Property Plant and Equipment - Part 1 - Overview - YouTube

>> Hello and welcome to Property, Plant, and Equipment, Part 1.

My name is Bennet Tchaikovsky.

My disclaimer and copyright notice.

The information and opinions in this presentation are those of the author only

and not the author's employers or affiliated organizations, including but not limited

to Irvine Valley College and the South Orange County Community College District.

The presentation is for educational purposes only

and does not constitute any legal or accounting advice whatsoever.

This presentation is copyright 2008 to 2020 by Bennet Tchaikovsky.

All rights are reserved.

Any distribution is strictly prohibited.

So we're going to be talking here today about property, plant, and equipment,

and it's a pretty large subject, so I'm going to be breaking this

up into various different videos.

This first video for part one is going to be an overview in terms of talking

about acquisition cost, salvage value, estimated useful life,

the logic behind choosing different depreciation methods,

noncurrent versus current classification, sum of the year's digits, should we be using that,

and then various different tax depreciation methods.

The next video will focus on straight line depreciation.

The third one will be focusing on the units of production, deprecation method.

Number four will be double declining balance.

The fifth will be talking about changes in estimates: When we have a change

in one of our estimates, what do we do?

Then we will have the sale of property, plant, and equipment, and then lastly,

talking about repairs and maintenance versus improvements or betterments.

One thing is that we're not going to be covering in this video sequence are property,

plant, and equipment impairments.

Those are generally going to be covered in intermediate accounting.

If you do want a video covering impairments, send me an email and let me know

and I can see what I can dig up for you.

Okay, so right over here, our property, this is our overview.

So let's kind of talk about some of the important concepts in terms

of property, plant, and equipment.

The first one is acquisition cost, which is the cost to get our equipment up and running

for use, and included in acquisition costs are going to be delivery fees, installation,

if there's any kind of initial testing or calibration.

The key is, is what do we need to do to get this equipment up and running.

One of the things we are not going to be including in acquisition cost would be any type

of registration, okay, any type of -- if I buy a truck, I'm not going to include gasoline.

Those are more of operating costs which will be immediately expensed.

Annual licensing costs, these -- and when we're looking at these,

we're going to be capitalizing those costs that --

to buy the equipment and to get that equipment up and ready for use,

those are going to be capitalized.

So our example here is Accounting Professor, Inc.,

purchases a 1999 used Toyota 4Runner for $800 on October 1, 2019.

To get the equipment operational, API spends an additional $3,200 on a new engine.

In addition to this $4,000 spent on the purchase and on the new engine, API spends another $100

to register the car for the coming year.

What is the acquisition cost for the equipment?

Remember, we're going to be including our purchase price plus the cost of, like,

whatever it takes to get that car up and running,

which in this case would be a new engine.

This is going to give us a total acquisition cost of $4,000.

What's very important here is this $100 that's spent to register the car

for the coming year is more of an ongoing expense

and therefore will not be included as part of the acquisition cost.

The next part here in terms of looking at our different components are going

to be salvage value, estimated useful life,

and then how do we classify property, plant, and equipment.

When we look here at salvage value, salvage value is an estimate of what we expect

to sell the property, plant, and equipment for at the end of the property,

plant, and equipment's useful life.

We never depreciate beyond salvage value.

I will be giving you questions trying to trick you into depreciating beyond salvage value,

and to really go through, we never want to depreciate beyond this,

and to determine the salvage value, we can look at historical values.

For example, if I buy a brand-new Toyota 4Runner,

what is this going to be worth in five years?

I can easily go on to various different websites, including Edmunds, Cars.com, CarGurus,

all -- there's different places where I can look.

Salvage value can change over time as this is going to be an estimate.

We will see what happens when salvage value does, in fact,

change because this, again, this is an estimate.

We're trying to make our best guess in terms

of what this asset will be worth at the end of its useful life.

The next concept is an estimated useful life.

This is how long we expect the property, plant, and equipment to last for.

Generally, a company can look at the past history of similar assets

to see how long the PPE will be around for.

So again, if I buy a Toyota 4Runner, how long will this car be around for?

More than likely, at least 10 years.

It could go longer.

So there's a lot of data and other things out there that we can be looking at.

Generally, as accountants, when a company is going through

and preparing a depreciation estimate, what we're really looking for here is, you know,

how reliable is this information or what's management's estimate.

If I purchase a BM Trouble You -- oh, excuse me, if I purchase a luxury vehicle that happens

to be made in Germany, will that car last for 10 years?

Well, more than likely, probably not.

Hopefully it might end up some day in Jay Leno's garage,

but for right now, it has to be reasonable.

So again, these are going to be estimates.

The last one here is just in terms of talking about the classification of PP&E,

meaning that when I am classifying this, how do I go about --

and doing it, how do I show it on the balance sheet?

And if I take a look really quickly over here, we'll go to my favorite company,

or one of my favorite companies, and I swear I do not work for Cambridge Analytica,

and I did this wrong, probably because I made this too large, and we'll go back over here.

I have a separate video on -- clearly, I don't watch my own videos, but if you go over here

and you do a search by the company ticker symbol,

I have a separate video on how to do this.

So if I go over here to the 10-Q, and in that 10-Q over here for Facebook,

when I look at their balance sheet, what you're going

to notice here is what they'll do is they're going to show assets here as current,

meaning that, well, everything that's going to be used within the next year.

They don't go through and say long-term or noncurrent.

They generally list out everything else.

So here property and equipment net, and that is going to be net of any accumulated depreciation,

is right over here at $32 billion, or $32.2 billion as of September 30, 2019.

So this is how we go through and classify or how we show on the balance sheet.

Again, it's not a current asset.

Why is it not a current asset?

Property, plant, and equipment by its very nature is giving us multiple years of benefit.

Therefore, we're going to be classifying this as a noncurrent term,

but it's generally just not going to be a current asset.

Most companies, on their balance sheet, they do not use noncurrent or long-term.

They will just show current assets and they'll dump everything else below.

Okay, so over here, why do we depreciate assets?

So as property, plant, and equipment gives us multiple years of use,

we need to reflect the use of this equipment, of this PP&E through depreciation expense.

We want to match the expense of using this property, plant,

and equipment over the years of benefit.

Our overall goal is when we're going through and doing this, is we want to kind

of have our total costs for the maintenance plus the depreciation

to be relatively level over a period of time.

Generally, companies are free to use whatever depreciation methods they want to use

under GAAP, and over here, when we do depreciate property, plant, and equipment, and it's very,

very important and you probably saw this in one of the earlier videos,

is how do I go through and record it.

I'm going to be debiting depreciation expense,

and I'm going to be crediting my contra asset account or accumulated depreciation

which is going to be accumulating all the depreciation that we've been taking every year.

We never credit the asset directly because it is a physical asset.

What's very important to note is that if we have companies over here, such as --

so for example, if I went through and I looked at this tab over here for the property, plant,

and equipment, even if an asset is fully depreciated, I still need to go through

and leave it on the books, meaning that I will have the asset less the amount

of the accumulated depreciation.

I may not be depreciating the asset any more, but if I'm using it in my operations,

I'm still going to be leaving it on my books.

So one of the other parts over here, too, is just to really talk quickly

about what are the different types of methods.

One is what we call an "accelerated method," and we're going to be using this

when there are greater maintenance costs, like our assets, property, plant,

and equipment's life, and then we have straight line depreciation, which is going to be used

when those costs are basically or relatively similar year over year.

So if I look at -- let's go ahead and take a look at straight line first.

So a straight line, this is the example I always love to give, is my 2010 Honda Accord,

great car, maintenance on it is relatively the same year over year.

So my maintenance costs, the dollar amount is pretty much going to be the same year over year.

My depreciation expense, therefore, with straight line,

I'm taking the same amount every year, so my total cost

or the depreciation plus the maintenance is going to be relatively level over a period

of time, which is kind of what we're aiming for.

Now, in terms of double declining balance,

this is what we call an "accelerated method" of depreciation.

The reason why we use it is that our maintenance costs are going to be going

up greatly later in life, like over time.

So when I have one of those great vehicles, right, that, yeah, I'm probably going

to get sued for something, but, you know, it's okay.

I've had one and they're very expensive to maintain,

but you got to keep your CEO happy, and that happens to be my wife.

So right over here, I have my maintenance costs that go up over a period of time,

so if I have an asset that has a lot of maintenance costs later in life,

I'm going to justify taking more depreciation expense earlier on because the total

of these two values here is going to be giving me my total cost.

So that's kind of the rationale behind using the various different methods.

Again, it has to do with the total cost of owning a piece of equipment.

So here are the methods, okay?

And these just state the formulas for them.

The first one is going to be straight line.

Acquisition cost minus salvage value divided by the estimated useful life,

this is going to give us our annual depreciation expense.

Do we recognize partial periods?

And the answer is yes.

So if I buy an asset on June 1st, I'm going to first figure

out what my annual depreciation expense is.

I'm going to multiply that by 7/12 to reflect the period of use.

And then over here, the main assumption is, is that the cost to maintain the property, plant,

and equipment are generally constant.

My next one is double declining balance.

This is acquisition cost minus accumulated depreciation, but it's not salvage value,

divided by the estimated useful life times two.

We are going to be looking at this in terms of partial periods and that's

when we saw what our assumptions were, were higher maintenance costs later in life.

So our next one here is units of production.

This is acquisition cost minus salvage value divided by the number of units to be produced.

This is going to give us a depreciation rate per unit.

We do not account for partial periods.

So if I produce 10,000 units, I need to take depreciation expense for 10,000 units.

I do not do any type of partial periods.

Both straight line and double declining balance are a function of time.

This here of units of production is a function of a number of units to be produced.

My assumptions over here is that the maintenance costs generally are going

to be directly aligned with those total units produced.

Okay, last one here is sum of the year's digits, and if you have an accounting professor

that wants you to do this, I want to have you to have some fun.

So I went to a conference that was put on by Haskell and White a few years ago

and they brought in a speaker who was an SEC or Securities and Exchange Commission examiner,

and he had gone through and looked at about 10,000 SEC filings,

so I decided to have some fun, and I'm a total accounting geek, so I went up to the person

and I said to him, I said, "Wow," I go, "So have you ever seen sum of the year's digits?"

And he paused and he was like, "I've seen it three times," and this is out of,

again, out of like 10,000 filings.

They didn't call it that.

And so if you have an academic that's teaching you, ask them to show you in an SEC filing

where somebody is using sum of the year's digits, and if you can actually find

that reference and give me an email, I'll give you a shout-out on my next video.

It is a method that is listed, but I'm going to tell you right now it is not used in real life.

The last one here are tax depreciation methods, and what you want to kind of remember is

that when it comes to taxes, things are done a little bit differently.

For example, there are some deductions you can take and I believe it's called the

"179 deduction" where you can right off your purchase of your asset fully

in the first year, immediately expense it.

And there's also something called "modify accelerated cost recovery system."

There's different methods that are there; however, I'm not going to be covering those here

because we're focused today more on financial accounting.

So the last part over here is in terms of what are we going to be doing in future videos.

I'm going to devote separate videos

to calculating depreciation expense using straight line,

double declining balance, and units of production.

We will also talk about the change in depreciation estimates,

when I change salvage value or the estimated useful life.

We will also be talking about the sale of property, plant, and equipment, and then lastly,

there'll be betterments versus repairs and maintenance.

So I want to thank you for joining me here today.

I have lost my thank-you slide.

Oh, there, thank you for watching.

So please do not forget to like and subscribe.

If you have any questions about this video, please email me at [email protected].

Have a great one, and I'll see you on the next video.