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Property, Plant, and Equipment CMA UAS Part 1

Property, Plant, and Equipment CMA USA Part 1

Table of Contents

Property, plant, and equipment (PP&E/PPE) are tangible assets that a company possesses for a long duration. They are typically fixed assets such as trucks, machinery, factories, and land, which facilitate the company’s operations and expansion and are not for resale.

PP&E assets are subject to depreciation over their useful life and can be sold for their salvage value.

What are Fixed Assets?

Assets are future economic benefits that are obtained or controlled by an entity as a result of past transactions or events ie;

  • They arose from a past transaction
  • Is presently owned by the company
  • Will provide probable future economic benifit

Initial Recording of Fixed Assets

Fixed assets are initially recorded at their historical value, which is the amount paid for the asset + all other costs required to make it ready for use

Examples of other costs required to make a fixed asset ready for use include:

  1. Shipping and handling fees incurred to transport the asset to the company’s location
  2. Installation and assembly costs necessary to set up and prepare the asset for use
  3. Legal fees incurred to obtain permits or licenses required to operate the asset
  4. Inspection and testing costs incurred to ensure that the asset is functioning properly and safely
  5. Training costs incurred to teach employees how to use the asset correctly and effectively
  6. Any other costs incurred to make the asset ready for its intended use.

Subsequent Recording of Fixed Assets

Subsequently measured at:

Initial Cost:                          xxxx
less: Depreciation              xxxx
less: Impairment                xxxx


Value of fixed asset          xxxxx

Depreciation of Fixed Assets

Under US GAAP (Generally Accepted Accounting Principles), depreciation is defined as the systematic allocation of the cost of a fixed asset over its useful life. Depreciation is recorded as an expense in a company’s financial statements, reflecting the decrease in the asset’s value over time due to wear and tear, obsolescence, or other factors.

The purpose of depreciation under US GAAP is to match the cost of the asset with the revenue it generates during its useful life. This provides a more accurate representation of a company’s financial performance, as it accounts for the wear and tear on its assets and the corresponding reduction in their value.

Note:-

Land is never depreciated because the useful life of the land is unlimited

Journal entry

Depreciation  Expense Dr
Accumulated Depreciation Cr

Depreciation Methods

US GAAP requires companies to select a depreciation method that reflects the pattern of the asset’s use and the expected rate of decline in its value. The most commonly used depreciation methods under US GAAP are straight-line depreciation, declining balance depreciation, and units-of-production depreciation.

Straight-line Depreciation(SLM)

SLM depreciation assumes that the asset depreciates at a constant rate over its useful life, which makes it easy to calculate and understand. The method simply takes the total cost of the asset, subtracts the estimated salvage value, and divides the result by the number of years of useful life. This provides a clear picture of the asset’s depreciation over time, which can then be recorded as an expense on the company’s financial statements.

Let’s learn all these depreciation Methods using one example

Example :

ABC Ltd, a US company, purchased machinery worth $500,000. The machine is expected to have a life of 4 years and is expected to produce 10,000 units of output during its lifespan. The machinery is also expected to have a salvage value of $100,000 at the end of its useful life.

Let’s dive into calculating the depreciation for ABC Ltd’s machinery using the straight-line method. This method assumes that the asset depreciates at a constant rate over its useful life, which makes it easy to calculate and understand.

To calculate the yearly depreciation, we first need to determine the depreciable base, which is the cost of the asset minus the estimated salvage value. In this case, the depreciable base is $500,000 – $100,000 = $400,000.

Next, we divide the depreciable base by the useful life of the asset in years. In this case, the useful life is 4 years, so the annual depreciation expense would be $400,000 / 4 = $100,000.

So, the yearly depreciation expense for ABC Ltd’s machinery using the SLM method would be $100,000 for each of the 4 years of its useful life. This means that at the end of the asset’s useful life, the total accumulated depreciation would be $400,000, which is the depreciable base we calculated earlier, and the book value will be 0.

Double Declining Balance(DDB)

Let’s explore another method for calculating depreciation – the double declining balance method. This method is more complex than the straight-line method but can be useful for assets that experience more rapid depreciation in their early years.

To calculate the double declining balance depreciation, we first need to determine the asset’s straight-line depreciation rate. This is done by dividing 100% by the asset’s useful life in years. In this case, the straight-line depreciation rate would be 100% / 4 = 25%.

Next, we need to double the straight-line depreciation rate to determine the double declining balance rate. So, the double declining balance rate for this asset would be 25% x 2 = 50%.

Year Particulars Amount
1 Opening BV $500,000
Depreciation $500,000 * 50% = $250,000
Carrying Value (Opening BV - Depreciation) $250,000 ($500,000 - $250,000)
Carrying Value $250,000
2 Opening BV $250,000
Depreciation $125,000
Carrying Value $125,000
3 Opening BV $125,000
Depreciation $25,000
Carrying Value $100,000

Here we stop the depreciation at year 3 with $25,000 even though there is $125,000 left to depreciate this is because we have to adjust the depreciation expense so that we don’t depreciate below salvage value

Sum-of -the -Years Digits(SYD)

“Sum of the years’ digits depreciation” is a depreciation method used in accounting to allocate the cost of an asset over its useful life. This method assumes that the depreciation expense should be higher in the earlier years of an asset’s life and lower in the later years.

To calculate the sum of the years’ digits depreciation, you need to first determine the asset’s useful life and then add the digits of the years together. For example, if an asset has a useful life of 5 years, you would add 5+4+3+2+1 to get a total of 15.

Next, you would allocate the depreciation expense based on the ratio of the remaining years of useful life to the total of the digits. For example, in the second year of an asset’s life with a useful life of 5 years, you would allocate 4/15 of the depreciable value, in the third year you would allocate 3/15, and so on. This method results in higher depreciation expense in the early years of an asset’s life and lower depreciation expense in the later years.

Now let’s take our first example question that we used earlier for calculating depreciation expenses using other depreciation methods, and try to calculate the depreciation expenses using SYD.

Calculations

To calculate the depreciation expense for each year using the sum of the digits method, you first need to find the total sum of the digits. In this case, the total sum of the digits is:

4 + 3 + 2 + 1 = 10

or to easily find the Sum-of-the-Years’-Digits we can use the formula. Sum-of-the-Years’-Digits = n(n+1)/2

Where n= useful life of the asset, here in our question useful life is 4 years so Sum-of-the-Years’-Digits= 4(4+1)/2 =10

Next, you need to determine the depreciable value of the machinery, which is the cost of the machinery minus its expected salvage value. In this case, the depreciable value is:

$500,000 – $100,000 = $400,000

Now you can calculate the annual depreciation expense for each year using the following formula:

Depreciation Expense = (Remaining Useful Life / Total Sum of the Digits) x Depreciable Value

Year Remaining Useful Life Total Sum of Digits Depreciable Value Depreciation Expense
1 4 10 $400,000 $160,000
2 3 10 $400,000 $120,000
3 2 10 $400,000 $80,000
4 1 10 $400,000 $40,000

In the first year, the remaining useful life of the machinery is 4 years, so the depreciation expense would be:

(4 / 10) x $400,000 = $160,000

In the second year, the remaining useful life of the machinery is 3 years, so the depreciation expense would be:

(3 / 10) x $400,000 = $120,000

In the third year, the remaining useful life of the machinery is 2 years, so the depreciation expense would be:

(2 / 10) x $400,000 = $80,000

Finally, in the fourth year, the remaining useful life of the machinery is 1 year, so the depreciation expense would be:

(1 / 10) x $400,000 = $40,000

Therefore, the total depreciation expense for the 4-year life of the machinery using the sum of the digits method would be:

$160,000 + $120,000 + $80,000 + $40,000 = $400,000

Units-of-production Method

To calculate depreciation using the units of production method, you need to follow these steps:

  1. Determine the total number of units that the machinery is expected to produce during its useful life. In this case, it is 10,000 units.

  2. Calculate the depreciation cost per unit of output by subtracting the expected salvage value from the total cost of the machinery and dividing the result by the expected number of units produced.

Depreciation cost per unit = (Total cost – Salvage value) / Expected units produced Depreciation cost per unit = ($500,000 – $100,000) / 10,000 Depreciation cost per unit = $40 per unit

  1. To calculate the depreciation expense for a specific year, multiply the number of units produced during that year by the depreciation cost per unit.

For example, in the first year, if 2,500 units of output are produced, the depreciation expense would be:

Depreciation expense = Depreciation cost per unit x Units produced in the first year Depreciation expense = $40 per unit x 2,500 units Depreciation expense = $100,000

Similarly, you can calculate the depreciation expense for each year of the machinery’s useful life by multiplying the number of units produced during that year by the depreciation cost per unit.

By using the units of production method, you can allocate the depreciation cost of the machinery based on its actual usage, which provides a more accurate reflection of the machinery’s wear and tear over time.

Plant Property and Equipment Depreciation GRaph

Depreciation for Tax Purposes

In the US, the Internal Revenue Service (IRS) prescribes the method of depreciation to be used for tax purposes.

  • MACRS (Modified Accelerated Cost Recovery System) is the most commonly used depreciation method required by the US tax laws, although it is not the only acceptable method that a company can use.
  • The depreciable base for tax purposes is always 100% of the cost of the asset + other costs required to make it ready for use
  • Salvage value is not deducted from the cost of the asset.
  •  US tax laws require that a portion of a year’s depreciation be taken in the year the asset is acquired and a portion when it is disposed of, the most common portion used is one-half year’s depreciation in both the first and last year, regardless of when the asset was actually purchased this is called half-year convention,  we will discuss this in detail in the example below.
  • If straight-line depreciation is used for tax purposes don’t subtract salvage value from the cost of the asset. The depreciable base for tax purposes is always 100% of the assets’ cost

MACRS Depreciation

If an asset with a value of $200,000 was purchased on June 30th and has a useful life of 3 years, what is the annual depreciation amount using the MACRS depreciation method?

Assuming the asset has a useful life of 3 years, we can use the MACRS (Modified Accelerated Cost Recovery System) depreciation method to calculate the annual depreciation amount. The MACRS method is commonly used in the United States to calculate depreciation for tax purposes.

First, we need to determine the asset’s cost basis, which is the initial value of the asset before depreciation. In this case, the asset has a value of $200,000.

Next, we need to determine the asset’s depreciation percentage using the MACRS system. For a 3-year asset, the percentage breakdown is as follows:

  • Year 1: 33.33%
  • Year 2: 44.45%
  • Year 3: 14.81%
  • Year 4: 7.41%

So, to calculate the annual depreciation amount, we can use the following formula:

Annual Depreciation = (Cost Basis x Depreciation Percentage)

Year 1: Annual Depreciation = ($200,000 x 33.33%) = $66,660

Year 2: Annual Depreciation = ($200,000 x 44.45%) = $88,900

Year 3: Annual Depreciation = ($200,000 x 14.81%) = $29,620

Year 4: Annual Depreciation = ($200,000 x7.41%) = $14,820

Which Method of Depreciation is Best?

A company must choose a depreciation method that best matches its revenue and not based on the method which generates the desired net income. Considerations for which depreciation method should be used include :

  • If the revenues are expected to be constant over the asset’s useful life, straight-line depreciation should be used
  • If revenues from the use of assets will be higher at the beginning of the asset’s life then an accelerated method of depreciation should be used.
  • If revenue from the asset is lower at the beginning of the asset’s life then units of production method should be used

Impairment

Impairment of assets is an important topic in the Property, Plant, and Equipment CMA USA Part 1 syllabus. An impairment occurs when the carrying amount of an asset exceeds its recoverable amount, which is the higher of its fair value less costs to sell and its value in use.

This situation arises when the future economic benefits from an asset are lower than its carrying amount. Companies are required to conduct impairment tests at regular intervals to ensure that the assets are not overstated on the balance sheet.

Impairment can occur due to various reasons, such as technological changes, shifts in market demand, regulatory changes, or physical damage to the asset. When an impairment is identified, the company must recognize the impairment loss by reducing the carrying amount of the asset and recognizing the loss in the income statement.

Impairment testing is important because it ensures that assets are valued accurately, which helps investors and other stakeholders make informed decisions about the company’s financial performance and health.

Recoverability Test

  • If the sum of the estimated undiscounted cash flows associated with the asset or asset group is greater than the carrying value then there is no impairment, even if the carrying value is greater than the fair value.
  • If the sum of the estimated undiscounted cash flows associated with the asset or asset group is less than the carrying value then there is impairment, hence the asset must be written down to its fair value and an impairment loss must be recognized.

Journal entry if there is an Impairment

Impairment LOSS Dr
Accumulated Depreciation Cr

Example :

Let’s say a company has a delivery truck that it purchased for $50,000 several years ago. The company believes that the market value of the truck has declined due to technological advancements and changes in market demand. The company conducts an impairment test and determines that the fair value of the truck is now only $30,000.

The carrying amount of the truck on the company’s books is $45,000, which is the original cost of the truck minus accumulated depreciation of $5,000.

To determine if the truck is impaired, the company needs to compare the carrying amount of the truck to its estimated future cash flows. If the sum of the estimated undiscounted cash flows associated with the truck is greater than its carrying value, then there is no impairment.

Let’s say the company estimates that the truck will generate $15,000 per year in cash flows for the next three years before it is sold. The sum of the estimated undiscounted cash flows associated with the truck would be:

$15,000 x 3 = $45,000

Since the sum of the estimated undiscounted cash flows is greater than the carrying value of the truck, there is no impairment. Even though the fair value of the truck is less than its carrying value, the truck does not need to be written down to its fair value and no impairment loss needs to be recognized.

However, if the company had estimated that the truck would only generate $10,000 per year in cash flows for the next three years, the sum of the estimated undiscounted cash flows would be:

$10,000 x 3 = $30,000

Since the sum of the estimated undiscounted cash flows is less than the carrying value of the truck, there is impairment. The truck must be written down to its fair value of $30,000, and the company must recognize an impairment loss of $15,000 ($45,000 carrying value minus $30,000 fair value). This impairment loss would be recognized as an expense in the income statement.

Under IFRS, the amount of an impairment loss is the difference between the carrying amount of the asset and the recoverable amount. The recoverable amount is the higher of (1) the fair value of the asset if sold minus the cost to sell, and (2) the asset’s value in use, which is the present value of the future cash flows to be generated by the asset in use, including its residual value.

Summary of Property, Plant, and Equipment CMA USA Part 1

Property, plant, and equipment (PP&E) are examples of fixed assets that are purchased by a company to be used in the production of goods or services.

Fixed assets are long-term assets that are purchased by a company to be used in the production of goods or services, rather than being sold directly to customers. Examples of fixed assets include property, plant, and equipment (PP&E) such as buildings, machinery, and vehicles.

Initial recording of fixed assets involves recording the cost of the asset in the accounting records, including any associated costs such as delivery, installation, and testing. Subsequent recording of fixed assets involves recording any changes in the value of the asset due to improvements, upgrades, or disposals.

Depreciation is the process of allocating the cost of a fixed asset over its useful life, to reflect its decreasing value as it is used over time. There are various methods of depreciation, including straight-line depreciation (SLM), double declining balance (DDB), sum-of-the-years digits (SYD), and units-of-production method.

SLM is the simplest and most common method, which allocates an equal amount of depreciation each year. DDB accelerates depreciation in the early years of an asset’s life, while SYD is a weighted average that also accelerates depreciation. The units-of-production method is based on the actual usage of the asset.

Depreciation for tax purposes may be calculated using the Modified Accelerated Cost Recovery System (MACRS) method, which is a form of accelerated depreciation that allows for larger deductions in the early years of an asset’s life.

The best method of depreciation depends on the nature of the asset, its expected useful life, and the company’s accounting policies.

Impairment occurs when the carrying value of a fixed asset exceeds its recoverable amount and requires the company to write down the value of the asset in its financial statements.

Key Points Property, Plant, and Equipment CMA USA Part 1

KEY TAKEAWAYS

  • Don’t subtract salvage value from the cost of the asset for the depreciable base while computing depreciation expense using Double Declining Balance
  • Depreciable base for tax purposes is always 100% cost of the asset never subtract salvage value from the cost of the asset for tax purposes
  • If the question asks to find accumulated depreciation using the Sum of the year’s digits method for ‘n’ years, instead of calculating individual years add up the fractions.
    Eg: if the question asks to find the first 2-year accumulated depreciation of an asset having 4 years of life.
    Calculate accumulated depreciation simply by finding sum of the digits ie; n(n+1)/2 here 4(4+1)/2=10 and add the fraction for the first two years ie, 4/10+3/10 =7/10*depreciable base

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Practice QuestionsProperty Plant, and Equipment CMA USA Part 1

14
Created on

PP&E

1 / 5

Blake Ltd. has determined that an impairment exists on one of its machines, but the company expects to continue using the asset for another three full years as no active market exists for the machine. Selected information on the impaired asset (on the date that impairment was determined to exist) is provided below.

 Original cost of machine £22,000
 Book (carrying) value of the machine 20,000
 Value in use (present value of future cash flows) 15,000
 Net selling price (fair value if sold less costs to sell) 12,000

According to IFRS, what is the amount of the impairment loss to be recorded by Blake?

2 / 5

Nella Corporation computes depreciation to the nearest whole month. A new piece of equipment was placed in operation on July 1, 20X1. It was expected to produce 400,000 units of product in its estimated useful life of eight years. Total cost was $300,000; salvage value was estimated to be $30,000. Nella employs a calendar year for financial reporting purposes. Actual production for the past 3 years was as follows.

Year 1 - 34,000 units
Year 2 - 62,500 units
Year 3 - 58,400 units

If Nella uses the sum-of-the-years'-digits method of depreciation, the amount of depreciation computed for this equipment for book purposes in 20X3 would be

3 / 5

Maple Industries purchased a lathe on June 1, Year 1, the beginning of the fiscal year. The lathe cost $43,200 and has an estimated salvage value of $3,600 and an estimated useful life of 8 years. The lathe has been used throughout the year.

Assuming that Maple Industries recognizes one-half year's depreciation on all assets purchased or sold during the year, the amount of straight-line depreciation that would be taken for financial reporting purposes in the fiscal year ending May 31, Year 2 would be

4 / 5

Maple Industries purchased a lathe on June 1, Year 1, the beginning of the fiscal year. The lathe cost $43,200 and has an estimated salvage value of $3,600 and an estimated useful life of 8 years. The lathe has been used throughout the year.

Assuming that Maple Industries calculates depreciation to the nearest whole month on all assets purchased or sold during the year, the amount of double-declining-balance (DDB) depreciation that would be taken for financial reporting purposes in the fiscal year ending May 31, Year 3 in the second year of the asset's life would be

5 / 5

Jason Company's fiscal year ended on November 30 of the current year. As of the fiscal year end, Jason had an irrevocable contract to replace its mainframe computer system on December 15 of the current year at a net cost of $750,000, reflecting the trade-in of the old hardware for $10,000, the trade-in value allowed by the vendor. The net book value of the old hardware on November 30 of the current year is $27,000. On its November 30 Statement of Financial Position for the current year, Jason should report the value of the old computer equipment as

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