CHAPTER 10 Plant Assets and Intangibles

Objective 1: Measure the cost of a plant asset

A. Plant assets (fixed assets) are those long-lived assets that are tangible in nature and are used

in the operation of the business. Exhibit 10-1 lists three categories of plant and intangible assets and the related expenses. B. Tangible assets (plant assets) are generally useful for more than one year. Intangible assets do not have a physical form. 1. The cost of the asset includes all amounts paid to acquire the asset and prepare it for its intended use in the business including purchase price !net of all discounts" taxes fees installation cost and so on. #easuring the cost of a plant asset is illustrated in Exhibit 10-$. Types of tangible assets and related costs include% a. &and and land improvements ' !1" and cost includes its purchase price bro(erage commission survey and legal fees bac( property taxes and the cost of clearing the land and removing un)anted buildings. &and is not depreciated. and i!pro"e!ents include fencing paving sprin(ler systems and lighting. &and improvements are depreciated.

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b.

#$ildings ' cost includes architectural fees building permits contractors* charges cost of material labor and overhead for constructed buildings and cost of renovation and repairs for existing buildings. Buildings are sub+ect to depreciation. %achiner& and e'$ip!ent ' cost includes purchase price less discounts plus transportation charges insurance )hile in transit sales and other taxes purchase commissions installation costs and cost to test the machine before use.

c.

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After the asset is up and running these costs are no longer capitali,ed !added to the asset account"- instead these costs !and others related to the machine" are recorded as expenses. #achinery and equipment are sub+ect to depreciation.

$" d.

($rnit$re and fixt$res ' cost begins )ith the basic cost of the asset !such as des(s chairs display rac(s"- additionally all other costs to get the asset ready for use are included in the asset account.

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/or a l$!p)s$! (or bas*et) p$rchase of several assets the relati"e)sales)"al$e !ethod is used to allocate that cost among the various assets acquired. The allocation is based on the assets* appraised or mar(et values.

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Expenditures relating to an asset can be classified as either capital expendit$res or ordinar& repairs. 1efer to Exhibit 10-. for a comparison. 1. A capital expendit$re is one made to increase the capacity or efficiency of an asset or to extend its useful life. Exa!ples are% the cost of a ne) engine that is put into a truc( or a ma+or overhaul. a. b. $. 1epair )or( that generates a ma+or repair is an extraordinar& repair. 1ecord this type of expenditure )ith a debit to the asset acco$nt+

An ordinar& repair maintains the asset or restores it to good )or(ing order. a. b. This type of repair does not extend the useful life of the asset. Examples are% the cost of ne) tires for the truc( or the cost of replacing a dead battery on the truc(. ,ebit an expense acco$nt such as 1epair and #aintenance Expense.

c. ..

2t is important to record capital expenditures and ordinary repair and maintenance expenses correctly as an error in recording causes errors on both the income statement and the balance sheet.

3.

,epreciation is the process of allocating a plant asset*s cost to expense over the asset*s useful life. 3epreciation is based on the !atching principle. 2t matches the cost of an asset )ith the revenue generated by the use of that asset. !1efer to Exhibit 10-4."

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3epreciation is not a process of valuation of the plant asset. 2t is based on historical cost not on current appraisal value. 3epreciation does not represent a fund of cash set aside to replace )orn or obsolete assets. Acc$!$lated ,epreciation a contra-asset account equals the portion of the asset*s cost that has already been depreciated !or expensed". The causes of depreciation include physical )ear and tear and obsolescence. The asset-s cost !covered previously" esti!ated $sef$l life. and esti!ated resid$al "al$e must all be (no)n in order to measure depreciation. a. The useful life is an esti!ate of ho) many years the asset )ill be useful to the business not an estimate of its actual physical life. 6seful life may be limited by )ear and tear or by obsolescence. Resid$al "al$e (sal"age or scrap "al$e) is the estimated expected cash value at the end of the asset*s useful life. 0ost minus residual value 7 depreciable cost.

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4. 5.

b.

c.

Objective 2: Account for depreciation

A. Three basic !ethods are used for computing depreciation8straight-line units-ofproduction and declining-balance. 6sing any of the three methods the entry to record depreciation each period is% 3epreciation Expense Accumulated 3epreciation 0. 99 99

B.

The three methods are illustrated based on the data in Exhibit 10-5.
1.

The straight)line (/ ) depreciation formula is% Cost ) Resid$al "al$e 1sef$l life in &ears 0 Ann$al depreciation expense

10-.

a.

The :& method allocates an e'$al a!o$nt of depreciation expense to each year of the asset*s life. #oo* "al$e (carr&ing "al$e) equals cost minus accumulated depreciation. !Exhibit 10-; illustrates straight-line depreciation."

b.

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The $nits)of)prod$ction (12P) depreciation formula is% Cost ) Resid$al "al$e 1sef$l life in $nits and. ,epr+3$nit x 0 ,epreciation expense3$nit

1nits of o$tp$t (c$rrent &ear)

Ann$al depreciation expense (c$rrent &ear)

a.

The 6<= method assigns a fixed amount of depreciation to each unit of output or production- ho)ever depreciation per year )ill vary )ith the output. 3epreciation each period is based on actual usage or output + !Exhibit 10-> illustrates 6<= depreciation."

b.

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The do$ble)declining balance (,,#) depreciation formula is% T4ice the straight)line rate x #oo* "al$e (,,# rate) at beg+ of &ear
a.

0 Ann$al depreciation expense

33B is an accelerated !ethod of recording depreciation- higher amounts of the asset*s cost are )ritten off to expense early in the life of the asset. !Exhibit 10-? presents 33B depreciation calculations." #oo* "al$e !cost minus accumulated depreciation" declines each year. Resid$al "al$e is not considered until near the last year of useful life. !1" @hen boo( value approaches residual value depreciation expense for that year is the amount required to bring remaining boo( value to residual value. This ad+ustment usually occurs in the last year of the asset*s useful life but may occur before then.

b. c.

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1egardless of the method used the same total amount of depreciation )ill be recorded over the useful life of the asset. 1. The three methods merely cause ti!ing differences in recording annual depreciation expense. All are acceptable under AAA=. Exhibit 10-B graphs depreciation patterns through time for the three methods. 0hoosing a depreciation method may depend on the nat$re of the asset. A business should match an asset*s expense against the revenue the asset produces. a. b. c. /or an asset that generates revenue evenly over time straight-line is best. 6<= is best suited for assets that )ear out because of physical use. The accelerated methods such as 33B are best suited for assets that generate greater revenue earlier in their useful life. A survey of ;00 companies !presented in Exhibit 10-10" reveals that the / !ethod is !ost pop$lar for financial reporting.

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d.

Objective 3: Select the best depreciation method for tax purposes

A. 3epreciation methods for financial state!ent presentation and inco!e tax reporting may vary. 1. $. The straight)line !ethod is most often used for financial statement purposes. An accelerated !ethod is most often used for tax purposes. a. The higher the depreciation expense the lo4er the income. &o)er income results in lo)er income tax expense and lo)er tax payments. &o)er tax payments mean greater !increased" cash flo). These tax savings can be invested.

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.b

The %odified Accelerated Cost Reco"er& /&ste! (%ACR/) is a special depreciation method created by the 1B?; Tax 1eform Act solely for income tax purposes. 2t requires strict adherence to many guidelines. Exhibit 10- 11 presents the various assets classes and lives for the depreciation methods prescribed by #A01:.

B.

Partial)&ear depreciation calculations are required for assets that are purchased andCor disposed of on a date other than the start of the fiscal year 1. 2n the first and last &ears of the asset*s life it may be necessary to calculate partial-year depreciation expense. $. 0ompute the entire year*s depreciation expense first then calculate the partial-year amount based on the n$!ber of !onths the item )as actually held that year.

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Changing the esti!ated $sef$l life or esti!ated resid$al "al$e requires a revised depreciation schedule. 1. The for!$la for re"ised depreciation (/ ) is%

Cost ) Acc$!$lated deprec+ ) 5e4 resid$al "al$e 0 5e4 ann$al depreciation expense 5e4 esti!ated $sef$l life re!aining $. 3. This type of change a change in acco$nting esti!ate is often footnoted.

The business may continue to use a fully depreciated asset but may not record additional depreciation expense.

Objective 4: Account for the disposal of a plant asset

A. A business disposes of plant assets )hen they )ear out become obsolete or are no longer useful to the business. Al)ays update depreciation by recording a partial)&ear depreciation expense- next calculate the asset*s re!aining boo* "al$e+ 2f an asset is 6$n*ed before it is fully depreciated record a loss equal to the remaining boo( value.

B.

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The rules for the sale of a plant asset are% 1. Record gain on the sale if the cash received !sales proceeds" is greater than the remaining boo( value. Record loss on the sale if the remaining boo( value is greater than the cash received !sales proceeds". The +ournal entry is% 0ash Accumulated 3epreciation &oss on :ale of Asset Asset <r 99 99 99 99

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0ash 99 Accumulated 3epreciation 99 Aain on :ale of Asset Asset

99 99

E.

The rules for the exchange (trade in! of a plant asset are% 1. $. Re!o"e balances of old asset and accumulated depreciation. The entry to record the trade-in is% Equipment !ne)" Accumulated 3epreciation !old" Equipment !old" 0ash 99 99 99 99

Objective ": Account for natural resources

A. The process of allocating the cost of a nat$ral reso$rce to expense over its useful life is called depletion. Datural resources include timber iron ore and petroleum. 1. ,epletion expense represents the portion of the cost of natural resources !iron ore gas oil coal timber" that is used up in a period.

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3epletion is calc$lated by the units-of-production formula% Cost ) Resid$al "al$e Esti!ated $nits of reso$rce and. expense 0 ,epletion expense3$nit

,epl3$nit x 5$!ber of $nits re!o"ed 0 Ann$al depletion (c$rrent &ear) (c$rrent &ear)

B.

Datural resources are reported at boo( value on the balance sheet. Acc$!$lated ,epletion is a contra-asset account similar to Accumulated 3epreciation.

Objective #: Account for intangible assets

A. The process of allocating the cost of an intangible asset to expense over its useful life is called a!orti7ation+ 1. The calc$lation of amorti,ation is based on the straight)line !ethod and uses the estimated useful life of the intangible asset or its legal life )hichever is shorter. Intangible assets represent rights to current and anticipated benefits. They have no physical characteristics. a. The $sef$l life of intangible assets varies- some have limited lives and some have unlimited lives. 2ncluded in the intangible asset category are patents copyrights trademar(s franchises and good)ill.

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b.

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Patents grant the holder the exclusive right to produce and sell an invention for $0 years.

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Cop&rights grant exclusive rights to reproduce and sell a )ritten or created )or(copyrights extend for >5 years beyond the author*s life. Trade!ar*s. brand na!es represent distinctive products or services. (ranchises. licenses are privileges granted to sell a product or service under specified conditions. 8ood4ill is the excess of the cost of an acquired company over the sum of the mar(et values of its net assets. a. b. 2t can only be recorded )hen a company is acquired. Aood)ill is not amorti,ed. 2f the value of the good)ill declines a loss is recorded for the decline in value.

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Even though research and de"elop!ent costs represent intangible assets these costs are expensed )hen incurred rather than capitali,ed and amorti,e.

10-B