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Property, Plant and Equipment (PP&E)

Guide to Understanding Property, Plant and Equipment (PP&E)

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Property, Plant and Equipment (PP&E)

In This Article
  • What is the definition of property, plant and equipment (PP&E)?
  • Which formula calculates property, plant & equipment (PP&E)?
  • What are some examples of assets considered PP&E?
  • Which factors increase or decrease a company’s PP&E balance?

Property, Plant and Equipment (PP&E) Accounting Definition

Property, plant, and equipment (PP&E), or “fixed assets,” is a line item that appears on the non-current assets section of the balance sheet.

For most companies, particularly those operating in capital-intensive industries (e.g. manufacturing, industrials), PP&E is a critical part of their overall business model and the ability to continue generating revenue over the long term.

Common examples of assets that are categorized as PP&E include:

  • Buildings
  • Equipment
  • Machinery
  • Offices Furniture and Fixtures
  • Computers
  • Vehicles (Trucks, Cars)

How to Calculate PP&E

Since PP&E is a long-term asset, the purchase of PP&E – i.e. capital expenditures (CapEx) – is not expensed immediately during the period incurred.

In an effort to match the revenues from the PP&E with the cost to abide by the matching principle under GAAP accounting, PP&E is instead decreased by depreciation over its useful life assumption.

The useful life assumption is the estimated number of years that the fixed asset is expected to offer benefits to the company.

The annual depreciation expense is equal to the total CapEx amount minus the salvage value, which is then divided by the useful life assumption of the PP&E.

Depreciation Formula
  • Depreciation Expense = (CapEx – Salvage Value) / Useful Life of Asset

The depreciation expense appears on the income statement to allocate the capital expenditure amount across the asset’s useful life.

But on the cash flow statement, depreciation is added back since it is a non-cash expense (i.e. there is no real cash outflow), while the CapEx appears in the cash flow from investing activities section in the period incurred.

Property, Plant and Equipment (PP&E) Formula

The carrying value of a company’s PP&E balance is affected by two primary factors:

  1. Capital Expenditures (CapEx)
  2. Depreciation

To calculate the ending PP&E balance, CapEx is added to the beginning PP&E balance and then the depreciation expense is subtracted.

PP&E Formula
  • Ending PP&E, net = Beginning PP&E, net + CapEx – Depreciation

However, it is important to confirm that CapEx and depreciation have the correct impact on PP&E.

  • CapEx → Increases PP&E
  • Depreciation → Decreases PP&E

More specifically, CapEx is often linked to the cash flow statement in financial models, so there will usually be a negative sign in front.

In that case, the Excel formula should subtract CapEx (i.e. two negatives make a positive) rather than adding it for the intended effect, i.e. the beginning PP&E balance should increase by the CapEx spending amount.

The depreciation expense should have the opposite effect, so we must confirm that depreciation reduces the carrying value of PP&E.

PP&E Calculator – Excel Template

We’ll now move to a modeling exercise, which you can access by filling out the form below.

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PP&E Example Calculation

Suppose a company’s PP&E balance at the beginning of Year 0 is $145 million.

In Year 0, the company spends $10 million in capital expenditures (CapEx) and incurred $5 million in depreciation.

  • Beginning PP&E Balance = $145 million
  • CapEx = $10 million
  • Depreciation = $5 million

Therefore, from $145 million, we add the $10 million in new PP&E purchases and then subtract the $5 million in depreciation expense.

The ending PP&E, net balance in Year 0 amounts to $150 million, as shown by the equation below.

  • Year 0 Ending PP&E = $145 million + $10 million – $5 million = $150 million

In the next period, Year 1, we will assume the CapEx spending declined to $8 million whereas the depreciation expense increased to $6 million.

Like all roll-forward schedules in the financial models, we’ll link the beginning PP&E balance in Year 1 to the ending balance in Year 0.

  • Beginning PP&E Balance = $150 million
  • CapEx = $8 million
  • Depreciation = $6 million

The ratio between CapEx and depreciation typically converges towards 100% as a company matures.

The potential long-term investments decline over time and the proportion of CapEx becomes comprised of mostly maintenance CapEx as opposed to growth CapEx.

If we add the $8 million in CapEx and subtract the $6 million in depreciation from the beginning PP&E of $150 million, we arrive at $152 million for the ending PP&E balance in Year 1.

  • Year 1 Ending PP&E = $150 million + $8 million – $6 million = $152 million

The $152 million in PP&E would be the carrying value shown on the balance sheet in the current period.

PP&E Calculator

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