Chapter Outline


Section 1Plant Assets

I.          Cost Determination
Plant assets
are tangible assets used in a company's operations that have a useful life of more than one accounting period. Consistent with cost principle, plant assets are recorded at cost when acquired. Cost includes all normal and reasonable expenditures necessary to get the asset in place and ready for its intended use.


A.  Land—has an unlimited life and is not usually used up over time.
Cost includes:

1.   The total amount paid for the land.

2.   Real estate commissions, title insurance fees, legal fees, and any accrued property taxes paid by the purchaser.

3.   Payments for surveying, clearing, grading, and draining, and government assessments (incurred at the time or purchase or later) for public roadways, sewers, and sidewalks.

4.   Cost of removal of any existing structures (less proceeds from sale of salvaged material). Land is not depreciated.

B.   Land Improvements—costs that increase the usefulness of the land.


1.   Examples include parking lot surfaces, driveways, fences, and lighting systems have limited useful lives.

2.   Costs are charged to a separate Land Improvement account so that their costs can be allocated to the periods they benefit.


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 costs, such as heat, lighting, power, and depreciation on machinery used to construct the asset. Cost also includes design fees, building permits, and insurance during construction (but not after it is placed in use; insurance then becomes an operating expense).


D.  Machinery and Equipment
Costs include all normal and necessary expenditures to purchase and prepare for intended use, including purchase price, taxes, transportation charges, insurance while in transit, and the installing, assembling and testing of the machinery and equipment.



Chapter Outline




II.        Depreciation—The process of allocating the cost of a plant asset to expense in the accounting periods benefiting from its use.


A.  Factors in Computing Depreciation


1.   Cost—described above.

2.   Salvage value—an estimate of the asset's value at the end of its benefit period (also called residual value or scrap value).

3.   Useful life—length of time the asset is expected to be productively used in a company's operations (also called service life). Factors affecting useful life include:


a.   Wear and tear from use in operations.

b.   Inadequacythe capacity of plant assets that is unable to meet the company's growing productive demands.

c.   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
Depreciation methods are used to allocate a plant asset’s cost over the accounting periods in its useful life.


1.   Straight-line method—charges the same amount to expense for each period of the asset’s useful life; most frequently used method. Computation:

a.   Cost minus salvage value (equals the depreciable cost) divided by the useful life equals annual depreciation expense.

b.   Can be expressed a rate by dividing 100% by the periods in the assets’ useful life.

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. Computation:

a.       Cost minus salvage value divided by the total number of units expected to be produced during its useful life equals the depreciation per unit.

b.       Depreciation cost per unit times number of units produced in the period equals the period’s depreciation expense.



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3.   Declining-balance method—an accelerated depreciation method that yields larger depreciation expense during the early years of an asset's life and less depreciation in the later years. Computation:

a.   Multiple the asset’s beginning of the period book value by a multiple of the straight-line rate. (Do not consider salvage value.)

b.   A common depreciation rate for the declining-balance method is double the straight-line rate; called the double-declining-balance method.


4.   Comparing depreciation methods—while the amount of depreciation expense per period differs for different methods, total depreciation expense is the same over a given asset’s life.


5.   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 often 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 the part of the year the asset was in use.

D.  Change in Estimates for Depreciation
Depreciation is based on estimates of salvage value and useful life; later, new information may indicate these estimates are inaccurate.


1.   Use the new estimate to compute depreciation for current and future periods by revising the deprecation expense computation by spreading the cost yet to be depreciated over the remaining useful life.

2.   The revision is referred to as a change in an accounting estimate and is reflected in future financial statements; not in prior statements.



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E.   Reporting Depreciation


1.   Both the cost and accumulated depreciation of plant assets are reported on the balance sheet or in its notes.

2.   To satisfy the full‑disclosure principle, the depreciation method(s) used must be disclosed in notes.

3.   Plant assets are reported on the balance sheet at book value; not at market value; emphasis on cost rather than market value is based on the going concern principle.

4.   Accumulated Depreciation does not represent funds accumulated to buy new assets when the currently owned assets are replaced.


III.       Additional Expenditures
In recording additional expenditures for an assets’ operation, maintenance, repair, and improvement, the company must decide whether to capitalize (that is, debit an asset account) or expense them.


A.  Types of Additional Expenditures

1.   Revenue expenditures (also called income statement expenditures) are additional costs of plant assets that do not materially increase the asset's life or productive capabilities; they are recorded as expenses and reported on the income statement.

2.   Capital expenditures (also called balance sheet expenditures) are additional costs of plant assets that provide benefits extending beyond the current period; they are debited to asset accounts and reported on the balance sheet.


B.   Ordinary Repairs

1.   Ordinary repairs are expenditures to keep an asset in normal, good operating condition.

2.   Ordinary repairs are treated as revenue expenditures.


C.   Betterments and Extraordinary Repairs

1.   Betterments (also called improvements) are expenditures that make a plan asset more efficient or productive.

2.   Extraordinary repairs are expenditures extending the asset’s useful life beyond its original estimate.

3.   Since betterments and extraordinary repairs benefit future periods, both are debited to the asset account as capital expenditures.



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IV.       Disposals of Plant Assets—Assets may be discarded, sold, or exchanged.


A.  Discarding Plant Assets


1.   Entry to record disposal of plant assets when fully depreciated (when accumulated depreciation equals the asset’s cost): debit Accumulated Depreciation, credit the plant asset account.

2.   Entry to record disposal of plant assets when not fully depreciated (when accumulated depreciation equals the asset’s cost): first, record depreciation expense through date discarded, then debit Accumulated Depreciation, debit Loss on Disposal (for the remaining book value), credit the plant asset account.


B.   Selling Plant Assets
First, record depreciation expense through date sold, then:


1.   Entry to record sale at book value: debit cash, debit Accumulated Depreciation, credit the plant asset account.

2.   Entry to record sale above book value: debit cash, debit Accumulated Depreciation, credit Gain on Disposal, credit the plant asset account.

3.   Entry to record sale below book value: debit cash, debit Loss on Disposal, debit Accumulated Depreciation, credit the plant asset account.







Chapter Outline




V.         Section 2Natural Resources—assets that are physically consumed when used. Examples include timber, mineral deposits, and oil and gas fields. Since they are consumed when used, they are also called wasting assets.


A.  Cost Determination and Depletion

1.   Natural resources are 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 a natural resource to the period when it is consumed.

3.   Natural resources are reported on the balance sheet at cost less accumulated depletion.

4.   The depletion expense per period is based on the units extracted; entry to record depletion: debit Depletion Expense, credit Accumulated Depletion


B.   Plant Assets Used in Extracting Resources
When the usefulness of plant assets used in extracting resources is directly related to the depletion of the natural resource, its cost is depreciated using the units-of-production method in proportion to the depletion of the natural resource.


VI.       Intangible Assets—Nonphysical assets (used in operations) that confer on their owners long-term rights, privileges, or competitive advantages.


A.     Cost Determination and Amortization

1.   An intangible asset is recorded at cost when purchased. Its cost is systematically allocated to expense over its estimated useful life through amortization. If an intangible asset has an indefinite useful life, it should not be amortized.

2.   Amortization is similar to depreciation and depletion, except that only the straight-line method is generally used for amortization.

3.   The effects of amortization are recorded in a contra account called Accumulated Amortization. The gross acquisition cost and accumulated amortization are disclosed.



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B. Types of Intangibles


1.   Patent—an exclusive right granted to its owner to manufacture and sell a patented machine or device, or to use a process, for 17 years.

2.   Copyright—the exclusive right given to its owner to publish and sell a musical, literary, or artistic work during the life of the creator plus 50 years.

3.   Leasehold—rights granted to the lessee by the lessor.


4.   Leasehold improvements—alterations or improvements to leased property, such as partitions, painting, and storefronts.

5.   Franchises and Licenses—rights that a company or government grants an entity to deliver a product or service under specified conditions.


6.   Trademarks and Trade Names—symbols, names, phrases, or jingles identified with a company, product, or service.


7.   Goodwill—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 value attributes not measured among its individual assets and liabilities.