Plant, Property and Equipment

The AICPA has issued an exposure draft for a proposed Statement of Position related to the Accounting for Certain Costs and Activities Related to Property, Plant and Equipment. Although many principles remain unchanged, the SOP takes a different view on several issues related to costs that may or may not be capitalized in relation to PP&E. The SOP divides the process of acquiring and owning a capital asset into four stages: preliminary; pre-acquisition; acquisition or construction; and in-service. Following are some of the key issues that the exposure draft raises.

Preliminary Stage
The preliminary stage begins when management first contemplates the acquisition or construction of a capital asset and continues until it becomes probable that the acquisition or construction will occur. The proposed SOP uses the term "probable" similarly to its use in FASB Statement No. 5, Accounting for Contingencies.

A capital acquisition becomes probable when three conditions exist:

• Management, having the authority to do so, must have authorized and committed to funding the proposed acquisition;
• Financial resources must be available for the acquisition; and
• The entity must be able to meet any requisite local and governmental regulations.

Almost all costs incurred during the preliminary stage are recognized as expenses in the period incurred. This includes the cost of feasibility studies, asset selection, surveying, engineering studies, design layout and traffic studies as well as costs associated with obtaining management approval. Direct costs of obtaining an option related to the acquisition may be capitalized.

If the cost of an option is capitalized, it must be reported on the balance sheet at the lower of its cost or its net realizable value, which would be its fair value less any costs that would be necessary to sell it. Any reductions to the carrying value of an option are charged to expense.

Pre-acquisition Stage
During the pre-acquisition stage, only those costs that are directly identifiable to the asset are capitalized. Incremental direct costs of pre-acquisition activities that are incurred in transactions with independent third parties are capitalized. Most costs that are incurred internally are recognized as expense. The only exceptions are:

• The direct costs of obtaining an option are capitalized.
• The cost of payroll and benefits for employees involved in the pre-acquisition activities are also capitalized.

The amount is based on a ratio of the hours spent on the activities to total hours, including compensated absences. Costs of occupancy and depreciation related to those employees are not capitalized.

Any costs that are capitalized during the preliminary and pre-acquisition stages will be included in the cost of the asset acquired or constructed. If it becomes probable that the asset will not be acquired or constructed, capitalized costs in excess of the net realizable value of the entity's interest in the asset are charged to expense.

Acquisition or Construction Stage
This stage begins when the entity obtains ownership of the asset or obtains rights to use it. It continues until the asset is acquired or asset's construction is substantially complete--upon completion of all major construction and installation activities--or when related revenues begin to be recognized. If only a portion of a project is substantially complete, the project can be divided into multiple projects if the substantially complete portion can be operated independently from the project's incomplete portions.

Costs directly associated with the specific asset that are incurred during the acquisition or construction stage should be capitalized. This includes incremental costs of acquiring, constructing or installing the assets that are incurred in transactions with independent third parties. Likewise, many of those costs are capitalized when incurred internally.

When evaluating costs incurred internally:

• Payroll and benefits for employees involved in the acquisition or construction are capitalized using the same ratio as used in the pre-acquisition stage.
• Depreciation and incremental costs associated with the use of machinery and equipment are capitalized.
• Inventory used directly in the construction or installation of the asset is capitalized.
• Overhead, general and administrative costs, rent, depreciation and occupancy are recognized as expense as incurred. However, if these costs are included in amounts spent in transactions with independent third parties, they are included in the capitalized amounts.

There are costs associated with real estate acquisitions that may require special attention. Property taxes, insurance and ground rentals are capitalized on property that is under construction until such time as it is prepared for its intended use. Demolition costs, if incurred in conjunction with the acquisition of real estate, are capitalized. Otherwise, they are charged to expense.

In-service Stage
The in-service stage begins when an asset is substantially complete and ready for its intended use. During this stage, costs are categorized as repairs and maintenance of existing components, replacement of existing components or acquisition of additional components.

Most costs incurred during the in-service stage, including all normal, recurring or periodic repairs, and maintenance, are charged to expense. Costs of replacing an existing component or acquiring a new component are capitalized. When determining the amount to capitalize, guidelines similar to those applied during the acquisition or construction stage are followed.

As these costs are incurred, certain issues should be considered:

• The cost associated with removing an existing asset or component is charged to expense.
• The book value of a replaced component is charged to depreciation.

Because of the issues associated with the repair or replacement of existing components, it may be appropriate in many cases to apply component accounting to assets included in PP&E. The SOP also provides guidance on the adoption and use of component accounting.

Presentation and Disclosure
The financial statements or footnotes should provide certain information in relation to property, plant and equipment. As a minimum, PP&E should be reported in separate categories for:

• Land and land improvements;
• Buildings and building improvements;
• Machinery and equipment; and
• Construction in progress, which includes capitalized costs incurred during the preliminary and pre-acquisition stages.

Information presented should include the carrying amounts for each separate category as well as the nature and amount of repairs and maintenance costs for each period for which an income statement is presented.

The SOP initially was intended to be effective for fiscal years beginning after June 15, 2002. But, according to AICPA sources, its Accounting Standards Executive Committee will discuss comments on the proposed SOP at its April meeting. It is likely that with all the other professional issues facing the AcSEC that the SOP will not be finalized before the end of the year. Early application is still encouraged.

You can access the SOP at www.cpa2biz.com by typing SOP into the search engine and scrolling down under Content and clicking on Accounting for Certain Costs and Activities Related to Property, Plant and Equipment.

Mark E. Dauberman, CPA, is a partner in the Beverly Hills-based firm of NSBN LLP. Dauberman is also a vice chair of CalCPA's Board of Directors, a member of CalCPA's Membership Committee and chair of CalCPA's Diversity Task Force. He can be reached at (310) 273-2501 or med@nsbn.com.

© 2002 California Society of Certified Public Accountants. For reprint permission, contact Aldo Maragoni, managing editor.