PP&E: What Gets Capitalized and at What Cost

Introduction

At the end of 2024, Alphabet carried $171.0 billion of property and equipment on its balance sheet, up from $134.3 billion a year earlier. About a fifth of the gross balance, $50.6 billion, consisted of assets not yet in service: data centers still being built and servers still being assembled. None of that was being depreciated yet. And $7.1 billion of property and equipment purchases had been recorded but not yet paid for. Each of those figures follows from the rules that decide what goes into the cost of property, plant and equipment (PP&E), and when that cost starts reaching the income statement.

PP&E is usually the largest asset of an industrial, retail, telecom or technology infrastructure company, and its carrying amount drives depreciation for years. The general principle for when a cost becomes an asset is explained in capitalizing vs expensing costs. Applied to a long-lived asset, that principle settles three questions: what the cost includes, how assets under construction are treated, and how the figures in a PP&E note fit together.

Under Accounting Standards Codification (ASC) 360, an item of PP&E is recorded at its historical cost: the price paid plus every expenditure necessary to bring it to the condition and location required for its intended use. For a purchased machine, that means:

Cost basis of PP&E

The amount at which property, plant and equipment is first recorded: the purchase or construction price plus all costs directly attributable to bringing the asset to the location and condition needed for its intended use. It is the starting point for depreciation and for measuring any later gain or loss on disposal.

Costs that do not prepare the asset for use are expensed: general administrative overhead, training staff to use new equipment, relocation of existing assets and losses incurred while a new plant ramps up to full output. Land is recorded at its cost, including demolition of old structures and clearing, but is not depreciated, because it does not wear out. When a company buys land and a building together for one price, it allocates the price between them in proportion to their fair values, a choice that matters because only the building is depreciated.

Retirement Costs Built Into the Asset

Some assets come with a legal obligation to dismantle them or restore the site at the end of their lives, such as an oil platform, a mine or a cell tower on leased land. The present value of that future cost is recorded as a liability when the obligation arises and added to the cost of the asset at the same time, so it is depreciated along with the asset over its life, while the liability grows each year through accretion expense. A company with large retirement obligations therefore carries PP&E above the price it paid, and reports a depreciation charge that partly reflects costs it has not yet paid. The mechanics are covered in asset retirement obligations.

When a company builds an asset itself, the cost includes the materials used, the payroll of employees working directly on construction, other costs directly identifiable with the project, and interest on borrowings used to fund it, which ASC 835-20 requires to be capitalized during construction. Until the asset is ready for its intended use, the accumulated costs sit in construction in progress, a PP&E line that is not depreciated.

Construction in progress

The accumulated cost of property, plant and equipment still being built or assembled, including materials, labor, other directly identifiable costs and capitalized interest. It is not depreciated until the asset is completed and placed in service, when it is transferred to the relevant asset class.

Depreciation begins when the asset is placed in service. Alphabet's 2024 annual report puts it directly: depreciation commences once assets are ready for their intended use, and assets not yet in service include data center buildings and servers in the process of construction or assembly. A company in a heavy building program can therefore accumulate tens of billions of dollars of PP&E that has no effect on depreciation yet, but will once the projects are finished.

The balance sheet shows a single net figure; the PP&E note shows how it is built. Gross PP&E is the original cost of the assets, before any depreciation. Accumulated depreciation is all the depreciation charged against them since they entered service, and net PP&E is gross cost less accumulated depreciation. Alphabet's note follows that structure, with assets not yet in service on a separate line because nothing has been depreciated on them:

Three readings stand out. Technical infrastructure, the servers and data centers behind Alphabet's cloud and artificial intelligence (AI) services, makes up about 70% of PP&E in service and grew by $27 billion in a year. Accumulated depreciation equals about 40% of the in-service cost, which suggests the asset base is relatively young. And assets not yet in service rose by $15.5 billion, a stock of future depreciation that will begin as each project is completed. How gross cost, accumulated depreciation and net PP&E move from one year to the next is traced in PP&E and debt roll-forwards.

Spending After Acquisition

Spending on an asset after it is in service is capitalized only if it extends its life, increases its capacity or improves its output; routine repairs and maintenance are expensed. Major overhauls and inspections, such as aircraft engine overhauls or refinery turnarounds, get special treatment under US generally accepted accounting principles (US GAAP): companies may expense them as incurred, capitalize and depreciate them until the next overhaul, or build the expected overhaul into the original asset's components. The choice of method changes when the cost reaches earnings and how it appears in earnings before interest, taxes, depreciation and amortization (EBITDA), so it is worth checking when comparing airlines, shipping companies or refiners.

For analysis, the PP&E note answers questions that the single net figure on the balance sheet cannot. How much of the company's capital is tied up in assets that are not yet earning, and when will they start to depreciate? Construction in progress that grows faster than assets in service signals a wave of depreciation ahead, which matters for margin forecasts. How old is the asset base? Accumulated depreciation as a share of gross cost gives a rough answer. And how much of the year's investment has not yet been paid for? Accrued purchases of PP&E, such as Alphabet's $7.1 billion, are future investing cash outflows.

The capital spending that builds the asset base, and how bankers separate maintenance from growth spending, is covered in cash flow from investing activities. The cost basis is where that spending lands on the balance sheet, and every later figure, from depreciation to impairment to the gain or loss on sale, is measured against it.