PP&E (Property, Plant, and Equipment) and Fixed Assets

• Accumulated Depreciation: A contra-asset account with a $credit$ balance.
• Net Book Value: Calculated as Cost ($debit$ balance) minus Accumulated Depreciation ($credit$ balance), resulting in a net $debit$ balance.

• Cash: $Debit$ PP&E, $Credit$ Cash.
• Debt: $Debit$ PP&E, $Credit$ Note Payable.
• Issuing Own Stock: $Debit$ PP&E, $Credit$ Stock. The asset is recorded at the fair market value of the stock issued, not its book value.

• Invoice price.
• Freight-in (shipping costs).
• Costs to bring the asset to its intended location and get it into the condition necessary for its intended use.

Land

• Key Principle: Land is not depreciated.
• Costs Included: All costs incurred up to, but not including, excavation (digging the foundation).
  • Purchase price.
  • Realtor commission.
  • Legal fees (e.g., title search, recording fees).
  • Costs to prepare the land (e.g., draining swamps, clearing brush and trees, site development like grading, filling holes, leveling).
  • Assumption of existing obligations (e.g., existing mortgage, back taxes).
  • Cost to knock down or demolish an old building on the property.
• Cost Reductions: Proceeds from the sale of any salvageable items from the land (e.g., existing buildings, scrap metal, standing timber) reduce the cost of the land.
• Distinction: Site development (grading, leveling) is a land cost; excavation (digging foundation) marks the beginning of building costs.

Land Improvements

• Key Principle: Land improvements are depreciable.
• Examples: Fences, water systems, sidewalks, paving, landscaping, lighting.
• Construction Period Interest: Any interest costs incurred during the construction of a land improvement are capitalized, added to the cost of the improvement, and then depreciated over its useful life.

Buildings (Plant, Factory, Warehouse, Office Building)

• Costs Included:
  • Purchase price.
  • Deferred Maintenance: Repairs neglected by the previous owner; these are capitalized as part of the building's cost, not expensed as ordinary repairs.
  • Alteration or improvement costs.
  • Architect fees.
  • Excavation: Digging the foundation is when building costs begin and become subject to depreciation.
  • Construction Period Interest: Interest costs incurred on funds borrowed specifically to construct the building are capitalized during the construction period.
• Basket Purchase: When land and a building are purchased together for a single price, the purchase price must be allocated between the land and the building based on their relative appraised values. This is crucial because only the building is depreciated.

### Equipment (Office Equipment, Machinery, Furniture, Fixtures, Factory Equipment)

• Costs Included:
  • Invoice price (less any discounts).
  • Freight-in (shipping costs, including insurance while in transit).
  • Installation charges.
  • Testing and preparation costs (e.g., rearranging the factory floor).
  • Sales and federal excise taxes.
  • Construction Period Interest: If the equipment is constructed (rather than purchased), interest costs incurred during its construction are capitalized.

General Rule: Expenditures that increase the quantity, quality, or extend the useful life of an asset are capitalized.

Additions (AIR):

• Definition: Increasing the quantity of a fixed asset (e.g., adding a new wing to a factory).
• Treatment: Capitalized ($Debit$ Asset, $Credit$ Cash/Payable).

Improvements/Betterments (AIR):

• Definition: Improving the quality or efficiency of a fixed asset.
• Treatment: Capitalized.

Replacements (AIR):

• Definition: Replacing an old asset or a significant component with a new one.
• Mnemonic: Additions, Improvements, Replacements (AIR) are considered extraordinary and should be capitalized.
• Treatment for Replacements:
  • If Carrying Value of Old Asset is KNOWN:
    • Remove the old asset from the books (recognize any gain or loss).
    • Record the new asset at its cost.
    • Example: Old asset: Cost $10$, Accumulated Depreciation (AD) $4$, Net Book Value (NBV) $6$. New asset cost $15$.
      • $Debit$ New Asset $15$.
      • $Credit$ Cash $15$.
      • $Debit$ Loss $6$. (If old asset's NBV is written off at a loss).
      • $Credit$ Old Asset (at NBV) $6$.
  • If Carrying Value of Old Asset is UNKNOWN:
    • Reduce the Accumulated Depreciation account for the cost of the improvement or replacement.
    • Journal Entry: $Debit$ Accumulated Depreciation (for the cost of the new component/improvement), $Credit$ Cash/Accounts Payable.
    • Effect: Debiting the contra-asset account (Accumulated Depreciation) effectively increases the asset's net book value, thus capitalizing the cost.

Ordinary vs. Extraordinary Repairs:

• Ordinary Repairs: Routine, recurring expenses (e.g., painting, routine maintenance). These are expensed as incurred.
• Extraordinary Repairs: Improve quality, increase usefulness, or significantly extend the asset's life. These are capitalized.
  • How to Capitalize: Can be added to the asset's value (if known) or, if the old asset value is unknown, by $debiting$ Accumulated Depreciation (which increases the asset's net book value).

General Rule: Interest is typically expensed as incurred.

Exception: Interest costs incurred during the construction of a fixed asset (whether for internal use or for resale) are capitalized.

Basis of Capitalization: Interest is capitalized only on the money actually spent (expended), not on the total amount borrowed.

• Uses the weighted-average accumulated expenditures (WAE) throughout the construction period.
  • Calculating WAE: If expenditures are made over time (e.g., $100,000$ in Jan, $200,000$ in July), each expenditure is weighted by the portion of the year it was outstanding (e.g., $100,000 imes \frac{6}{12}$ if outstanding for $6$ months).

Appropriate Interest Rate:

• Specific Construction Loan: For expenditures up to the amount of a specific construction loan, use the interest rate of that loan.
• General Debt: If weighted-average accumulated expenditures exceed the specific construction loan amount, the surplus expenditures are capitalized using the weighted-average interest rate of the company's general debt.
  • Calculating Weighted-Average General Debt Rate: $( ext{Amount of Debt}<em>1 imes ext{Rate}</em>1 ) + ( ext{Amount of Debt}<em>2 imes ext{Rate}</em>2 ) / ext{Total General Debt}$. For example, (250,000 imes 10 ext{%}) + (250,000 imes 8 ext{%}) / 500,000 = 9 ext{%}.

Cap on Capitalized Interest: The total capitalized interest costs for a period cannot exceed the actual amount of interest incurred for that period.

US GAAP vs. IFRS: Under US GAAP, any interest income received on unexpended portions of a loan (e.g., investing cash borrowed but not yet spent) does not offset the capitalized interest expense. IFRS treats this differently.

Conditions for Capitalizing Interest (ALL three must be met)

1. Expenditures for the asset have begun: Actual money has been paid out (e.g., for attorneys, architects, permits).
2. Activities necessary to prepare the asset for its intended use have begun: Work is actively in progress (e.g., filing permits, drawing plans).
3. Interest cost is being incurred: The company has borrowed money and is incurring interest on that debt.

Delays During Construction

• Ordinary Delays: Typical pauses for inspections (e.g., plumbing, electrical). Interest continues to be capitalized during these periods, as they are considered part of the normal construction process.
• Intentional Delays: Pauses due to management decisions (e.g., waiting for market conditions to improve, high interest rates). Interest cannot be capitalized during these periods; it must be expensed.

### End of Construction Period

• Capitalization of interest ceases when the asset is substantially complete and ready for its intended use.
• Interest costs incurred before construction begins or after it is substantially complete must be expensed. It's only during the construction term.