If you are finding yourself wondering whether to capitalize or expense property, plant and equipment (PPE), the following refresher on common items/questions about how to properly report under U.S. Generally Accepted Accounting Principles (GAAP) may help.
PPE is recorded on the balance sheet at cost and includes all expenditures directly related to the acquisition and/or construction of its purpose and intended use. Such expenditures would also include those incurred to relocate the asset in order to bring it to working condition (e.g. shipping and handling costs).
If the piece of equipment is intended to be self-constructed, all costs incurred that can be traced to preparing such asset for service should be capitalized within construction in progress. With that said, one should also consider allocations of overhead as an element of cost.
Although there is no defined dollar-threshold under GAAP, it is highly recommended to set a capitalization policy with a dollar threshold in place. This policy would help establish when costs incurred need to be reviewed further in order to determine if such should be expensed versus capitalized. The typical amount used from our experience is between $1,000 to $2,500, but overall the amount chosen should not materially affect the financial statements.
How long is the useful life?
Once an asset is placed into service, it should be depreciated over its useful life. An asset’s useful life is essentially the length of time the asset is expected to contribute directly or indirectly to future cash flows. Since an asset’s useful life is company management’s estimate, consideration of the length should be driven from its expected use, time constraints (legal or contractual), past experiences with similar assets, obsolescence and economic factors.
What about depreciation?
There are several options to consider when determining which is the correct depreciation method. GAAP provides several methods, but the most commonly used is the straight-line method, which allocates the cost of an asset over its estimated useful life in equal installments. It is not uncommon for a business to deviate from GAAP and just use the current method used for tax purposes universally. However, the use of the accelerated tax depreciation method for book purposes can create a large difference between the PPE value on the balance sheet and the asset’s fair market value.
Selling your business?
Finally, if you are potentially considering selling your business in the next few years, it would be wise to consider tracking capital expenditures incurred on a monthly basis and into growth and maintenance categories. Growth being costs incurred due to the growth of operations and maintenance being costs incurred to replace older, depreciating PPE in place. This is a typical ask by potential purchasers who want to gain a complete understanding of a business’ cash flow.
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Financial statement reporting on property, plant and equipment can prove challenging. We can help you report these assets in a reliable, cost-effective manner.
Article written by:
Michael Schultz, CPA
Senior Manager, Transaction Advisory Services