-1 7-X4

Equipment

86,000

Repair Expense

2,000

Cash

88,000

Paid for equipment (($90,000X.90) + $5,000), and repair cost

6.2. Interest Cost

Amounts paid to finance the purchase of property, plant, and equipment are expensed. An exception is interest incurred on funds borrowed to finance construction of plant and equipment. Such interest related to the period of time during which active construction is ongoing is capitalized. Interest capitalization rules are quite complex, and are typically covered in detail in intermediate accounting courses.

6.3. Training Costs

The acquisition of new machinery is oftentimes accompanied by employee training regarding the correct operating procedures for the device. The normal rule is that training costs are expensed. The logic here is that the training attaches to the employee not the machine, and the employee is not owned by the company. On rare occasion, justification for capitalization of very specialized training costs (where the training is company specific and benefits many periods) is made, but this is the exception rather than the rule.

 
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