Difficulty: Intermediate | Prerequisites: Basic accounting for asset purchases. Familiarity with debits and credits for long-lived assets is assumed.
This topic covers how companies measure, classify, and record their long-lived tangible and intangible assets. It sits at the intersection of the balance sheet and the income statement: get the initial cost wrong, and every subsequent period's depreciation or amortisation is wrong too. You need to know what qualifies as PP&E versus inventory, what costs get capitalised versus expensed, and how goodwill arises in an acquisition. The rules for asset exchanges, donated assets, and capitalised interest are all fair game for exam questions.
PP&E and intangible assets are long-lived resources capitalised at cost, including all expenditure necessary to get the asset ready for its intended use. Goodwill arises only in an acquisition and equals the excess of the purchase price over the fair value of net assets acquired. Subsequent expenditures are capitalised only if they add future economic benefit; routine repairs and maintenance are expensed.
Property, Plant, and Equipment (PP&E)
Long-lived tangible assets used in operations and not held for sale. Includes land, buildings, machinery, and equipment. Does not include inventory.
Intangible Assets
Long-lived assets without physical substance, such as patents, copyrights, and trademarks. Goodwill is a specific type of intangible that arises only through acquisition.
Goodwill
The excess of the purchase price of an acquired company over the fair value of its net assets. In simple terms, it is the premium paid for things like brand reputation, customer relationships, and workforce quality that do not appear individually on the balance sheet.
Capitalised Interest
Interest cost included in the cost of a self-constructed asset during its construction period. The specific-interest and weighted-average methods yield the same result unless construction debt interest rates differ from other debt rates.
Asset Exchange
A transaction in which one non-monetary asset is swapped for another. Gains or losses are recognised based on the fair value of the asset given up compared to its book value.
Donated Assets
Assets received without payment, recorded at fair value on the date of donation with a corresponding credit to revenue.
Subsequent Expenditures
Costs incurred after an asset is placed in service. Additions, improvements, and rearrangements are capitalised. Repairs and maintenance are expensed.
Fair Value
The price that would be received to sell an asset in an orderly transaction between market participants. When fair value is not directly determinable, it must be estimated. Fair value is often estimated as the discounted present value of future cash flows, not the undiscounted amount.
PP&E includes land, buildings, machinery, oil wells, and similar tangible assets used in operations. Intangible assets include patents, copyrights, and goodwill. Inventory does not qualify as PP&E or intangible, even though it is a long-lived physical item for some businesses, because it is held for sale rather than for use in operations.
The cost of land includes the purchase price plus all expenditure necessary to ready it for its intended use: grading, title search costs, and recording fees. Property taxes for the current period are not included in the cost of land. They are an operating expense of the period.
When a company builds an asset for its own use, interest incurred during the construction period is capitalised as part of the asset's cost. Two methods exist for calculating the amount: the specific-interest method (using the rate on construction-specific borrowing) and the weighted-average method (blending rates across all borrowings). The two methods produce the same result unless the construction debt carries a different rate from the company's other interest-bearing debt.
When one non-monetary asset is exchanged for another, the company compares the fair value of the asset given up to its book value.
If fair value exceeds book value, a gain is recognised.
If book value exceeds fair value, a loss is recognised.
Example from the source: Wolf Computer exchanged a machine with a book value of $40,000 and a fair value of $45,000 (plus $6,000 cash) for a patent. Wolf recognises a $5,000 gain (fair value $45,000 minus book value $40,000).
When a company receives an asset as a donation, it records the asset at its fair value on the date of donation and credits revenue for the same amount, regardless of what the asset originally cost the donor.
Example: Canova Company received land appraised at $200,000 (which had cost the city $80,000). Canova records a debit to Land for $200,000 and a credit to Revenue for $200,000.
Goodwill arises only through an acquisition. It equals the excess of the purchase price over the fair value of the net assets acquired. The formula is often stated as Goodwill = Book Value - Fair Value, but more precisely it is the purchase price minus the fair value of identifiable net assets.
Goodwill is not amortised. It is tested for impairment.
After an asset is in service, additional costs are either capitalised or expensed.
Capitalised: Additions (new components), improvements (upgrades that extend life or increase capacity), and rearrangements (reorganisation of existing assets).
Expensed: Repairs and maintenance (routine upkeep that does not add future benefit).
Three approaches can be used to determine the fair value of an impaired asset: prices of similar assets, the market price of the asset, and the sum of the discounted expected cash flows. The sum of the undiscounted cash flows cannot be used to determine fair value (though it is used in the initial recoverability test under US GAAP).
Goodwill = Purchase Price - Fair Value of Net Assets Acquired
Gain/Loss on Asset Exchange = Fair Value of Asset Given Up - Book Value of Asset Given Up
Donated Asset Entry: Debit Asset (at fair value), Credit Revenue (at fair value)
Students often include property taxes for the current period in the cost of land. Property taxes are a period expense, not a capitalised cost.
Students sometimes record donated assets at the donor's original cost. The correct treatment is to use the asset's fair value on the date of donation.
Students confuse the recoverability test (which uses undiscounted cash flows) with the measurement of fair value for impairment (which uses discounted cash flows, market prices, or prices of similar assets). The undiscounted cash flows figure is not a valid measure of fair value.
Students often think goodwill can arise internally. It cannot. Goodwill is recognised only through the acquisition of another company.
⚠️ Know which costs are included in land versus which are period expenses. Property taxes for the current period is a favourite wrong-answer trap.
⚠️ Asset exchange gains and losses: be able to compute the gain or loss given book value, fair value, and any cash exchanged.
⚠️ Donated assets: the credit is to revenue at fair value, not at the donor's historical cost.
⚠️ Fair value of an impaired asset: know the three valid approaches and know that undiscounted cash flows is the one that does not qualify.
⚠️ Subsequent expenditures: repairs and maintenance is the one category that is expensed, not capitalised.
True or False: Inventories are classified as PP&E. (False, inventories are current assets held for sale.)
Fill in the blank: Goodwill = Purchase Price - ______. (Fair Value of Net Assets Acquired)
True or False: Fair value is often estimated as the undiscounted present value of future cash flows. (False, it is estimated as the discounted present value.)
Fill in the blank: The one type of subsequent expenditure that is normally expensed rather than capitalised is ______. (Repairs and Maintenance)
True or False: If fair value is not determinable, it must be estimated. (True)
Q: Each of the following would be considered PP&E or an intangible asset except: (a) an oil well, (b) a building, (c) inventories, (d) a patent. Which is the exception?
A: (c) Inventories. Inventory is a current asset held for sale, not a long-lived operating asset.
Q: What would not be included in the initial cost of land: (a) grading, (b) title search costs, (c) recording fees, (d) property taxes for the current period?
A: (d) Property taxes for the current period. They are an operating expense.
Q: Wolf Computer exchanged a machine with a book value of $40,000 and a fair value of $45,000 for a patent, also giving $6,000 cash. What gain or loss does Wolf recognise?
A: A gain of $5,000 (fair value of $45,000 minus book value of $40,000).
Q: Canova Company received donated land appraised at $200,000 (original cost to the donor: $80,000). How should Canova record this?
A: Debit Land $200,000, Credit Revenue $200,000. The donor's original cost is irrelevant.
Q: Which of the following approaches cannot be used to determine the fair value of an impaired asset: (a) prices of similar assets, (b) market price, (c) discounted expected cash flows, (d) undiscounted cash flows?
A: (d) The sum of the undiscounted cash flows. That figure is used for the recoverability test, not for measuring fair value.
Q: Which type of subsequent expenditure is not normally capitalised: additions, improvements, repairs and maintenance, or rearrangements?
A: Repairs and maintenance.
The initial measurement of PP&E and intangibles directly determines the depreciation and amortisation expense covered in the companion study notes on depreciation methods. Goodwill connects to the business combinations and consolidation material. Impairment testing ties into fair value measurement standards, which appear again in the financial instruments chapters.
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