Accounting Principles for PPE and Intangible Assets

Posted on Jan 27, 2026 in Financial and Accounting Management

Selling PPE and Recording Gains or Losses

Key Ideas: Property, Plant, and Equipment (PPE) is carried on the balance sheet at cost minus accumulated depreciation, which equals the book value (carrying value). When you sell an asset, you must:

  • Remove the asset’s cost.
  • Remove the related accumulated depreciation.
  • Record the cash (or receivable) received.

The difference between cash received and book value is a gain or loss on sale.

Journal Entry Pattern

Assume: Cost of machine = $50,000; Accumulated depreciation at sale date = $35,000; Cash proceeds = $18,000.

Book value = $50,000 – $35,000 = $15,000. Therefore, the gain = $18,000 – $15,000 = $3,000.

  • Dr Cash: $18,000
  • Dr Accumulated Depreciation: $35,000
  • Cr PPE (Machine): $50,000
  • Cr Gain on Sale of PPE: $3,000

If proceeds are less than the book value, you would debit a Loss on Sale.

Capitalizing vs. Expensing Asset Costs

Historical Cost of PPE: Capitalize all costs necessary to acquire the asset and make it ready for use. These are capitalized costs and appear on the balance sheet; they are allocated over time via depreciation.

Typical Items Capitalized

  • Land: Purchase price, legal fees to obtain title, cost of clearing and grading, delinquent back taxes, or costs incurred before the asset is ready for use.
  • Building: Architect’s fees, construction costs, and interest on construction loans during construction.

Costs to Expense

Ordinary repairs, annual property taxes, and other costs that do not extend useful life or increase capacity should be expensed immediately.

Capitalization Rule: Capitalize expenditures that provide benefits over multiple periods (extending useful life or improving efficiency). Expense if they only benefit the current period.

Non-Monetary Exchanges of PPE

Measurement: Measure the new asset and gain/loss at the fair value of what you give up or what you receive, whichever is more clearly evident.

Gain/Loss: Compute the book value of the old asset (Cost – Accumulated Depreciation). Compare the fair value (usually of the old asset) plus or minus cash with the book value to determine the gain or loss. Recognize gain/loss unless the exchange lacks commercial substance.

Basic Journal Entry Structure

Assume: Old machine cost $100,000, accumulated depreciation $40,000 (BV = $60,000). Fair value of old machine = $50,000. You receive $10,000 cash plus a new machine in exchange.

Total consideration received = $50,000 (FV of old) + $10,000 (cash) = $60,000. In this case, there is no gain or loss because the book value is $60,000.

  • Dr Accumulated Depreciation: $40,000
  • Dr Cash: $10,000
  • Dr New Machine: $50,000
  • Cr Old Machine: $100,000

If the fair value of the old asset plus or minus cash does not equal the book value, plug the difference to Gain or Loss.

Understanding Depreciation

Definition: Depreciation is the systematic and rational allocation of the cost of tangible assets (less residual value) over their useful life. It is a cost allocation process, not a valuation process.

What Depreciation Is Not

  • It does not attempt to show current market value.
  • It does not set aside cash for replacement.
  • It does not measure physical wear exactly; it uses estimates of useful life and residual value.

Comparing Depreciation Methods

All methods use the same allocation base: Depreciable Base = Cost – Residual Value.

Straight-Line (SL)

Depreciation Expense = (Cost – Residual) / Estimated Useful Life in Years

This results in the same expense each year and ignores the timing of usage.

Sum-of-the-Years’-Digits (SYD)

Depreciation Expense = (Cost – Residual) × (Remaining Life in Years / SYD Sum)

Where SYD Sum = N(N+1)/2. This is an accelerated method: more depreciation is recorded earlier and less later.

Declining Balance (Double-Declining, DDB)

Depreciation Expense = Beginning Net Book Value (NBV) × DB Rate

The DDB rate is 2 × the SL rate. Do not subtract residual value in the formula, but stop when the NBV hits the residual value.

Units of Production (Activity-Based)

Depreciation Expense = [(Cost – Residual) / Total Estimated Units] × Units This Period

This ties depreciation to actual usage, such as units made or hours used.

Amortization of Intangible Assets

  • Finite-life Intangibles: Amortize over useful life (usually straight-line). Examples include patents, copyrights, franchises with fixed terms, some licenses, and customer lists.
  • Indefinite-life Intangibles: These are not amortized; instead, test annually for impairment. Examples include many trademarks (renewable every 10 years), some franchises, and goodwill.

Sum-of-the-Years’-Digits (SYD) Calculation

The SYD denominator for an N-year life is N(N+1)/2.

Example: Cost = $100,000, Residual = $10,000, Life = 5 years.

  • Depreciable Base = $100,000 – $10,000 = $90,000
  • Sum of Digits = (5 × 6) / 2 = 15
  • Year 1 Fraction = 5/15 → Depreciation = $90,000 × 5/15 = $30,000
  • Year 2 Fraction = 4/15 → Depreciation = $24,000
  • Year 3 Fraction = 3/15 → Depreciation = $18,000

Changes in Depreciation Estimates

Companies can use different methods for different assets or for GAAP versus tax purposes. When estimates change (remaining life or residual):

  1. Compute the current book value at the date of change.
  2. Compute the new depreciable base (Book Value – New Estimated Residual Value).
  3. Allocate that base over the new remaining useful life using the chosen method.

Do not restate prior years; changes are treated prospectively.

Impairment Testing for PPE

Impairment applies when a triggering event suggests assets may be overstated (e.g., technological obsolescence).

Step 1: Recoverability Test

Compare the book value to the undiscounted future cash flows expected from using and disposing of the asset. If book value is greater than undiscounted cash flows, the asset is not recoverable and impairment exists.

Step 2: Measure Impairment Loss

Impairment Loss = Book Value – Fair Value

The journal entry is Dr Impairment Loss and Cr Accumulated Depreciation. After a write-down, use the new carrying value and remaining useful life to compute future depreciation. We do not write the value back up later.

Accounting for Software Development Costs

Software is an exception to the general rule of expensing all R&D. For software to be sold, leased, or marketed:

  • Before Technological Feasibility: All development costs are R&D and are expensed as incurred.
  • After Technological Feasibility: Capitalize as an intangible asset (software development costs). Later, amortize over the software’s estimated product life.
  • After Production Starts: Additional costs are treated as inventory costs and expensed through COGS when sold.

Goodwill Valuation and Accounting

Goodwill is an unidentifiable intangible representing value that cannot be tied to a specific right (e.g., brand reputation). It is only recognized when a business is purchased, not internally generated.

Goodwill = Purchase Price – (Fair Value of Identifiable Assets – Fair Value of Liabilities)

Goodwill is not amortized; instead, it is tested annually for impairment. If the fair value of the reporting unit is less than its carrying value, goodwill is written down.

Characteristics of Intangible Assets

  • Characteristics: No physical substance, not financial instruments, and they convey legal or economic rights. Future benefits are often more uncertain than PPE.
  • Classification: Identifiable (patents, trademarks, licenses) vs. Unidentifiable (goodwill).
  • Acquisition: Externally acquired intangibles are capitalized at purchase price plus related costs. For internally developed identifiable intangibles, capitalize only certain direct costs (like legal fees), while R&D is expensed.