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CHAPTER 10
PLANT ASSETS, NATURAL RESOURCES
Additional Information on Related Assignment Material
The Serial Problem for Success Systems continues in this chapter. Problems 10-1A and 10-2A can be
completed using Excel. Problem 10-1A and 10-8A can be completed with Sage 50 Software.
Connect (Available on the instructor’s course-specific website) repeats all numerical Quick Studies, all
Exercises and Problems Set A. Connect provides new numbers each time the Quick Study, Exercise or
Problem is worked. It allows instructors to monitor, promote, and assess student learning. It can be used
in practice, homework, or exam mode
10-3
Chapter Outline
Notes
I. Plant Assets—Tangible assets used in a company's operations that
have a useful life of more than one accounting period. Consistent with
cost principle, recorded at cost. Cost includes all normal and
reasonable expenditures necessary to get the asset in place and ready
for its intended use.
A. Land
Cost includes purchase price, real estate commissions, title
insurance, legal fees, accrued property taxes, legal fees, title
insurance fees, accrued property taxes, surveying, clearing,
landscaping, and local government assessments (current or future)
for streets, sewers, etc. Also includes cost of removal of any
existing structures (less proceeds from sale of salvaged material).
Land cost is not allocated to expense if it has an indefinite life.
B. Land Improvements
Costs that increase the usefulness of the land.
1. Examples: parking lot surfaces, driveways, fences, and
lighting systems (all have limited useful lives).
2. Costs are charged to a separate Land Improvement account.
3. Costs are allocated to the periods they benefit (depreciated).
C. Buildings
1. If purchased, cost usually includes its purchase price,
brokerage fees, taxes, title fees, attorney costs, and all
expenditures to make it ready for its intended use (any
necessary repairs or renovations such as wiring, lighting,
flooring and wall coverings).
2. If constructed for own use, cost includes materials and labor
plus a reasonable amount of indirect overhead cost (heat,
lighting, power, and depreciation on machinery used to
construct the asset). Cost also includes design fees, building
permits, and insurance during construction.
D. Machinery and Equipment
Costs include all normal and necessary expenditures to purchase
them and prepare them for their intended use (purchase price,
taxes, transportation charges, insurance while in transit, and the
installing, assembling and testing of machinery and equipment).
E. Lump-Sum Purchase
A group of plant assets purchased with a single transaction for a
lump-sum price. Individual asset cost is determined by allocating
the cost of the purchase among the different types of assets
acquired based on their relative market values.
Chapter Outline
Notes
II. Depreciation—The process of allocating the cost of a plant asset to
expense in the accounting periods benefiting from its use. Recorded as
a debit to Depreciation Expense and a credit to Accumulated
Depreciation.
A. Factors in Computing Depreciation
1. Cost—described in section I above.
2. Salvage value—(residual value or scrap value) an estimate of
the asset's value at the end of its benefit period.
3. Useful life—(service life) length of time the asset is expected
to be productively used in a company's operations. Factors
affecting useful life include:
a. Inadequacy—the insufficient capacity of plant assets to
meet the company's growing productive demands.
b. Obsolescence—refers to a plant asset that is no longer
useful in producing goods or services with a competitive
advantage because of new inventions and improvements.
B. Depreciation Methods
1. Straight-line method—charges the same amount to expense
for each period of the asset’s useful life. Method used by most
companies.
Computation: Cost minus salvage value (equals the
depreciable cost) divided by the number of accounting periods
in the asset's useful life equals the periodic depreciation.
2. Units-of-production method—charges a varying amount of
cost to expense for each period of an asset’s useful life
depending on its usage. Examples of capacity measurements:
miles driven, product outputs, hours used. Computation:
a. Cost minus salvage value divided by the total number of
units expected to be produced during assets useful life
equals the depreciation per unit.
b. Depreciation per unit is multiplied by number of units
consumed in the period equals the period’s depreciation.
3. Declining-balance method—an accelerated depreciation
method which yields larger depreciation expenses during the
early years of an asset's life and smaller charges in later years.
Computation: Multiply the asset's beginning of period book
value by a depreciation rate (usually twice the straight-line
rate) to determine the period’s depreciation. If double the
straight-line rate is used the method is referred to as double
declining-balance. (Note that salvage value is not used in the
calculation.)
Chapter Outline
Notes
4. Depreciation for tax reporting—differences between financial
and tax accounting systems are normal and expected.
a. Many companies use accelerated depreciation in
computing taxable income because it postpones its tax
payments by charging higher depreciation expense in the
early years and lower amounts in the later years.
b. Federal income tax law rules for depreciating assets are
called the Modified Accelerated Cost Recovery System
(MACRS).
c. MACRS is not acceptable for financial reporting because
it allocates costs over an arbitrary period that is less than
the asset's useful life.
C. Partial Year Depreciation
When an asset is purchased (or disposed of) at a time other than
the beginning or end of an accounting period, depreciation is
recorded for part of the year.
D. Revising Depreciation
If estimated salvage and/or useful life is revised:
1. Depreciation expense computations are revised by spreading
the remaining cost to be depreciated over the revised useful
life remaining.
2. The revision is referred to as a change in an accounting
estimate and is reflected in current and future financial
statements, not prior statements.
E. Reporting Depreciation
1. Cost of plant assets and accumulated depreciation are reported
on the balance sheet or in its notes.
2. To satisfy the full-disclosure principle, the depreciation
method or methods used must be disclosed in a balance sheet
note.
3. Plant assets are reported at their undepreciated costs (book
value), not at fair value. (basis is going-concern assumption)
Exception: Impairments (permanent decline in fair value)
allow asset write-downs to fair value.
4. Accumulated depreciation on the balance sheet does not
represent funds accumulated to buy new assets when the
presently owned assets must be replaced.
Chapter Outline
Notes
III. Additional Expenditures—Those made to operate, maintain, repair,
or improve plant assets after their initial purchase. To record these
expenditures one must decide whether to capitalize (increase and
asset) or expense in current period.
A. Ordinary Repairs—expenditures to keep an asset in normal, good
operating condition. They do not materially increase the asset's life
or productive capabilities.
1. Treated as revenue expenditures (also called income statement
expenditures). Recorded as expenses on current period's
income statement.
2. Examples: cleaning, repainting, and lubricating.
B. Betterments (Improvements) and Extraordinary Repairs—
expenditures to make a plant asset more efficient or productive;
both are treated as a capital expenditure.
1. Betterments often involves adding a component to an asset
that does not always extend its useful life.
a. Examples: adding a wing to a building or changing a
machine from manual function to automatic.
b. Debited to the asset account.
c. The increase in asset’s book value results in need to revise
future depreciation.
2. Extraordinary repairs are expenditures that do extend the
asset's useful life beyond its original estimate.
a. Examples: roofing replacement and major overhauls of
machinery and equipment.
b. Treated as capital expenditures (debited to asset account)
because they benefit future periods.
10-7
Chapter Outline
Notes
IV. Disposals of Plant Assets—Assets may be discarded, sold, or
exchanged due to wear and tear, obsolescence, inadequacy, or damage
by fire or other accident. General accounting steps in a disposal of a
plant asset:
• Record depreciation up to the date of disposal—this also
updates Accumulated Depreciation.
• Remove account balances of the disposed asset—including its
Accumulated Depreciation.
• Record any cash (and/or other assets) received or paid in the
disposal.
• Record any gain or loss resulting from comparing the asset's
book value with the market value of any assets received.
Exception: in the case of an exchange that lacks commercial
substance—discussed in Appendix 10A.
A. Discarding Plant Assets—no longer useful and has no market
value
Follow general accounting steps above.
1. If fully depreciated, no loss.
2. If not fully depreciated, record loss equal to the book value.
B. Selling Plant Assets
Follow general accounting steps above.
1. Sale is at a gain if value received exceeds book value.
2. Sale is at a loss if value received is less than book value.
Chapter Outline
Notes
V. Natural Resources—Assets that are physically consumed when used.
Examples include timber, mineral deposits, and oil and gas fields.
Often called wasting assets.
A. Cost Determination and Depletion
1. Recorded at cost, which includes all expenditures necessary to
acquire the resource and prepare it for its intended use.
2. Depletion is the process of allocating the cost of natural
resources to the periods when it is consumed, known as the
resource's useful life.
3. Depletion expense (debit) per period is based on the units
extracted. The calculation is similar to units-of-production
depreciation. Accumulated depletion is credited in the
recording.
4. Natural resources are reported on the balance sheet at cost less
accumulated depletion.
B. Plant Assets Used in Extracting
When the usefulness of these plant assets is directly related to the
depletion of the resource, the plant asset is depreciated in
proportion to the depletion of the resource (use units-of-production
method and the life of the resource).
VI. Intangible Assets—Certain nonphysical assets (used in operations)
that confer on owners long-term rights, privileges, competitive
advantages. Examples in B below.
A. Cost Determination and Amortization
1. Recorded at cost when purchased. If simply developed by the
business, relative immaterial costs are expensed.
2. Amortization—process of systematically allocating cost of
intangible asset to expense over its estimated useful or
economic life. (If it has an indefinite useful life, it should not
be amortized but is tested annually for impairment—this test is
discussed in advanced course)
a. Useful or economic life may differ from legal life.
b. Computed on a straight-line basis (cost divided by useful
or economic life)
c. Amortization period cannot exceed 40 years.
d. Debit Amortization Expense and credit Accumulated
Amortization.
lease or the life of the improvements whichever is shorter.
Debit Rent Expense to amortize.
10-9
Chapter Outline
Notes
B. Types of Intangibles
1. Patent—an exclusive right granted to its owner to produce and
sell a patented item or to use a process for 20 years.
2. Copyright—the exclusive right to publish and sell a musical,
literary, or artistic work during the life of the creator plus 70
years.
3. Franchises and Licenses—rights that a company or
government grants an entity to deliver a product or service
under specified conditions. If agreement is for indefinite or
perpetual period, costs are not amortized.
4. Trademarks and Trade Names—symbols, names, phrases, or
jingles identified with a company, product, or service.
5. Goodwill—specific meaning in accounting: the amount by
which the value of a company exceeds the value of its
individual assets and liabilities. Implies the company as a
whole has certain valuable attributes not measured among its
individual assets and liabilities. Goodwill is measured as the
excess of cost of an acquired entity over the valuable of net
assets acquired. It is not amortized but is tested annually for
impairment.
6. Leasehold—the rights to possess and use leased property
granted by the property’s owner (lessor) to the lessee in a
contract called a lease. Recorded, if there was a cost involved,
as an intangible asset by the lessee (or sublessee). As
leased property, such as partitions, painting, and storefronts.
Amortization results in debit to Amortization Expense—
Leasehold Improvements.
VII. Global View—Compares U.S.GAAP to IFRS
A. Accounting for Plant Assets—both systems are broadly similar on
issues involving cost determination, additional expenditures and
disposal.
1. Decreases in value—although both systems require recording
decline in value to be recorded as asset impairment, the test
for impairment under each system differs. U.S.GAAP uses
fair value and IFRS uses recoverable costs.
2. Increase in value—U.S.GAAP prohibits recording increases in
plant asset value whereas IFRS permits upward asset
reevaluation.
10-10
Chapter Outline
Notes
B. Accounting for Intangibles—similarities and differences are
consistent with accounting for plant assets however the
requirements for recording increases in value of intangibles is very
restrictive and rare.
VIII. Decision Analysis—Total Asset Turnover
A. Measure of company’s efficiency using assets to generate sales.
B. Calculated by dividing net sales by average total assets.
IX. Exchanging Plant Assets —Appendix 10A
A. Accounting for the exchange depends on whether the transaction
has commercial substance. Commercial substance exists if the
company’s future cash flows change as a result of the transaction.
B. If commercial substance exists, a gain or loss is recorded based on
the difference between the book value of the assets given up and
the market value of the assets received.
C. If exchange lacks commercial substance, no gain or loss is
recorded, and the asset received is recorded based on the book
value of the assets given up.
1. STRAIGHT LINE
2. UNITS OF PRODUCTION
(Depreciable)
a) FHC - Estimated salvage Cost per
3. DOUBLE-DECLINING BALANCE
Book Value (beginning of year) x RATE* = Depreciation (for that year)
=
10-12
Alternate Demonstration Problem
Chapter Ten
A new machine costs $120,000, has an estimated useful life of five years
and an estimated salvage value of $15,000 at the end of that time. It is
expected that the machine can produce 210,000 widgets during its useful
life.
The New Times Company purchases this machine on January 1, 2013, and
uses it for exactly three years. During these years the annual production of
widgets has been 80,000, 50,000, and 30,000 units, respectively. On
January 1, 2016, the machine is sold for $45,000.
Required:
1. Calculate the depreciation expense for each of t he first three years
using:
a. Straight-line
b. Units-of-production
c. Double-declining-balance
2. Prepare the proper journal entry for the sale of the machine under the
three different depreciation methods.
Solution: Alternate Demonstration Problem
Chapter Ten
1a. Straight-line
The depreciation expense each year is equal to cost minus salvage
value divided by useful life. In this example the cost is $120,000, the
10-14
2. The journal entry for the sale of the asset will have the same general
form regardless of the method of depreciation adopted, except that
Straight-line
Cash .........................................
45,000
Accumulated depreciation .....
63,000
Loss on sale of machine ........
12,000*
Machine ..............................
120,000
* Book value of 57,000 less sale price $45,000 equals loss of $12,000
Units-of-production
Cash .........................................
45,000
Accumulated depreciation .....
80,000
Machine ..............................
120,000
Gain on sale of machine ...
5,000
* Sale price $45,000 less book value of $40,000 equals gain of $5,000
Double-declining balance
Cash .........................................
45,000
Accumulated depreciation .....
94,080
Machine ..............................
120,000
Gain on sale of machine ...
19,080
*Sale price $45,000 less book value of $25,920 equals gain of $19,080
