PPE, Inventory, and GAAP Accounting Principles

Posted on May 22, 2026 in Financial and Accounting Management

Chapter 10: Property, Plant, and Equipment (PPE)

Tangible Assets: Depreciated vs. Non-Depreciated

Tangible Assets (Depreciated): Buildings, equipment, machinery, furniture, autos, trucks, land improvements, and natural resources (subject to depletion).

Tangible Assets (NOT Depreciated): Land (never depreciated), Construction in Progress (CIP), and assets held for sale.

Capitalizing Tangible Asset Costs

Equipment Capitalization: Purchase price + sales tax + freight + shipping insurance + installation + special foundation + trial runs (net of scrap) + legal fees to establish title.

Land Traps:

Delinquent taxes: Capitalize.
Current-year taxes after purchase: Expense.
Demolishing an old building to use land: All costs are allocated to land (including demolition).

Intangible Assets: Amortization and Capitalization

Amortized (Finite Life): Patents, copyrights, finite franchises, and capitalized software. Use straight-line method; residual value = $0.

NOT Amortized (Indefinite Life): Goodwill, indefinite trademarks, indefinite franchises, and in-process R&D. These are subject to impairment testing.

Capitalization Rules:

Externally purchased: Purchase price + legal/filing fees + successful defense costs.
Internally generated: Nothing (no goodwill, no brand, no R&D-born patents).

Natural Resources and Asset Retirement Obligations

Natural Resource Cost: Sum of Acquisition + Exploration + Development costs (e.g., mine shaft/well) + PV of Asset Retirement Obligation (ARO).

ARO Journal Entry:

Dr. Natural Resource (asset) XXX
Cr. ARO Liability XXX

Depletion: Always uses the units-of-production method.

Rate = (Total cost − Residual) ÷ Estimated total units
Expense = Rate × Units extracted this period

Equipment Depreciation:

Movable: Use own useful life and any depreciation method.
Not movable: Use units-of-production; use the shorter of equipment life or resource life.
Rate = (Equipment cost − Equipment residual) ÷ Estimated total resource units

Goodwill Calculation and Acquisition Entries

Goodwill Formula: Goodwill = Consideration paid − (Fair Value of identifiable assets − Fair Value of liabilities assumed)

Journal Entry at Acquisition:

Dr. Identifiable assets (FV) XXX
Dr. Goodwill XXX
Cr. Liabilities assumed (FV) XXX
Cr. Cash / Stock paid XXX

Lump Sum Purchase Price Allocation

Lump Sum Allocation Formula: Asset cost = (FV of asset ÷ Total FV of all assets) × Total purchase price

Non-Cash Exchanges and Asset Issuance

Non-Interest-Bearing Note: Record asset and note at the PV of future cash flows (not face value). For a deferred annuity, calculate the PV of the annuity and then discount it back to today. Discount = Face − PV (amortized as interest expense each period).

Donated Asset:

Dr. Asset (FV) XXX
Cr. Contribution Revenue XXX

Stock Issuance: Asset cost = FV of stock (if actively traded) OR FV of asset (if not). Use whichever is more clearly determinable; stock market price is preferred.

Exchange of Old Asset (Commercial Substance):

New asset = FV of old + cash paid
Gain/Loss = FV of old − BV of old (recognize immediately)

No Commercial Substance:

Gain: Not recognized; new asset = BV of old + cash paid.
Loss: Always recognized; new asset = FV of old + cash paid.

Interest Capitalization for Self-Constructed Assets

Step 1: AAE = each expenditure × (months outstanding ÷ 12).
Step 2: Calculate interest:
- Specific loan: Use that rate first (up to loan amount), then weighted average rate for excess.
- No specific loan: Use weighted average rate for all AAE.
- Weighted average rate = Total interest ÷ Total debt.
Step 3: Capitalize the LOWER of: Calculated interest OR Actual interest incurred.

Research and Development (R&D) Accounting

Expense Immediately: Salaries, materials, equipment for a single project, outsider fees, and depreciation on R&D equipment.
Capitalize: Equipment used for multiple projects (then depreciate as R&D expense), patent filing/legal fees, and successful patent defense fees.
R&D for Others: Record as Inventory/COGS.

Come back for Research and Development.

Fixed Asset Turnover Ratio Analysis

Formula: Net Sales ÷ Average PP&E
Average PP&E: (Beginning PP&E + Ending PP&E) ÷ 2
Always use net PP&E (after accumulated depreciation).
Interpretation: A higher ratio indicates more efficient use of fixed assets. “Company generates $X in sales per $1 invested in fixed assets.”

Partial Year Depreciation and Estimate Changes

Partial Year Depreciation:

Straight-Line (SL): Annual depreciation × (months owned ÷ 12).
Double-Declining Balance (DDB): Cost × rate × (months ÷ 12) in year 1; then full rate on remaining book value thereafter.
Units of Production: No adjustment needed; use actual units.
1/2 Year Convention: Take 50% depreciation in both year 1 and the final year regardless of when bought or sold.

Change in Estimate (Prospective): Do not restate prior years.

New annual depreciation = (Book value at change date − New salvage) ÷ Remaining useful life.
Example: Book value Jan 1, 2027 = $166,000, new salvage = $22,000, remaining life = 6 years. New depreciation = ($166,000 − $22,000) ÷ 6 = $24,000/year.

Chapter 8: Inventory Accounting

Inventory Ownership and Goods in Transit

Ownership of goods in transit depends entirely on the shipping terms.

Consignment: A (Consignor) may ask another company (Consignee) to sell their goods. The Consignor retains legal title the entire time. Key rule: Consigned goods stay on the Consignor’s books as inventory—never on the Consignee’s—until sold to a third-party customer.

Goods in Transit:

Freight-In: Transportation cost paid to get inventory from the supplier to your warehouse.
Freight-Out: Transportation cost paid to ship goods from your warehouse to your customer.

F.O.B. Shipping Point: Title transfers when goods leave the seller’s dock. Buyer owns the goods while in transit, pays shipping costs, and includes them in inventory even if not yet physically received.

F.O.B. Destination: Title transfers when goods arrive at the buyer’s location. Seller owns the goods while in transit, pays shipping costs, and keeps them in inventory until delivery is complete.

Lower of Cost or Market and Net Realizable Value

LCM (Lower of Cost or Market): Calculate three things:

Ceiling (NRV) = Selling price – Cost to sell.
Floor = NRV – Normal Profit Margin (Normal Profit Margin = Selling Price − Cost − Costs to Sell).
Market = Replacement cost (must stay between ceiling and floor).

Final Step: Compare Cost and Market; use whichever is LOWER.

NRV (Net Realizable Value): NRV = Estimated Selling Price − Costs of Completion, Cost to Sell, Disposal, and Transportation.

If NRV < Cost: Write down inventory to NRV.
If Cost < NRV: No entry needed; keep at cost.

FIFO and LIFO Inventory Valuation Methods

FIFO (First In, First Out): Under FIFO, periodic and perpetual systems will always produce the same result.

LIFO (Last In, First Out) — Periodic System:

Calculate Goods Available for Sale: BI + All Purchases.
Determine Ending Inventory (EI) by taking the oldest units remaining (BI plus any early purchases not used for COGS).
Goods Available for Sale − EI = COGS.

Because LIFO periodic looks at the full period all at once, it pulls from the newest layers first across the entire period before assigning anything to EI.

Chapters 1 and 2: Conceptual Framework

FASB: Sets U.S. GAAP (1973).
SEC: Oversees public companies.
PCAOB: Oversees auditors (created by Sarbanes-Oxley).
IASB: Sets IFRS.

Qualitative Characteristics and Recognition

Qualitative Characteristics:

Relevance = Predictive value + Confirmatory value + Materiality.
Faithful Representation = Complete + Neutral + Free from error.
Enhancing = Comparability, verifiability, timeliness, and understandability.

4 Expense Recognition Approaches:

Cause & Effect: COGS.
Period Association: Salaries.
Systematic Allocation: Depreciation.
Immediate: R&D, advertising.

Closing Entries and the Accounting Cycle

Closing Entries (Close to Retained Earnings):

Debit Revenue → Credit Retained Earnings.
Debit Retained Earnings → Credit Expenses.
Debit Retained Earnings → Credit Dividends.

10-Step Accounting Cycle: 1. Source documents, 2. Analyze transactions, 3. Journal entries, 4. Post to ledger, 5. Unadjusted trial balance, 6. Adjusting entries, 7. Adjusted trial balance, 8. Financial statements, 9. Close temporary accounts, 10. Post-closing trial balance.

Cash vs. Accrual Basis and Revenue Recognition

Cash Basis: Record revenue when cash is received; record expense when cash is paid. Simple but doesn’t match when work was actually done.

Accrual Basis: Record revenue when it is earned and record expense when it is incurred. Matches revenues and expenses to the period they actually belong to.

Percentage of Completion:

% Complete = Costs incurred to date ÷ Total estimated costs.
Revenue = % Complete × Total contract price.
Gross Profit = Revenue − Costs incurred.

Balance Sheet Treatment:

CIP > Billings: Asset (Costs and profits in excess of billings).
Billings > CIP: Liability (Billings in excess of costs and profits).
CIP = Costs incurred + Gross profit recognized to date.

GAAP vs. IFRS: PP&E Reporting Standards

GAAP: Must record at historical cost (cost minus accumulated depreciation) only.
IFRS: Can record at historical cost OR fair value (revaluation model).

IFRS Revaluation Rules:

Increase in value: OCI (Revaluation Surplus).
Decrease in value: Expense on income statement.
Must apply to the entire class of assets, not just one.