Property, Plant and Equipment

Property, Plant and Equipment

Definition and Classification

Property, plant and equipment (PPE) are tangible non-current assets that a business uses in its operations to generate income. These assets have a useful life of more than one year and include items such as land, buildings, machinery, vehicles, and furniture. They are classified as non-current assets in the statement of financial position.

Cost Price of Property, Plant and Equipment

The cost price of property, plant and equipment includes:

• The purchase price of the asset.
• All expenses incurred to bring the asset to its location and condition for use, such as transport and installation costs.
• Any other costs necessary to prepare the asset for its intended use.

Financing costs related to loans taken to acquire the asset are not included in the cost price. Maintenance costs are also excluded.

Recording the Purchase of Property, Plant and Equipment

The purchase of PPE is recorded in the relevant asset accounts. For example, machinery purchases are recorded in the machinery account. It is crucial to maintain an assets register that records details such as:

• Location
• Serial number
• Cost price
• Date of acquisition
• Expected lifespan
• Carrying amount
• Current year’s depreciation
• Accumulated depreciation

Depreciation

Depreciation is the systematic allocation of the depreciable amount of an asset over its useful life. The depreciable amount is the cost of the asset minus its residual value. The residual value is the estimated value of the asset at the end of its useful life.

Depreciation can be calculated using various methods, but the three common methods are:

1. Straight-line method
2. Diminishing balance method
3. Production unit method

Straight-Line Method

This method spreads the cost of the asset evenly over its useful life. The annual depreciation expense is calculated using the formula:

Annual Depreciation = (Cost Price - Residual Value) / Useful Life

For example, if a machine costs R500 000, has a residual value of R50 000, and a useful life of 10 years, the annual depreciation would be:

Annual Depreciation = (500 000 - 50 000) / 10 = R45 000

Diminishing Balance Method

This method applies a fixed percentage to the carrying amount of the asset each year. The annual depreciation expense decreases over time as the carrying amount decreases. For example, if the carrying amount of a machine is R460 000 and the depreciation rate is 20%, the first year's depreciation would be:

Depreciation = 20% × 460 000 = R92 000

The next year's carrying amount would be R460 000 - R92 000 = R368 000, and the depreciation for the second year would be:

Depreciation = 20% × 368 000 = R73 600

Production Unit Method

This method calculates depreciation based on the actual usage of the asset. The formula used is:

Annual Depreciation = (Units Produced / Total Expected Units) × Cost Price

For example, if a machine has a total expected production of 2 000 units, and in the first year it produces 500 units, the depreciation would be:

Annual Depreciation = (500 / 2000) × 460 000 = R57 500

Recording Depreciation

Under the double-entry accounting system, depreciation is recorded by debiting a depreciation expense account and crediting an accumulated depreciation account. For example, if the annual depreciation is R92 000, the journal entry would be:

Debit: Depreciation Expense R92 000
Credit: Accumulated Depreciation R92 000

Disposal of Property, Plant and Equipment

When an asset is disposed of, it must be removed from the books. The disposal can occur through scrapping, selling, or trading in the asset. The following steps should be taken:

1. Record the depreciation for the period up to the date of disposal.
2. Transfer the accumulated depreciation to a realisation account.
3. Transfer the cost price of the disposed asset to the realisation account.
4. Record any cash received from the sale or trade-in.
5. Calculate the profit or loss on disposal. If the total of the debit side of the realisation account is greater than the credit side, it indicates a loss. If the credit side is greater, it indicates a profit.
6. Transfer the profit or loss to the profit or loss account.

Example of Disposal

Suppose Bilgredon sold a machine for R60 000 cash, with an accumulated depreciation of R402 500. The journal entries would be:

Debit: Realisation of Machinery R460 000
Credit: Machinery (at cost) R460 000
Debit: Accumulated Depreciation R402 500
Credit: Realisation of Machinery R402 500
Debit: Bank R60 000
Credit: Realisation of Machinery R60 000
Debit: Realisation of Machinery R2 500
Credit: Profit on Sale of Machinery R2 500

Conclusion

Property, plant and equipment are essential for a business's operations. Proper recording, depreciation, and disposal of these assets are crucial for accurate financial reporting and compliance with accounting standards.

Check your understanding

1. What is the difference between the straight-line method and the diminishing balance method of depreciation?
2. How do you calculate the cost price of property, plant and equipment?
3. What are the steps involved in the disposal of an asset?
4. Why is it important to maintain an assets register?