A manufacturer builds a $5,000,000 factory over 18 months and racks up $500,000 of interest on construction debt. How much of that interest becomes part of the factory's cost basis versus expensed today? The answer is $300,000 capitalized and $200,000 expensed, and getting it wrong misstates the gross property, plant and equipment balance by up to $300,000 and depreciation over the 40-year life that follows. Example 1 resolves it.
ASC 360 governs PP&E recognition, measurement, and impairment. The driver of every PP&E question is matching: spread cost against the revenue the asset produces, not against the period in which the cash flowed.
PP&E is recorded at historical cost. Cost includes the purchase price (less discounts), legal fees, sales taxes, freight, insurance in transit, installation, testing, and anything else needed to bring the asset to its intended use. Land also includes closing costs, title insurance, surveys, grading, drainage, and demolition of any existing structures net of salvage. Land is never depreciated.
Common mistakes
- Capitalizing all interest incurred during construction. ASC 835-20 caps capitalization at the lesser of avoidable and actual. In Example 1, capitalizing all $500,000 overstates the asset by $200,000 and propagates $5,000-per-year over-depreciation for 40 years. Trap: $5,500,000 cost basis, $137,500 annual depreciation.
- Using discounted cash flows in Step 1 of the impairment test. Step 1 is undiscounted by design. A candidate who discounts at 8% and finds $108,000 < $130,000 carrying declares impairment when the GAAP screen of $115,000 (undiscounted) was the actual test.
- Depreciating salvage value. SL and units-of-production use (Cost − Salvage) as the depreciable base. Forgetting to subtract $10,000 salvage on $110,000 cost over 5 years yields $22,000 SL instead of $20,000, a $2,000 error every year. DDB ignores salvage in the annual calc but still floors at salvage.
Bottom line
- PP&E cost basis = purchase price + every cost to ready the asset for use + capitalized interest + ARO at fair value.
- Land includes demolition net of salvage and is never depreciated.
- Capitalize what extends future benefit, expense what restores prior condition; the test is economic, not dollar size.
- Interest capitalization: capitalize the lesser of avoidable or actual interest, specific borrowing rate first and the general rate on the excess.
Exam shortcut
Pattern reads that unlock the trap. "Avoidable interest exceeds actual" → cap at actual. "Undiscounted cash flows exceed carrying" → no impairment, stop at Step 1. "Fair value below carrying but undiscounted above carrying" → no impairment under GAAP. "Reclassified as held for sale" → measure at lower of carrying or FV − CTS, stop depreciating. "Disposal mid-year" → bring depreciation to date first, then compute gain/loss.
The full lesson (about 5,447 words, 36 min read) adds 8 worked examples, all 8 common mistakes, a self-check, free in the app.
Learning objectives
- II.D1
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