What Are Plant Assets in Accounting?
Learn about plant assets in accounting. Understand how these essential long-term physical resources are acquired, managed, and recorded on a company's books.
Plant assets represent a significant category of investments for businesses, providing the foundational resources necessary for sustained operations. These assets are crucial for a company’s ability to generate revenue and provide goods or services over an extended period. Understanding how these long-term investments are accounted for is fundamental to grasping a company’s financial health and operational capacity. The accounting treatment of plant assets reflects their enduring nature and their role in a business’s long-term strategy.
Characteristics of Plant Assets
Plant assets, often referred to as property, plant, and equipment (PP&E) or fixed assets, possess distinct characteristics. First, they are tangible, meaning they have physical substance. This physical presence distinguishes them from intangible assets like patents or trademarks.
Second, plant assets are long-lived, expected to provide economic benefits for more than one accounting period. This extended useful life means their costs are not fully expensed in the year of purchase. Third, these assets are acquired for use in a company’s operations, such as producing goods, supplying services, or for administrative purposes, rather than for immediate resale.
Common examples of plant assets include land, buildings, machinery, equipment, and vehicles. Land is a plant asset because it is tangible and used in operations, though it is unique as it generally does not depreciate. Buildings, machinery, equipment, and vehicles also fit these criteria, directly supporting business activities.
Determining Initial Cost and Capitalization
The initial cost of a plant asset includes its purchase price and all expenditures necessary to acquire and prepare it for its intended use. This ensures the asset is recorded at its full historical cost, which is verifiable and objective. For instance, if a company purchases new manufacturing equipment, the capitalized cost would include the invoice price, freight charges, installation expenses, and any testing costs before operation.
Costs associated with land acquisition include the purchase price, real estate commissions, legal fees, title search, surveying, or clearing costs. Even the cost of removing an old building on purchased land, minus any salvage value, is typically added to the cost of the land if the purpose is to prepare the site for new construction. These expenditures are capitalized, meaning they are recorded as an asset on the balance sheet rather than immediately expensed on the income statement.
Accounting for Depreciation
Depreciation is an accounting process that systematically allocates the cost of a tangible plant asset, excluding land, over its useful life. This allocation matches the asset’s expense with the revenues it helps generate, aligning with the matching principle in accounting.
Three key components are needed to calculate depreciation: the asset’s capitalized cost, its estimated salvage value, and its estimated useful life. Salvage value is the estimated residual amount the company expects to receive from disposing of the asset at the end of its useful life. Useful life is the estimated period or amount of activity over which the asset will be used.
Several depreciation methods exist, each distributing the asset’s cost differently over its useful life. The straight-line method allocates an equal amount of depreciation expense to each period. Accelerated methods record higher depreciation expense in the earlier years of an asset’s life and lower amounts in later years. Another method, units of production, allocates cost based on the asset’s actual usage or output. Depreciation impacts the financial statements by reducing the asset’s book value on the balance sheet through an accumulated depreciation account and recognizing depreciation expense on the income statement, which reduces net income. While depreciation reduces reported profit, it is a non-cash expense, as it does not involve an actual cash outflow in the period it is recorded.
Disposing of Plant Assets
When plant assets are no longer useful to a business, they must be disposed of, removing them from accounting records. Common disposal methods include selling the asset, retiring it by scrapping or abandoning it, or exchanging it for a new asset. Before recording the disposal, any depreciation for the current period up to the date of disposal must be recorded to ensure the asset’s accumulated depreciation is up-to-date.
To remove the asset, both its original cost and accumulated depreciation are eliminated from accounting records. If the asset is sold, the proceeds received are compared to the asset’s book value, which is its original cost less accumulated depreciation. If the proceeds exceed the book value, a gain on disposal is recognized; if they are less, a loss is recognized. These gains or losses are reported on the income statement. For assets retired without sale, a loss equal to the asset’s book value is usually recognized, as no cash is received.