Page 39 - cfi-Accounting-eBook

The Corporate Finance Institute Accounting

Repairs and Replacements of PPE
The nature of PPE assets is that some of these assets need to be
regularly fixed or replaced to combat equipment failures or to adopt
more sophisticated technology. For example, it is normal for companies
to repair or replace old factories or automobiles with new assets when
necessary. The general rule in accounting for repairs and replacements
is that repairs and maintenance work is expensed while replacements
of assets are capitalized. Repairs are easy to record, it is simply a debit
to repair or maintenance expense and a credit to cash. Replacements,
however, are a bit more complicated. For replacements, the old cost of
the asset is derecognized from the company’s books and the new cost
of the replacement is recorded/recognized.

Bundled Purchases
Finally, it is fairly common to see companies purchasing a group of
assets as a bundle in a single transaction. To account for these bundled
transactions, accountants will use the proportional method, also
known as the relative fair value method. This is a method that calculate
each asset’s apportioned cost based on the fair value of each of the
individual assets in relation to the purchase price. For example, let’s
say that XYZ Company paid $80 million for a bundle purchase of land,
building, and machinery and the fair value of each are $30 million, $50
million, and $20 million respectively. Using the following table, we can
calculate the cost allocation for each individual asset.

Asset Fair Value % of Total Total Price Cost Allocation
Fair Value

Land $30 Million 30% $80 Million 30% * $80M = $24M

Building $50 Million 50% $80 Million 50% * $80M = $40M

Machinery $20 Million 20% $80 Million 20% * $80M = $16M

Total $100 Million 100% $80 Million $80 Million

corporatefinanceinstitute.com 39