What it means
PPE covers items a company expects to use for more than one year to make products, deliver services or run its operations. They are not bought to be resold in the normal course of business.
Typical examples are factories, delivery vehicles, computers, furniture and production lines. On the balance sheet PPE is recorded at cost, which includes the purchase price plus costs of getting the asset ready for use, such as delivery and installation.
Each year, depreciation spreads the cost over the asset's useful life, so the carrying value falls. Land is normally not depreciated because it does not wear out.
The balance sheet may show gross PPE, which is the original cost, and net PPE, which is cost less accumulated depreciation. Net PPE is the more useful number for judging what the assets are still worth in the books.
Companies also record impairment when an asset's value falls below its carrying amount. Analysts use PPE to understand how capital-intensive a business is.
A manufacturer or airline will have a large PPE balance, while a consulting firm will have a small one. The ratio of revenue to net PPE, called fixed asset turnover, shows how well a business uses its assets to produce sales.
PPE also drives cash needs. Replacing and expanding assets is called capital expenditure, and a company that underinvests may look profitable for a while before its assets wear out.
Readers of the accounts should compare capital expenditure with depreciation to see whether the business is maintaining its asset base. The abbreviation also stands for personal protective equipment in health and safety.
In accounting it always means property, plant and equipment.
In practice
Real-world examples.
Example
A bakery buys an industrial oven for $60,000 and expects it to last ten years. It records the oven as PPE and charges $6,000 of depreciation to profit each year. After three years the oven's carrying value is $42,000.
Example
A logistics company reviews its balance sheet and finds net PPE of $24,000,000 against revenue of $60,000,000. Lenders compare this with similar firms to judge whether the fleet is being used efficiently. A sharp fall in the ratio would suggest that vehicles are sitting idle.
Example
A software company rents its offices and keeps most work on cloud servers, so its PPE is small relative to revenue. Investors treat it as an asset-light business that needs little capital to grow. They still look at its lease commitments, which behave like borrowing.
Formula
Calculation
Net PPE = Gross PPE - Accumulated depreciation
Fixed asset turnover = Revenue / Net PPE
A manufacturer reports gross PPE of $5,000,000 and accumulated depreciation of $1,800,000.
Net PPE = $5,000,000 - $1,800,000 = $3,200,000.
If its annual revenue is $8,000,000, fixed asset turnover = $8,000,000 / $3,200,000 = 2.5, meaning each dollar of net PPE supports $2.50 of revenue.Case study
Seen in the real world.
Harrow Packaging is a fictional company with older machines that were largely depreciated. Its reported profit looked strong because depreciation was low, but the finance director noticed that capital spending had been far below depreciation for four years.
She showed the board that the net PPE balance was shrinking and that two key lines were due for replacement. In this illustrative case, the board approved $4,500,000 of new equipment, and although profit dipped in the first year because of higher depreciation, output and reliability improved. Scrap rates fell and customer complaints about late deliveries almost disappeared. The finance director now presents capital expenditure against depreciation to the board every year, so that wear and tear is visible in the numbers before it shows up in the factory. Lenders welcomed the change, since it showed that the company planned for replacement and did not simply defer it.
Watch out
Common mistakes.
- Reading gross PPE as the current value of the assets, when net PPE (after depreciation) is closer to their carrying value.
- Depreciating land, which normally does not wear out, or forgetting that buildings on the land must be depreciated separately.
- Ignoring the gap between capital expenditure and depreciation when judging whether a business is maintaining its assets.
Questions
People also ask.
Is inventory part of PPE?
No, because inventory is held for sale, while PPE is held for use in the business. A delivery van is PPE for a bakery but inventory for a car dealer.
Why does PPE matter to lenders?
Physical assets can often be used as security for loans, and a larger asset base may support more borrowing.
Does a high PPE balance mean a good business?
Not necessarily, because it only shows how capital-intensive the business is, and a heavy asset base can be a burden if sales are weak, because depreciation, maintenance and financing costs continue regardless.
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