The accounting treatment for Property, Plant and Equipment (commonly referred to as PPE) is set out within IAS16. PPE may also be referred to as fixed assets or tangible assets and generally, PPE is not hard to account for with only a couple of main points to understand in order to grasp the basics:
The Initial Value of the Fixed Asset
The first figure that must be calculated is the cost value of the assets in question. Most fixed assets on a company’s balance sheet will be held at cost, inline with IAS16. The method for calculating the cost is as follows:
- Take the actual cost price of the asset. Ie. the money that was actually transferred in order to buy the asset.
- Add on any further costs that were incurred in relation to the asset, this could be installation costs, delivery costs or site preparation costs which are all permitted under IAS16.
Once these 2 calculations have been performed, the cost value of the assets has now been determined.
The Classification of the Fixed Asset
Most business provide each asset with its own classification. This may not actually be necessary but it does provide much more clarity within the balance sheet as to what the total assets balance is made up of and it also makes the next step, calculating depreciation, easier to calculate.
The majority of assets can be classified into either:
- Plant and Machinery
- Land & Buildings
- Office Equipment
- Motor Vehicles
- Fixtures and Fittings
Of course, there may be other classes that a business wants to use but by using the above classifications of PPE, the balance sheet is much cleaner and comparable to other sets of accounts.
Calculating Depreciation
One of the most important steps in the accounting for PPE is to calculate the depreciation the assets. A simple way of looking at depreciation is viewing it as the decrease in value of an asset over time (we all know how cars depreciate etc.). However, this is not strictly true. Depreciation is actually just a way of spreading the cost of an asset over its useful life to the business – in other words, this is how we show the expense of purchasing a fixed asset in a company’s income statement over the years that it is useful to the company’s operations rather than having one big expense in the year it was actually purchased.
There are 2 methods for calculating the depreciation of an asset:
- Straight line method. The asset’s useful life is calculated and then a charge is made based on that each year. For example, if we imagine a car worth £10,000 had a useful life of 10 years. we divide the £10,000 by 10 (years) to give us an annual charge of £1,000. If the fixed asset is expected to have a residual value at the end of its useful life then we alter the calculation slightly by taking the Cost – Residual value and then dividing this by the amount of years to get the annual charge.
- The reducing balance method. With the reducing balance method the depreciation charge will diminish year on year meaning more of the assets value is put through the profit and loss account at the start of its useful life rather than at the end. This is calculated initially by working out a percentage charge. If we take the example above, the charge would be 10% per year based on depreciation over 10 years. The first year of depreciation is calculated based on the straight line method but the following years are calculated in a different way. For year 2, any depreciation charged to date is removed from the cost of the asset and then this is multiplied by 10% to give us the charge for the year. This is the same for all following years: Take the cost less any depreciation and then multiply by the rate of depreciation. In the last year of depreciation (the 10th year), simply take the residual value of the asset and write it off as an expense to the profit and loss account.
Once the depreciation amount has been calculated, an accounting entry will need to be posted on a regular basis to show the depreciation expense within the income statement and also to reduce the net book value of the asset on the balance sheet. For a guide on the accounting entries required for depreciation, please visit out guide to depreciation journal entries.
Showing Fixed Assets on the Balance Sheet
The main principle of accounting for PPE is that it has to be shown on the balance sheet at its Net Book Value.
The net book value is simply the cost of the asset less any depreciation that has been charged on it to date. This gives us the “current value” of the asset which makes the figure shown on the balance sheet a true and fair representation of the asset in question.
Normally, all fixed assets will be compiled together to get one total figure which will be shown in the Non-current assets section of the balance sheet. A note will be added into the back-end of the accounts which will split out the fixed assets into their respective classes. The note will then go on to list the following:
- Cost value of all the classes of assets
- The accumulated depreciation to date of each class of asset
- The current net book value of each class of asset
A total net book value should then be displayed within the note which should tie directly back to the fixed asset figure on the face of the balance sheet.
Those are the main steps in understanding how to account for Fixed Assets.
Summary
To ensure you understand exactly how to account for fixed assets, we have compiled the key steps below:
- Find out the original cost of the asset (this is the initial value that will be shown on the balance sheet)
- Classify the asset in to the appropriate category (motor vehicles, office equipment etc.)
- Work out the method of depreciation that will be used (straight-line or reducing balance)
- Work out the monthly depreciation charge (the expense)
- Show the correct net book value on the balance sheet.