1. Property, Plant, & Equipment
By: John Hanna
Justin Byrd

2. Property, Plant, & Equipment
PP&E is a part of generally every company in the country
PP&E is also known as “fixed assets”
Can include assets from office equipment, manufacturing equipment, heavy machinery, and buildings just to name a few

3. What we will cover…. Overview Controller’s Role
Capital Budgeting Process
Method of Evaluating Projects (Payback, Accountant’s, Discounted Cash Flow)
Hurdle Rates
Project Risk Analysis
Inflation
Ranking Capital Projects
Post-Project Appraisals
Other Aspects of Fixed Assets

4. PP&E
Planning is critical to long-term health of an organization (Investment, Financial Performance)
Investment issues (Long recovery period, possible bankruptcy)
Break-even point is higher for companies when investing in PP&E (depreciation, insurance, property taxes, maintenance)
Technological advances in today’s society cause companies to continually invest in more PP&E
Increase Productivity
Increased ROI
Analytical Approaches

5. Role of Controller
Financial knowledge is needed to evaluate the acquisition decisions of purchasing new fixed assets. The Controller and his or her team must take appropriate steps to determine the benefit of purchasing new equipment.
Once the CEO and Board of Directors agree to the investment, the Controller must properly account for the asset and measure depreciation as well as performance throughout the asset’s useful life.

6. Role of Controller Controller’s Tasks for PP&E
Review all requests for probable rate of return
In business plan, include all assets needing to be purchased and determine if sufficient funds are present and the sales number that needs to be met in order to cover purchase
Planning and Control
Lease, Rent, or Buy
Insurance Coverage
Depreciation Policy
Internal Control
Property Records (Location, Transfers, etc)
Reporting System (Maintenance, Idle Time, Cost vs. Budget)

7. Capital Budgeting Controller should be involved in planning
Provided to the CEO and other senior executives to select certain projects that will be undertaken
Spending must be kept within an established limit
For larger projects, inform management how the assets is operating as well as anticipated earnings
Capital Budget – 9 Steps

8. Capital Budget – 9 Steps
1.) Planning period, determine spending limits
2.) Present worthy capital investment projects (ROR, expansion)
3.) Preliminary screening of proposals
4.) Once screened, classify new projects by need and benefit
5.) Review, compatible with resources? Rate of Return?
6.) Present data to Board of Directors or CEO
7.) When time to purchase, authorize from management
8.) Periodic reports, cost to date, cost to completion
9.) Post-completion audit, actual vs. estimated cash flow

9. Limit of Capital Budget
Top management will set budget, and is determined by setting a maximum amount to spend towards capital expenditures.
Factors include….
Strategic Plans
Stage of Business Cycle
Current and Anticipated Inflation Rates
Anticipated Competitor Actions
Age and Condition of Present Plant Equipment
Growth Prospects of Company
Capital Structure of Company (Debt to Asset ratio)
Internal Cash Generation/Spending

10. Capital Expenditure Proposals
All decisions to purchase will go to top management
Factors to replace old equipment
Salvage Value of Used Equipment
Investment and Installation Costs
Useful Life of New Asset
Operating Cost
Factors for expansion of facilities
Market New Products
Increase Sales Quantity
New Project’s ROR
Marketing

11. Evaluating Projects
Since companies cannot undertake every capital expenditure, evaluations of analytical data is examined to select the appropriate projects
1.) Estimate expected capital outlay and estimated future cash flow
2.) Relate future benefits to cost
3.) Evaluate Risk and determine vs. the estimated rate of return
Three Methods
Payback Method
Accountant’s Method
Discounted Cash Flow Method

12. Payback Method
Amount of time needed to pay back original investment from product’s cash flows
Advantages
Company is low on cash and can pay back over a short period
Risky investments
Identify profitability, eliminates undesirable projects
Disadvantages
Confuses recovery of investment with profitability
Early liquidity is prominent, rejects longer projects
Useful life is not considered, can discard asset as soon as payback is met

13. Accountant’s Method
Compares earnings vs. outstanding investment instead of initial investment
Based on making available the depreciation recovered from other capital investments instead of charging against original investment

14. Accountant’s Method Advantages Disadvantages
Easier than Discounted Cash Flow Method
Disadvantages
Depreciation method is critical
Time Value of Money
Rate of Return doesn’t change

15. Discounted Cash Flow Method
Important factor of method is when cash is received and when it can be reinvested
Two methods
IRR (Internal Rate of Return)
NPV (Net Present Value)

16. Discounted Cash Flow Method
IRR Method
Used as a method to determine maximum constant earnings from an asset over its useful life and relate to the breakeven point
Four Steps
Amount and year of investment
Determine cash flow per year after tax
Apply discount factors (2) and find present worth
Calculate with various discount factors until it correlates to original investment

17. Discounted Cash Flow Method
IRR Advantages
Proper allocation to cash flow and time value of investments
Easy with the use of cash to purchase items (Capital vs. expenses)
Financial analysts can compare other projects
Models the cost-of-capital approach
IRR Disadvantages
Difficult and complex
Calculations are not quickly done
Reinvestment = Calculated Rate of Return

18. Discounted Cash Flow Method
NPV Method
Considers time value of money
Difference between two is NPV uses a predetermined rate, which is the rate the company uses to consider taking the risk of the capital investment
To acquire a new product, the total of the PV of cash flow exceeds the proposed investment
A failed attempt to a capital investment is when the NPV is negative

19. Hurdle Rates Minimum ROR a project should earn to be acceptable
Businesses in different industries and even each line of business within a company can have different hurdle rates
Business risks determine rates in departments as well as ROR in each division will be different
Different business strategies may exist to establish different hurdle rates
Basis of hurdle rate is cost of capital

20. Project Risk Analysis Important factors for decision-maker to know
Expected rate of return
Probability of receiving expected rate of return
Sensitivity analysis
Range of possible returns
Should include probability of each of the possible returns
When depreciation or other expenses roll off books

21. Project Risk Analysis Sensitivity Analysis
Mathematical technique where changes may be made to any of the input factors and consequences of a events that take place
Those who estimate the return on investment know that the estimate is dependent on assumptions
Important to estimate how much an error can affect results
Knowing the potential cost and probability of an error occurring allows the controller or analyst focus on most important variables

22. Project Risk Analysis Hurdle Rate
Minimum rate of return that a capital project should earn before being deemed acceptable
Investments in capital assets should not only recoup costs, they should pass the hurdle rate
Is usually the discount rate used in considering alternative investments
Used in other contexts as well

23. Project Risk Analysis New Manufacturing Environment
Automation is primary source of expense reduction, but…
Prior to purchase of automation equipment, should look into other options
Rearrange plant floor, more streamline procedures, eliminate non-value added function
Investments becoming more significant
A machine may cost X dollars, but an automated factory may cost 50X dollars
One must decide how best to allocate costs to optimize value
Equipment is becoming increasingly complex, so benefits should be more tangible

24. Inflation Questions to consider regarding inflation
Should adjustments be made for inflation in cash flows?
Should inflation rates be used for different cost factors?
Should the hurdle rate be adjusted for inflation?
“Using of proper discount rate, depends on whether the benefits and costs are measured in real or nominal terms. To be consistent and free from inflation bias, the cash flows should match with discount rate.”(Kannadhasan)

25. Ranking Capital Projects
Projects should be ranked in order of priority
Should be practically grouped so management can focus on the more important and promising projects
Grouping example:
Absolutely Essential
Highly Necessary
Economically Justified Projects
All Other

26. Ranking Capital Projects
Projects usually ranked by economic return
Information important for ranking and presentation to management
Priority
Rate of Return
Total Cost
Reasons For
Benefits of
Risks Associated with Project

27. Post-Project Appraisals
Despite good analysis of costs and risks, sometimes projects do not meet the expected rate of return
Without appraisal, management is unaware of the causes of problems or that they even exist
Why this shortfall occurred is important for management to ascertain
Shows what steps can be taken to improve investment planning and control
Factors on which to focus
Cash flow, break-even points, and actual vs. estimates of operating expenses

28. Post-Project Appraisals
Advantages of well-planned post-project appraisal
May detect weaknesses in strategic planning that lead to poor decisions
May detect environmental factors that influence business which were not foreseen
Experience can focus attention on basic weaknesses in overall plans, policies, and procedures
Can detect strengths/weaknesses in individual performance
May enable corrections in current projects prior to completion of commitments or expenditures
Project Risk Analysis

29. Other Aspects of Fixed Assets
Working Capital
Increases in working capital may be required to purchase additional inventory and accounts receivable
Decreases may create need for additional investment
Lease vs. Buy
NPV should be used to compare a lease acquisition against a purchase acquisition
Idle Equipment
Controller should inform management about losses from idle equipment and place responsibility
Losses from idle equipment can derive from depreciation, property tax, insurance, and utilities

30. Other Aspects of Fixed Assets
Idle Equipment
Three causes of idle time
Those controllable by production staff
Poor planning; lack of materials, tools, power; machine breakdowns; improper supervision
Those resulting from administrative decisions
Building of additional capacity (short-term idle) until demand builds to match capacity
Those arising from economic causes
Seasonal demand or excess capacity in industry

31. Other Aspects of Fixed Assets
Internal Control Requirements Surrounding Equipment
Identify all fixed assets by affixing serial numbers or bar codes to items
Transfer of equipment between departments only with written approval for security of physical property
Necessary to track both for insurance and depreciation purposes
Prevent equipment from leaving plant without property pass signed by appropriate authority
Perform physical inventory on all fixed assets
Maintain detailed records on each piece of equipment

32. Other Aspects of Fixed Assets
Internal Control Requirements Surrounding Equipment
Review purchase requisitions to ensure small accounts not made to avoid approval of higher authority
Review retirements of fixed assets
Can assets can be used by another department or do they have another other use?
Secure bids on sizeable transactions
Provide for proper insurance coverage during construction of equipment and when complete
Review expenses to ensure capital expenditures no treated as expenses

33. Other Aspects of Fixed Assets
Internal Control Requirements Surrounding Equipment
Track the following items for capital projects
Amount authorized
Actual commitments to date
Actual costs incurred to date
Estimated cost to complete
Indicated total cost
Indicated overrun or under run compared to project budget

34. Other Aspects of Fixed Assets
Plant and Equipment Records
Necessary adjunct to effective control
Convenient source of information for planning, control, insurance, and tax purposes
Records should include:
Name of asset, type of equipment, control number, description, size, model, style, serial number, motor number, purchased new or used, date purchased, vendor name, invoice number, purchase order number, location, account number, transfer information, basis, date retired, sold to, scrapped, cost recovered, depreciation information

35. Other Aspects of Fixed Assets
Plant and Equipment in Relation to Taxes
Many cities and states levy real and personal property taxes or enforce franchise taxes based on value
Maintenance of records can be means of satisfying IRS
Plant and property values, through depreciation expense, is important for federal income tax
The burden of proof is on the taxpayer regarding correctness of claimed depreciation
Handout

36. Overview What is Property, Plant, and Equipment?
What is the controller’s role in the budgeting, acquisition, and retirement of these assets?
What are the most recognized methods to evaluate a capital budget project?
How are capital projects ranked?
Why should a post-project appraisal be performed?
What other issues factor into the capital budgeting process?

37. Work Cited
"Beauliey Pleads Guilty to Tax Fraud-CEO of Beaulieu to Step Down from Corporate Position". Department of Homeland Security. September 17, 2009 <
Kannadhasan, M. "Effects of Inflation on Capital Budgeting Decisions-An Analytical Study ". Investopedia. September 17, 2009 <
"Project Risk and Analysis". CFOonthego. September 19, 2009 <
"Property, Plant, and Equipment". Investopedia. September 17, 2009 <
Roehl-Anderson, Janice, and Steven Bragg. The Controller's Function-The Work of the Managerial Accountant. Hoboken: Wiley, 2005.