What is property, plant and equipment, and what does it mean?

By Matt Lee AAA
A:

Property, plant and equipment (PP&E) is a term that describes an account on the balance sheet. The PP&E account is a summation of all a company's purchases of property, manufacturing plants and pieces of equipment to that point in time, less any amortization. Amortization is used to devalue an asset as the asset is used, and is designed to measure the asset's economic value throughout its useful life. The balance in this account is remeasured every reporting period due to the amortization deduction, but the balance displayed depends on a few separate determining factors.

To enter a balance into the PP&E account, a firm must find the historic cost of all the assets first. Historic, or purchase, costs are the initial prices the firm paid for securing the use of the asset. If, for example, a company purchased a factory for $10 million, then the historic cost of this factory is $10 million. Historic costs are equal to the nominal purchase price. Once the historic costs are determined, the amortization can be deducted over time, and the balance, called the book value, is entered into the account.

Two of the three different asset classes, property and equipment, are the only assets that are amortized within this account - land is not. The rationale for this is that the economic value of land does not decrease over time, but will most likely increase. The historic costs of the land, or any other asset, may also be adjusted from time to time to better reflect the current market value. For example, if the firm purchased $50,000 worth of land in 1960, the true value of that land would not be obvious on the balance sheet (it may be worth $1 million now). Therefore, from time to time as the company sees fit, assets may be re-evaluated in order to determine a more appropriate cost to use on the balance sheet, but all readjustments must be disclosed within the footnotes sections of the company's financial statements.

For related reading, see the Fundamental Analysis Tutorial and What's the difference between book and market value?

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