CFA Level I Exam · Analysis of Long-Term Assets

PP&E Cost and Depreciation Methods for CFA Level I

Updated 7 October 2026 · Fact-checked

PP&E is recorded at cost: the purchase price plus every cost needed to get the asset ready for use. Depreciation then spreads cost less residual value over useful life. Straight-line gives equal charges, accelerated methods such as double declining balance charge more early, and units-of-production follows usage. Land is not depreciated.

Understand Property, Plant and Equipment: Cost and Depreciation

Property, plant and equipment (PP&E) are tangible assets a company uses to make goods or provide services, and expects to use for more than one period. Examples are buildings, machines, vehicles and land.

Under IFRS (IAS 16), you record PP&E at cost. Cost is the purchase price, plus import duties and non-refundable taxes, minus trade discounts, plus any cost directly needed to bring the asset to its location and working condition. That includes freight, installation, testing, and professional fees. It also includes the initial estimate of dismantling and site-restoration costs. For a qualifying asset that takes a long time to build, borrowing costs during construction are capitalized too. Costs that are not needed to make the asset ready are expensed: staff training, administrative overhead, advertising, and losses while operations ramp up.

After purchase, you allocate cost to expense through depreciation. The depreciable amount is cost minus residual (salvage) value. You spread it over the useful life. Land is not depreciated because it normally has an unlimited life. Depreciation is an allocation of cost, not a cash outflow and not a measure of market value.

Three methods matter. Straight-line charges the same amount each year. Accelerated methods, mainly double declining balance (DDB), charge more in early years and less later. Units-of-production links the charge to actual output or usage. Over the whole life, total depreciation is the same under every method. Only the timing differs. Accelerated methods give lower early profit and lower early book value, and the gap reverses later.

Under IFRS you must depreciate components of an asset separately when each has a significant cost relative to the total and a different useful life. An aircraft's airframe and engines are a standard example. US GAAP permits component depreciation but it is rarely used. Useful life and residual value are management estimates. IFRS requires you to review them at least annually. A change is a change in estimate, applied prospectively with no restatement of past years. Longer lives or higher residual values lower depreciation and raise reported income.

Key formulas to remember

Initial cost of PP&E: Cost = purchase price − trade discounts + import duties and non-refundable taxes + directly attributable costs + initial dismantling/restoration estimate; Exclude training, overhead, advertising and start-up losses. Borrowing costs are capitalized only for qualifying assets.
Straight-line depreciation: Annual depreciation = (Cost − Residual value) ÷ Useful life; Same expense every full year. Book value falls in a straight line to residual value.
Double declining balance rate: DDB rate = 2 ÷ Useful life (in years); This is twice the straight-line rate. Other declining-balance factors, such as 1.5, use the same logic.
Double declining balance expense: Depreciation = DDB rate × Beginning book value; Do not subtract residual value in the calculation. Stop when book value reaches residual value; never go below it.
Units-of-production depreciation: Depreciation = (Cost − Residual value) ÷ Total expected units × Units produced in the period; Useful life is measured in units (output, hours or kilometres), not years.
Book value (carrying amount): Book value = Cost − Accumulated depreciation; Under DDB, book value after n years = Cost × (1 − rate)^n, before the residual-value floor.

How to solve Property, Plant and Equipment: Cost and Depreciation questions

Use this order for any PP&E cost or depreciation question. It works for cost, expense, book value and method-comparison items.

1Decide what the question asks for: initial cost, one year's expense, book value, or the effect of a method or estimate.
2If cost is needed, list every item. Include purchase price net of trade discounts, duties, non-refundable taxes, freight, installation, testing and dismantling estimates. Drop training, overhead and start-up losses.
3Compute the depreciable amount: cost minus residual value. Remember land has no depreciation.
4Pick the method from the wording: equal charges means straight-line, a rate on declining book value means DDB, and output or hours means units-of-production.
5For DDB, use rate × beginning book value and ignore residual value until the last year. Cap the final charge so book value ends at residual value.
6For a change in estimate, compute the current book value, subtract the new residual value, and divide by the remaining life. Apply it from now on.
7For comparison questions, remember that early-year expense and early-year net income move in opposite directions, while total depreciation over the life and cash flow (ignoring tax) are the same.
8Check which option matches your answer. Wrong options are often built from a common slip, such as forgetting salvage or including training costs.

Quickest way: Fast DDB and cost check

When to use it: Use this when the question gives a clean cost, life and salvage and you must find one specific year's DDB expense or book value.

Compute the rate: 2 ÷ life. Convert it to a decimal, such as 40% or 0.4.
Get the beginning book value of the target year with Cost × (1 − rate)^(n − 1). On the BA II Plus, enter 0.6 then press y^x, type the exponent, then press = and multiply by cost.
Multiply that beginning book value by the rate to get the year's expense.
Check against the floor: if beginning book value minus the expense would drop below salvage, the expense is only beginning book value minus salvage.
For cost questions, scan the list once and cross out training, overhead and start-up losses. Add everything else and subtract trade discounts.

Common mistakes in Property, Plant and Equipment: Cost and Depreciation

Subtracting salvage value before applying the DDB rate in year 1.
Straight-line and units-of-production both use cost minus salvage, so students carry the habit over.
Fix: For DDB, apply the rate to full beginning book value. Use salvage only as the floor that book value cannot go below.
Capitalizing staff training, administrative overhead or initial operating losses into asset cost.
These costs occur around the time of purchase, so they feel like part of the asset.
Fix: Ask whether the cost is needed to bring the asset to location and working condition. If not, expense it.
Depreciating land, or including land in a building's depreciable base.
A property purchase is often one lump-sum price.
Fix: Allocate the price between land and building. Depreciate only the building, and depreciate components separately under IFRS where they differ in life and cost.
Restating prior years when useful life or residual value changes.
Students confuse a change in estimate with an error correction.
Fix: A change in estimate is applied prospectively. Use current book value less new residual value over remaining life.
Thinking accelerated depreciation lowers total expense or saves cash on its own.
Lower early profit looks like a real reduction in cost.
Fix: Total depreciation over the life is identical. Only timing changes, and depreciation is non-cash. Any cash effect comes only through tax rules.
Using years instead of units in the units-of-production method, or ignoring a period with no output.
Students default to life in years.
Fix: Divide by total expected units. If no units are produced in a period, depreciation for that period is zero.

Worked examples

Example 1

A company buys a machine with a list price of €400,000 and receives a 10% trade discount. It also pays import duty of €12,000, freight of €6,000, installation of €14,000 and testing of €4,000 before the machine can operate. It spends €5,000 training operators. Under IFRS, the initial cost of the machine is closest to: A) €392,000, B) €396,000, C) €401,000.

Show the solution

Price after trade discount: €400,000 × (1 − 0.10) = €360,000.
Add directly attributable costs: import duty €12,000, freight €6,000, installation €14,000, testing €4,000. Total: €36,000.
Cost = €360,000 + €36,000 = €396,000.
Staff training of €5,000 is not needed to bring the machine to working condition, so it is expensed.
Option A leaves out testing (€392,000). Option C wrongly adds training (€401,000).

Answer: B) €396,000

Example 2

A company buys equipment for $100,000. Useful life is 5 years and residual value is $10,000. It uses double declining balance depreciation. Depreciation expense in year 3 is closest to: A) $14,400, B) $18,000, C) $21,600.

Show the solution

DDB rate = 2 ÷ 5 = 40%.
Year 1: 40% × $100,000 = $40,000. Book value at end of year 1 = $60,000.
Year 2: 40% × $60,000 = $24,000. Book value at end of year 2 = $36,000.
Year 3: 40% × $36,000 = $14,400. Book value at end of year 3 = $21,600.
Check the floor: $21,600 is above the $10,000 residual value, so no cap applies.
$18,000 is the straight-line charge ($90,000 ÷ 5). $21,600 is the year 3 ending book value, not the expense.

Answer: A) $14,400

Exam tips

Cost questions are usually a list of items. Decide in or out for each one, then add. Expect training, overhead and start-up losses as the traps.
For DDB, ignore salvage until the last year. Always check whether the final-year charge would push book value below salvage.
Method-comparison questions ask about early years. Accelerated methods give higher expense, lower net income and lower book value early, while cash flow before tax effects is unchanged.
Know the IFRS point: component depreciation is required where components are significant and have different lives. US GAAP allows it but it is rare.
Estimate questions test direction. A longer useful life or higher residual value lowers depreciation and raises income. The change is prospective.

Practice questions from Analysis of Long-Term Assets

Property, Plant and Equipment: Cost and Depreciation in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Property, Plant and Equipment: Cost and Depreciation: frequently asked questions

What is the difference between straight-line and accelerated depreciation?

Straight-line gives the same expense every full year. Accelerated methods such as double declining balance give higher expense in early years and lower expense later. Total depreciation over the asset's life is the same under both.

How do you calculate double declining balance depreciation?

Find the rate as 2 ÷ useful life. Multiply it by the beginning book value of each year, ignoring residual value. Stop depreciating once book value reaches the residual value.

Does CFA Level I require component depreciation under IFRS?

Yes. IFRS requires you to depreciate separately each significant part of an asset that has a different useful life. US GAAP permits it but it is rarely used. Expect a conceptual question rather than a long calculation.

What costs are included in the initial cost of PP&E?

Include the net purchase price, import duties, non-refundable taxes, freight, installation, testing and the initial estimate of dismantling costs. Exclude training, administrative overhead and initial operating losses.