Accounting for Property, Plant, and Equipment
When the equipment is acquired for cash the expenditures to be capitalized include all the costs and expenditures necessary to enable the equipment to function as intended. These expenditures include the purchase price of the equipment, freight charges, permits and license associated with the equipment, insurance, initial set up cost, ordinary installation costs, programing costs, and other expenses that are incurred in the process of getting the equipment ready for use. All these expenses are referred to as the capital expenditures of the equipment (Schroeder, Clark, Cathey & Schroeder, 2017). However, other costs might be incurred while getting the equipment ready for use but are not necessary costs. For instance, the repair of an avoidable damage during initial set up might lead to an extra cost. This cost is classified as incurred costs. Another thing to be mentioned in the capital expenditures is the discounts that are associated with the equipment purchase, installation or use. The discounts are usually deducted from the capital expenditures. For instance, if the equipment’s listed price is $10,000 and an entity manages to negotiate a discount of 10%, the capital expenditure becomes $9,000 instead of the listed $10,000.
- Bonds having an established market price
Since the capitalized cost of equipment involves all the expenditures necessary to bring the equipment to its designed function, while exchanging the equipment using bonds having an established market price, the capitalized cost of equipment is the market value of the bonds. When the market value of equipment is not determinable by reference to a similar purchase of cash, the acquiring company has no additional capitalized expenditures other than the market value of the bonds with the already established market price.
- Common stock not having an established market price
When the market value of equipment cannot be determined by a similar purchase and the acquiring wants to use common stock that does not have an established market price, the capitalized cost of the equipment should be the fair value of the common stock. The fair value of the common stick can be established through different ways including listing the stick or security on an exchange and having willing buyers to bid. The seller can sell the stick at the bid price and buy the same stock at the asking price. Other ways of determining the fair value of the stock include independent appraisals and discounted cash flow from the asset (Hlaing & Pourjalali, 2012).
- Similar equipment not having a determinable market price
If the market value of equipment cannot be determined by a similar purchase for cash and an acquiring company wants to determine the capitalized cost of equipment by exchanging it with similar equipment without a determinable market price, the capitalized cost is determined by the market value of the equipment being exchanged. This implies the costs of expenditure related to purchasing the equipment and getting it ready for use should be determined to know the expected value of the similar equipment. It would be unfair to exchange the equipment for similar equipment with less or more value. If the value of the similar equipment is less, then the difference should be topped up. In contrast, if the similar equipment has more value, then the acquiring company should top up the difference.
While making the decision on whether expenditures related to property, plant and equipment already in use should be capitalized, the following factors should be considered:
- Expenditures are material in nature – all expenses should be material in nature implying that costs should have specific amounts.
- The expenditures are non-recurring in nature – this implies that the costs should not be incurred on a regular basis, rather they should be one time expenditures. Otherwise, the costs should be classified as incurred costs and not capitalized costs.
- They lead to future benefits by increasing the service life of an asset – any expense that would contribute to the asset being used for an extended period should be capitalized.
- If the expenditures increase the quality of existing services arising from the use of the asset, the costs should be capitalized.
- If the expenditures lead to a decrease in the future operating costs related to the use of the asset, then these costs should be capitalized.
- Another factor is if the expenditure increases or adds a new asset service. If this is the case, the expenditures should be capitalized.
- Any other expenditure that lead the future benefit of an asset including the costs associated with compliance with laws and environmental regulations should be capitalized (Hunt & Kieso, 2012).
While accounting for the gain or loss on the sale of property, plant and equipment, an entity compares the book value or original purchase price of the equipment with the price at which the equipment is sold. This is done by getting the original purchase price and subtracting the accumulated depreciation as well as the impairment charges. The difference between this carrying amount and price of the sale of the equipment is then determined (Hlaing & Pourjalali, 2012). If there was cash gained while disposing off the asset, then a gain is reported on the income statement as gain on sale. In contrast, if a loss was made, the value of the loss is reported on the income statement as loss on sale.