Property, Plant and Equipment Under ASC 360: Capitalization, Depreciation, Disposals and Audit Tests

Fixed assets are usually less volatile than receivables or inventory, which is why they often get routine treatment: a rollforward, a sample of additions, a depreciation recalculation. The risks are often about judgment rather than arithmetic: costs capitalized that should have been expensed, assets still depreciating after they were scrapped, useful lives that have not been revisited. The framework is ASC 360, Property, Plant, and Equipment, with related guidance on interest (ASC 835-20), asset retirement obligations (ASC 410-20) and internal-use software (ASC 350-40).

This guide covers what to capitalize, how to depreciate, how to account for disposals and what auditors test. Impairment of long-lived assets is covered separately in the ASC 360 and ASC 350 impairment guide.

Initial measurement: what to capitalize

PP&E is recorded at historical cost. Cost includes the purchase price and all expenditures necessary to get the asset ready for its intended use:

• the invoice price, less discounts, plus non-refundable taxes and duties
• freight and handling to the site
• site preparation, installation and assembly
• testing and commissioning costs, including pre-production test runs necessary to get the asset ready
• professional fees directly attributable to the asset, such as architects and engineers
• for self-constructed assets, direct materials and labor, and a reasonable allocation of overhead directly related to construction
• capitalized interest under ASC 835-20 for assets constructed over a period, where the criteria are met

The stages of a project

Practice divides a capital project into four stages. The framework comes from a proposed AICPA SOP that was never issued, not from the Codification, but it is used in practice. In the preliminary stage, before acquisition or construction of a specific asset is probable, costs such as feasibility studies and site surveys are expensed. In the pre-acquisition stage, once the project is probable, directly identifiable costs are capitalized and allocated overhead is expensed. In the construction stage, directly related costs are capitalized. In the in-service stage, once the asset is substantially complete and ready for its intended use, capitalization generally stops. Costs of training staff, general overhead and start-up costs are expensed.

Repairs and maintenance vs improvements

This is the day-to-day capitalization judgment. Expenditures that extend useful life, increase capacity or efficiency, or improve quality or output are capitalized. Expenditures that maintain the asset at its originally assessed standard of performance are expensed as repairs and maintenance. Some entities use a dollar threshold below which everything is expensed. A threshold is acceptable if it does not materially distort the financial statements, and should be documented in a capitalization policy. The threshold may match the tax de minimis safe harbor, but the book policy has to stand on its own.

Related items:

• Major overhauls and component accounting. Where a component has a materially different life, such as a roof or an engine, entities may account for components separately. When a component is replaced, the carrying amount of the replaced part should be derecognized.
• Asset retirement obligations. If the entity has a legal obligation to retire an asset, such as removing equipment or restoring a leased site, ASC 410-20 requires recognizing a liability at fair value and capitalizing a corresponding amount into the asset's cost.
• Leasehold improvements. Depreciated over the shorter of the useful life and the lease term, including renewal periods where the lease term as defined in ASC 842 includes them. See the ASC 842 guide.
• Software. Internal-use software costs follow ASC 350-40, with stages similar to those above.
• Assets acquired in a business combination are recorded at fair value under ASC 805.
• Contributed assets at not-for-profits are recorded at fair value.

Depreciation

ASC 360-10-35 describes depreciation accounting as a system that distributes the cost of a tangible asset, less salvage value if any, over the estimated useful life in a systematic and rational manner. It is a process of allocation, not valuation.

Method

Straight-line is the most common. Accelerated methods (declining balance, sum-of-the-years'-digits) and units-of-production are acceptable if they better reflect the pattern in which the asset's economic benefits are consumed. The method is an accounting estimate, and a change in method is a change in estimate effected by a change in principle, accounted for prospectively with appropriate justification.

Tax depreciation under MACRS or bonus depreciation is not automatically acceptable for books. It can be used only if the result does not differ materially from depreciation over the asset's estimated useful life under ASC 360. When the books follow the tax return and the lives are shorter than the economics, the book depreciation needs to be adjusted. The difference between book and tax is tracked as a deferred tax item. See the income taxes guide.

Useful life and salvage value

Useful life is the period over which the asset is expected to contribute to cash flows, considering physical wear, technological obsolescence, legal limits and the entity's replacement practice. Salvage value is the estimated amount obtainable at the end of the life. Many entities assume zero, which is acceptable if immaterial.

Useful lives and salvage values are reviewed periodically. A change is a change in accounting estimate, applied prospectively. Disclose the effect when material. Use the depreciation calculator to recompute schedules.

Land and construction in progress

Land is not depreciated. Construction in progress is not depreciated until placed in service. A common error is leaving large projects in CIP for years after the building is in use.

Disposals

Sales, retirements and abandonment

When an asset is sold, retired or abandoned, remove its cost and accumulated depreciation, and recognize the difference between proceeds and carrying amount as a gain or loss. Depreciate up to the disposal date. Entities often let fully depreciated assets stay on the register; that is acceptable if the register flags them, but assets that are physically gone should be removed.

An asset to be abandoned is considered held and used until it is disposed of, but its useful life is revised to reflect the shortened period. An asset to be exchanged for a similar asset is under the nonmonetary exchange rules.

Held for sale

An asset (or disposal group) is classified as held for sale when specific criteria are met, such as management with the authority having committed to a plan to sell, the asset being available for immediate sale in its present condition, an active program to locate a buyer, a sale that is probable and expected to complete within one year (with limited exceptions), active marketing at a price that is reasonable relative to current fair value, and an unlikely change to the plan. Once classified, depreciation stops and the asset is measured at the lower of carrying amount and fair value less cost to sell. See the ASC 360 and ASC 350 guide.

Disclosures

Disclose depreciation expense, balances of major classes of depreciable assets by nature or function, accumulated depreciation, the depreciation methods and useful lives, capitalized interest if material, and assets pledged as collateral. Use the GAAP disclosure checklist.

What auditors test

Fixed assets can carry lower inherent risk than estimates-heavy areas, but the risk rises with new construction, a capitalization policy that is loosely applied, aggressive tax-driven lives, or an environment of covenant pressure where expenses are tempting to capitalize. Under AU-C 315, consider these factors when assessing risk.

Start with the rollforward

Obtain the fixed asset rollforward by class: beginning cost, additions, disposals, transfers, ending cost, and the same for accumulated depreciation. Agree opening balances to the prior-year audited statements and ending balances to the general ledger. The fixed asset rollforward template and fixed asset rollforward calculator can structure it.

Additions

• Select additions above a threshold, plus a sample of smaller items, and vouch to invoices, contracts, bills of lading and, for self-constructed assets, payroll and materials records.
• Evaluate whether each addition is capital in nature under the policy. Review repairs and maintenance expense accounts for large items that should be capitalized (completeness of additions), and review additions for items that should be expensed.
• Test the in-service date, which drives depreciation start.
• Review capitalized interest calculations.
• Inspect significant additions where practical.

Depreciation

• Recompute depreciation for a sample, or for the whole population using analytical procedures. A substantive analytical procedure comparing depreciation expense to the average depreciable base is efficient.
• Evaluate useful lives and methods against the policy, industry norms and the entity's experience. Challenge long-held lives in industries with technology change.
• Check consistency of method and any changes in estimate.

Disposals

• Completeness of disposals needs specific attention because the register may not reflect assets that left the business. Search for proceeds from sales of equipment in cash receipts and other income, review scrap and trade-in activity, ask operations about retired or relocated assets, and observe whether assets on the register are physically present.
• Test gains and losses on disposals.

Existence

• Select assets from the register and inspect them, and select assets in the field and trace them to the register to test completeness.
• Agree title or ownership to deeds, titles and registrations for significant items.

Impairment indicators

Consider whether events or changes in circumstances indicate that carrying amounts may not be recoverable, such as idle plants, significant adverse changes in use, losses at an asset group or a closed location. Cross-reference the impairment procedures.

Presentation

• Classification between PP&E, assets held for sale and CIP.
• Disclosure of encumbered assets, which links to debt covenants. See the debt guide.

Document under AU-C 230.

Issues to look for

• Repairs capitalized to improve current-year earnings.
• Fully depreciated assets still carried when disposed of long ago.
• Tax lives used for books without a reasonableness check.
• CIP not transferred when the asset was placed in service.
• Disposals unrecorded because no one told accounting.
• Missing leasehold improvements amortization after a lease change.
• Capitalization threshold not applied consistently.

FAQ

What costs can be capitalized into PP&E?

All costs necessary to bring the asset to its location and condition for intended use: purchase price, freight, installation, testing and directly attributable professional fees. Costs during the preliminary stage, training and general overhead are expensed.

What is the difference between a repair and an improvement?

An improvement extends the asset's life, increases its capacity or efficiency or improves its output, and is capitalized. A repair maintains the asset at its original level of performance and is expensed.

Can I use tax depreciation for book depreciation?

Only if the result does not differ materially from depreciation over the asset's estimated useful life. Otherwise, book depreciation should reflect the useful life, and the difference creates a deferred tax item.

When does depreciation stop?

When the asset is disposed of, or when it is classified as held for sale. Land and assets under construction are not depreciated.

What is the biggest audit risk for fixed assets?

Two risks that need specific attention are completeness of disposals and the capitalization of items that should have been expensed. Both can be tested by looking outside the register, at repairs expense and at cash receipts.

CORAA prepares ready-to-review audit files for US CPA firms; see /us.

Sources

• FASB ASC 360-10 (Property, Plant, and Equipment, Overall): initial measurement, depreciation (35-4 onward), held for sale (45-9), disclosure (50-1)
• FASB ASC 835-20 (capitalization of interest); ASC 410-20 (asset retirement obligations); ASC 350-40 (internal-use software); ASC 842-20 (leasehold improvements); ASC 250-10 (changes in estimate and principle); ASC 845 (nonmonetary exchanges)
• AICPA, AU-C Sections 315, 520 and 230

AU-C references are to AICPA Professional Standards, paraphrased here; read the standard itself before relying on a requirement. This page is guidance, not professional advice. Report an error