# College Accounting Notes - Chapter 10

Chapter Ten                                                                               Page 384

Plant Assets, Natural Resources, and Intangibles

Objective: To have students demonstrate their knowledge in determining what is a capital asset and what gets expensed. They will analyze costs and the use of the asset to determine how to classify it. They will be able to calculate the expense on a capital asset by using one of three depreciation methods. The will determine disposal, asset changes, asset exchanges, and types. They will do the same for Natural Resources and Intangibles.

Topics to be covered:

Plant Assets

-       Determine the acquisition cost

-       Three types of Depreciation

o   Straight Line

o   Accelerated Methods (DDB & MACRS)

o   Units of Production

-       Full and partial depreciation

-       Factors

o   Disposal

-   Revising Depreciation

Natural Resources

-       Determine the cost

-       Plant assets used in extracting resources

-       Depletion

Intangible Assets

- Determine cost

- Different types of Intangibles

- Amortization

Plant Assets

Plant Assets – Are tangible (a physical property to it) and used in a company’s operation that has a useful life of more than one accounting period. They are commonly referred to as Property Plant and Equipment, (PP&E), or fixed assets.

There are two important features:

-       Used in operations (not inventory)

-       Has a life extending more than one accounting period (more than a year).

Process

-       First value the asset and record it onto the balance sheet at the total purchase cost.

-       Determine the useful life.

-       Then allocate their cost to the periods that that benefit from their use.

o   The new balance sheet account used is “Accumulated Depreciation”. It is a contra asset account that is reported on the balance sheet to reduce the gross asset.

o   The expense account used is a debited account – Depreciation Expense.

This process relates back to the Matching Principle. Putting it on the balance sheet is called “Capitalizing”. Putting small costs and costs related to that period only, to the P&L as an expense is called “Expensing”.

There are four steps in dealing with a fixed asset: (pg 393)

1.    Acquisition - Compute the cost using Cost Determination.

2.    Use – Allocate costs to periods using useful life

3.    Account for subsequent expenditures

4.    Disposal – Record final depreciation, sale, exchange, replacement, or W/O.

Cost Determination

-       Cost Principle – cost includes all normal and reasonable expenditures necessary to get the asset in place and ready to use. It can include freight, unpacking, assembly, installing, testing, and sales tax.

Types of Fixed Assets

Land – This is recorded at cost which can include; real estate commissions, title insurance, legal fees, accrued taxes, surveying, clearing, grading, draining, removal of existing building, preparing the land. Other costs could include; Government assessments, roads, sewers, and sidewalks. All have added value to the land and increase its value. Land has value but is NOT subject to depreciation.

Land Improvements – These have limited life and are used up over time. Some examples include; parking lots, landscaping, driveways, and lighting. These get allocated to the asset and either expensed or depreciated.

Buildings – Cost of purchasing or constructing a structure. Some costs would include; materials, labor, brokerage fees, taxes, title, attorney fees, renovations, wiring, flooring, lighting, materials, architect fees, permits, and insurance. Costs incurred after it has been placed into service are considered to be operating expenses and are expensed unless their useful like is greater than one accounting period and increase its value.

Machinery and Equipment – All normal costs necessary to prepare it for use. (see cost determination). Some additional costs include transportation, assembly, and testing. (Units of Production depreciation can also be used on this category).

Lump Sum Purchases – This is when more than one item is purchased for one price. An example would be a building purchased on land with a parking lot. In this case there are three different assets in this purchase that need to be classified. The classification needs to be done in order for the assets to be properly depreciated. You would need to get appraisal values to determine the different asset value is called “Apportioned Costs”

Apportioned Costs (pg 394)

-       You get an appraised value for each individual part of the asset you purchased. They get added up to get an apportioned total, most times different from the purchase total price.  Then divide each individual appraisal amount into the new total appraisal amount to get a percentage for each component. The total of all of the appraisal percentages must add up to 100%. The one total purchase price is now multiplied by each individual appraisal percent to get an estimated value for each component. The total of all of the estimated costs must equal the original total purchase price.

Depreciation

Uses the cost of the asset to allocate or expense the portion of the plant asset used in the accounting period that it relates to, or that a benefit was received.

It does not measure the decline in market value or physical deterioration.

The entry used will always be:

Dr. Depreciation Expense (plus name of asset type)

Cr. Accumulated Depreciation (plus name of asset)

Accumulated Depreciation – This is a contra asset account shown in the fixed asset section of the balance sheet. It is used to reduce the value of the gross asset while the gross asset account intact. When recording amounts into this account you will always credit this account. When W/O or disposing of an asset you would debit this account for the balance in it. It is also a permanent account.

Depreciation Factors (four of them)

1.    Depreciation Base:

Cost               – All necessary and reasonable expenditures to acquire and prepare it for use.

Less: Salvage Value           - Estimated value at the end of its useful life. This is the expected trade-in value.

Equals: Depreciation Base

2.    Useful Life – Length of time that it is productive in a company’s operation. This is also referred to as “Service Life”. This must be greater than one accounting period (one year). This is based on FASB and IRS rules.

3.    Inadequacy – Insufficient capacity of a plant asset and cause to dispose of it.

4.    Obsolescence – No longer useful in producing goods and cause to dispose of it.

Depreciation Methods

There are four common types of depreciation methods:

1.    Straight Line

2.    Units of Production

3.    Double Declining Balance

4.    MACRS – Used for taxes, the IRS provides rates and useful life

All Methods will have the same journal entry and same reporting format:

J/E -    Dr. Depreciation Expense (plus asset name)

Cr. Accumulated Depreciation (plus asset name)

Reporting on B/S(pg. 401):                       Gross Asset

Less:  Accumulated Depreciation

Equals: Net Book Value of All Assets

1.    Straight Line (pg 396) – Charges the same amount of expense to each period of an asset’s useful life.  This is the most common of all depreciation methods.

Formula: (cost – salvage value)/useful life= depreciation per year. The ending book value can never be lower than the salvage value.

Half-Year Convention (pg 400) – In the year of acquisition, no matter when the asset was purchased, you can only take one half of a year’s depreciation. So if an asset was purchased in April or December, only a half of a full year’s depreciation can be taken. This would extend the depreciation over another year more than its useful life but not more than the total depreciation for that asset. This is different from the actual month of acquisition when a purchase in April will result in nine months of depreciation and a purchase in December only one month. It is easier for bookkeeping purposes. This is each company’s choice of which method they follow.

2.    Units of Production (pg 398) – This depends on amount of production or amount of usage. It is based on a per unit cost.  Depreciation will vary based on the actual units produced in that period. To get the initial cost per unit an estimate of the total amount of units to be produced over its life is necessary.

Formula: (cost-salvage value)/ Total estimated units to be produced = estimated cost per unit. Next times the estimated cost per unit by the actual amount of units produced in that period to get the depreciation. The ending book value can never be lower than the salvage value.

3.    Double Declining Balance (pg 399) – This is an accelerated depreciation method. It yields a larger depreciation expense than straight-line in the early years. It uses the same theory as the straight-line method but with two added elements. First it does not take salvage vale into account. The last year is usually adjusted so the asset does not go below the adjusted book value. The second element is that it doubles the rate of depreciation for each year based on the straight-line rate.

The Formula: for example would be, if an asset has a useful life of five years under straight-line the rate would be 20% year. Using double declining balance the rate would be 40% per year and would require that after the fourth year we take the total accumulated depreciation to date subtract it from the gross asset. Take that amount and subtract it from the salvage value to get the fifth year’s, lower, depreciation.

4.    MACRS – Modified Accelerated Cost Recovery System. Used for tax purposes with useful life and depreciation rates provided by the IRS.

Different methods will produce different results during the period but at the end of the useful life the results will all be the same. Companies will choose one method and stick with it for the purpose of conforming to the Consistency Principle. (pg 399)

Change in Depreciation (pg 400 & 401)

When a change in salvage value occurs:

Formula: (current gross value – accumulated depreciation to date) - revised salvage

Remaining Useful Life

When a change in useful life occurs:

Formula: (current gross value – accumulated depreciation to date) - salvage

Remaining Revised Useful Life

Types of Expenditures

Revenue Expenditures – Expenses based on cost and materiality. If it does not materially increase the assets life or productivity the cost are directly expensed.

Capital Expenditures – Balance sheet recorded costs to the gross asset account, called capitalized expenses. Additional costs that produce benefits beyond the current period to increase and improve the production and or life of the asset.

Three Types of Repairs (pg 402)

1.    Ordinary Repair – Does not extend useful life or increase productivity. (ie maintenance such as an oil change). This type is expensed.

J/E  Dr. Repair Expense (or other named expense)

Cr. Cash

2.    Betterments – Makes an asset more efficient or productive but does not always add to its useful life. This type is capitalized and depreciated from that point forward.

J/E  Dr. Asset

Cr. Cash

3.    Extraordinary Repairs – These extend the useful life beyond its original estimated life. These are capitalized and depreciated based on the remaining new adjusted life.

J/E  Dr. Asset

Cr. Cash

Disposal of Plant Assets

When an asset becomes worn out or obsolete. You can;

-       Discard it – the asset is no longer useful or has no market value

-       Sell it – get money for it

-       Exchange it for a better one

Steps in Disposal (pg 405)

1.    Record the depreciation up to the disposal date

2.    Reverse the accumulated depreciation by debiting it for the whole balance

3.    Reverse the total asset cost by crediting it for the whole balance

4.    Record any cash or new asset value with a debit

5.    Record a gain with a credit to Gain on Sale if cash is greater or debit to Loss on Sale if cash is less.

J/E      Dr. Cash

Dr. Accumulated Depreciation

Cr. Asset (name)

Cr. Gain on Sale or Disposal

Natural Resources

Natural Resources  (pg 406)– Assets that are physically consumed when used. They come from the earth. (ie gas, timber, coal , oil, minerals). These are recorded at what you paid for the site.

Depletion – this is the process of allocating the cost of natural resources to the period that it is consumer (mined, harvested). Depletion is the same as depreciation. The key is getting a cost per unit.

The Formula: (cost-salvage value)/Total estimated units of capacity=Depletion per unit. Depletion times actual units produced in that period.

J/E      Dr. Depletion Expense

Cr. Accumulated Depletion

Intangible Assets

Intangible Assets (pg 407) – Assets that are not physical in properties but represent something.  They give the owner Legal Rights, Privileges, or Competitive Advantage. They lack physical substance in most cases. (ie licenses, trademarks, copyrights, patents, contracts, lists).  They are recorded at cost. If the intangible has an indefinite life then you do not amortize it (goodwill).

Amortization – this is the process of allocating the purchase price over the stated useful life. The formula is the same as Straight Line Depreciation except that amortization is used.

J/E      Dr. Amortization Expense (name)

Cr. Accumulated Amortization (name)

Demo Problem pg 411

Quick Study, Exercises, and Problems

1. Do QS:       10-1 – Cost of plant asset pg 418

10-3 – Depreciation Method S/L pg 418

10-4 – Depreciation Method Units of Prod pg 418

10-6 – Depreciation Method DDB pg 419

Ex.     10-1 - Cost of plant asset pg 419

10-2- Cost & recording of assets pg 420

2. Do QS:       10-7 – Revenue vs. Capital expenditures pg 419

Ex.       10-3 – Lump sum – Allocation of Costs pg 420

Ex.      10-6-  S/L pg 420

10 -7-  Units of prod. – pg 420

10- 8 – DDB – pg 420

10-9 – S/L pg 420

10-10 – DDB pg 420

3. Do QS:       10--5 – Revised Depreciation pg 419

Qs.      10-8 -Disposal of asset pg. 419

10-13- Asset Exchange pg 419

Ex.       10-11 Revising depreciation pg. 420

4. Do QS:       10-10 – Classify assets pg 419

Qs.      10-9 Natural Resources depletion pg 419

10-11 Intangible amortization pg. 419

Ex.       10 -18 Depletion pg 421

10- 19 Amortization pg 421

10- 20 Goodwill pg 422

5. Do  Ex.       10-4 S/L  pg. 420

10-5 DDB pg. 420

Ex.       10-12 – S/L pg 420

10-13 – DDB pg. 421

-Test-

6. Do Ex.        10-16 – Disposal of assets pg 421

Ex.       10-17  - Disposals pg. 421

7. Do Ex.        10-15 – Types of Repairs pg. 421

Ex.       10-14 – Extraordinary repairs pg. 421

8. Do Prob.    10-1 - Apportioned costs and depreciation pg. 422

9. Do Prob.    10-2 – Asset cost and depreciation pg. 423

10. Do. Prob. 10-3 – Depreciation and Revisions pg. 423

11. Do Prob. 10-5 – Depreciation Methods pg. 424

( extra problem 10-4 Depreciation and revisions pg 424)