Plant Assets and Intangibles

Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Chapter 9

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Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.2

Measure the cost of a plant asset

Account for depreciation

Record the disposal of an asset by sale or trade

Account for natural resources

Account for intangible assets

Describe ethical issues related to plant assets


Plant assets are relatively expensiveChallenge determining the full costLast several years and allocated to those yearsCan be sold or traded in

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Real or tangible assetsBuildings, desk, equipment

Natural resourcesOil, diamonds and coal

Intangible assetsSoftware programs and knowledge

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Plant Plant AssetsAssets

Natural Natural ResourcesResourcesNatural Natural

ResourcesResourcesIntangible Intangible

AssetsAssets

DepreciationDepreciation DepletionDepletionDepletionDepletion AmortizationAmortization


Measure the cost of a plant asset

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Cost of an asset =Sum of all costs incurred to bring the asset to its intended purpose, less any discounts

Rule for measuring the asset’s cost

The Cost PrincipleThe Cost Principle

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Land and land improvements BuildingsMachinery and equipmentFurniture and fixtures


NOT depreciatedCosts included in land:

Purchase priceBrokerage feesSurvey and legal feesProperty taxes in arrearsTitle transferCosts of clearing and removing unwanted buildings

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Capitalized


Subject to depreciationExamples:

FencingPavingSprinkler systemsLightingSigns

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Land

Land Improvements

Not Depreciated

Depreciated

Two entirely separate assets


Building ConstructedConstructedArchitectural feesBuilding permitsContractor chargesPayments for material, labor, and overheadCapitalized interest cost, if self-constructed

Building PurchasedPurchased Purchase priceCosts to renovate the building for use

Similar to construction costs

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Cost includes:Purchase price (less any discounts)Transportation chargesInsurance while in transitSales tax and other taxesPurchase commissionInstallation costsThe cost of testing before it is used

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Purchase price (less any discounts)Shipping chargesCosts to assemble

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Purchase a group of plant assets for a single price

Also called basket purchase

Assign cost to individual assets based on relative sales values

LandLand ImprovementsBuildingEquipment

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Obtain a recent appraisalCompute the ratio of each asset’s market value to the total

The journal entry to record the purchase:


Capital ExpendituresDebited to an asset accountIncrease asset’s capacity of efficiency ORExtend useful life


ExpensesDebited to an expense accountMaintain asset in working order

Oil changes, tires, batteriesPatching a roof

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If capital expenditure incorrectly recorded as expense:

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This chapter lists the costs included for the acquisition of land. First is the purchase price, which is obviously included in the cost of the land. The reasons for including the other costs are not so obvious. For example, removing a building looks more like an expense.

1.State why the costs listed in the chapter are included as part of the cost of the land.

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The other cost (for example, back property taxes, transfer taxes, removing a building, and survey fees) are included as part of the cost of the land because they are necessary to get the land ready for its intended use.


(Continued)

2. After the land is ready for use, will these costs be capitalized or expensed?

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After the land is ready for use, subsequent land-related cost such as property taxes, ground maintenance and ordinary land related would be expensed.


Rural Tech Support pays $130,000 for a group purchase of land, building, and equipment. At the time of your acquisition, the land has a market value of $70,000, the building $56,000, and the equipment $14,000.

1.Journalize the lump-sum purchase of the three assets for a total cost of $130,000. You sign a note payable for this amount.

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Market Value

% of Market Value

Cost of Each Asset

Land $70,000 50% $65,000

Building 56,000 40% 52,000

Equipment 14,000 10% 13,000

Total 140,000 $130,000


1. Journalize the lump-sum purchase of the three assets for a total cost of $130,000. You sign a note payable for this amount.

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Journal Entry

DATE ACCOUNTS AND EXPLANATIONS DEBIT CREDIT

Land $ 65,000

Building 52,000

Equipment 13,000

Notes Payable $130,000


Account for depreciation

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Allocation of cost to expense over its useful lifeMatches expense against revenue generated

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$40,000 cost

5-year life

$8,000 per year


Wear and tear from useTruck can only go so many miles before it is worn out

Physical factorsAge and weather

ObsolescenceComputers and other technology

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Depreciation is NOT:


Cost–includes all items spent in order for the asset to performEstimated useful life

Expressed in years, units, miles, or outputEstimated residual value

Also called salvage valueExpected cash value at end of useful life

Cost minus estimated residual value is called depreciable cost

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CostCost Useful LifeUseful Life Residual Value

Residual Value


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Straight-line

Units-of production

Declining- balance


Data Item Amount

Cost of capitalized asset Asset debit amount

Estimated residual value Salvage value

Depreciable costCost–estimated residual value

Estimated useful life–Years Length of the service–how long the company can

use the assetEstimated useful life–Units

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An equal amount of depreciation to each year.Calculated as:

Straight-line depreciation = (Cost – Residual value) × 1/life × #/12

The number represents the number of months used in a year

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The carrying value of an asset as it depreciatesCalculated as:

Cost – Accumulated depreciation

As an asset is usedAccumulated depreciation increasesNet book value decreases

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A fixed amount of depreciation to each unitUnit can be miles, units, hours, or output

Calculated as:

Annual depreciation varies with the number of units produced

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Depreciation amount changes per year

Journal entry accounts are the sameDifferent amount each period

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Accelerated methodMore depreciation expense near the start of an asset’s life Less depreciation expense as it ages

Primary accelerated method Double-declining-balance

Residual value is not in formulaIgnored until last year

Calculated as:

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2 times straight line rate Book value declines

Book value becomes period’s depreciable cost

Depreciation expense declines

Final year’s expense leaves book value equal to residual value, no lower


Cost = $50,000 Life = 5 years or 100,000 units

Residual value = $5,000


Straight-line Units-of- production

Double-declining-

balance

Assets that generate

revenue over time

Assets that depreciate due

to wear and tear from use

Assets that produce more

revenue in their early years


Only for methods using monthsStraight-line

Double-declining balance

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Period of time used changes the formula for time


Changes in useful life or residual valueConsidered a change in estimateMust report on the reason and effect of the changeAsset book value is depreciated over the remaining life

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Changes in Useful LifeThe asset’s remaining depreciable book value is spread over the asset’s remaining life

Change in residual value

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Asset has reached the end of its estimated lifeIf still useful, a company will continue to use itReport book value on balance sheetRecord no more depreciationAsset never reported below residual value

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S9-3: COMPUTING FIRST-YEAR DEPRECIATION AND BOOK VALUE

At the beginning of the year, Alaska Freight Airlines purchased a used airplane for $43,000,000. Alaska Freight Airlines expects the plane to remain useful for five years (4,000,000 miles) and to have a residual value of $7,000,000. The company expects the plane to be flown 1,400,000 miles the first year.

1. Compute Alaska Freight Airlines’ first-year depreciation on the plane using the following methods:

a. Straight-lineb. Units-of-productionc. Double-declining-balance

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(Continued)

Compute Alaska Freight Airlines’ first-year depreciation on the plane using the following method:

a. Straight-line

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$43,000,000 – 7,000,000 / 5 years = $7,200,000


(Continued)


b. Units-of-production

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$43,000,000 – 7,000,000 4,000,000 miles$9 per mile X 1,400,000 miles = $12,600,000

= $9 per mile


(Continued)


c. Double-declining-balance

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1st year ($43,000,000 - $0) X 2/5 X 12/12 = $17,200,0002nd year ($43,000,000 - $17,200,000) X 2/5 X 12/12 = $10,320,000


Record the disposal of an asset by sale or trade

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Asset wears out or becomes obsolete.Company can:

Sell the asset for cashScrap the asset for no cashTrade the asset for another asset

Non-like property exchangeLike-kind exchange

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Result in a gain or loss

No gain or loss


Update depreciationRemove old asset from books

Zero out asset by crediting for original costZero out accumulated depreciation of asset by debiting for all depreciation taken

Record the value of any cash paid or receivedIf a note was signed, credit Notes payable

Determine difference between total debits and total credits

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Asset traded for a like-kind assetDifference will be recorded as a debit to the new asset account

Asset sold or exchanged for a dissimilar assetGain or loss will be recorded

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If debits > creditsIf debits > credits If debits < creditsIf debits < credits If debits = creditsIf debits = credits

GAIN LOSSNO GAIN OR LOSS


Global Positioning Net purchased equipment on January 1, 2012, for $36,000. Global Positioning Net expected the equipment to last for four years and to have a residual value of $4,000. Suppose Global Positioning Net sold the equipment for $26,000 on December 31, 2013, after using the equipment for two full years. Assume depreciation for 2013 has been recorded.

1.Journalize the sale of the equipment, assuming straight-line depreciation was used.

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Journal Entry


Dec 31 Cash 26,000

Accumulated depreciation 16,000

Equipment 36,000

Gain on sale of asset 6,000


Brown’s Salvage Company purchased a computer for $2,600, debiting Computer equipment. During 2012 and 2013, Brown’s Salvage Company recorded total depreciation of $2,000 on the computer. On January 1, 2014, Brown’s Salvage Company traded in the computer for a new one, paying $2,500 cash. The fair value of the new computer is $3,100.

Journalize the sale of the equipment, assuming straight-line depreciation was used.

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Journal Entry


Jan 1 Computer equipment (new) 3,100

Accumulated depreciation (old) 2,000

Computer equipment (old) 2,600

Cash 2,500


Account for natural resources

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Plant assets coming from the earthIn or on the groundExamples: Iron ore, oil, natural gas, diamonds, coal, and timber

Expensed through depletionDepletion expense–the portion of the cost used upComputed by the units-of-production method

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Formula

Estimated total units equals amount to reasonably removeCost–Residual value equals value to be depletedAs resources sold, costs are moved to Depletion expense

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Accumulated depletion–a contra account similar to Accumulated depreciation.Reported on the balance sheet similar to other depreciable assets

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TexAm Petroleum holds huge reserves of oil and gas assets. Assume that at the end of 2012, TexAm Petroleum’s cost of oil and gas reserves totaled $72,000,000,000, representing 8,000,000,000 barrels of oil and gas.

1.Which depreciation method does TexAm Petroleum use to compute depletion?

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Units-of-production is the depreciation method used to compute depreciation.


(Continued)

2. Suppose TexAm Petroleum removed 400,000,000 barrels of oil during 2013. Journalize depletion expense for 2013.

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Journal Entry


Dec 31 Depletion expense 3,600,000,000

Accumulated depreciation 3,600,000,000


Account for intangible assets

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Non-current assets with no physical formProvide exclusive rights or privilegesExpensed through amortization using the straight-line method

Credit to the asset directlyIf intangible has indefinite life, it is not amortized

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CR


Exclusive 20-year right to

produce & sell an invention

Amortized over its useful life

Exclusive right to sell a book,

musical work, film, art, software,

or intellectual property (70 years

beyond the authors life)


Represent distinctive products or

servicesNike - swoosh,

Chevrolet – “Like a Rock”


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Patent Copyright Trademarks - brand names

Issued by the federal government


Franchises & licenses

Privilege to sell goods or services under specific

conditions

Examples: McDonalds, Holiday Inn,

Dallas Cowboys


Goodwill

Excess of cost to purchase another

company over market value of its net assets

Recorded only by an acquiring company

Goodwill is notamortized, current value

is adjusted


Important to several industriesPharmaceutical companiesExamples: Procter & Gamble, General Electric, Intel, and Boeing

Not an intangibleExpensed as incurred

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When one media company buys another, goodwill is often the most costly asset. TMC Advertising paid $170,000 to acquire Seacoast Report, a weekly advertising paper. At the time of the acquisition, Seacoast Report’s balance sheet reported total assets of $130,000 and liabilities of $70,000. The fair market value of Seacoast Report’s assets was $100,000.

1.How much goodwill did TMC Advertising purchase as part of the acquisition of Seacoast Report?

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$170,000 – ($100,000 – $70,000) = $140,000


(Continued)

2. Journalize TMC Advertising’s acquisition of Seacoast Report.

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Journal Entry


Assets 100,000

Goodwill 140,000

Liabilities 70,000

Cash 170,000


Describe ethical issues related to plant assets

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CapitalizeResults in higher asset value and larger net incomeLooks better to investorsIf cost provides a future benefit, then capitalize

ExpenseResults in lower net incomeLess taxesIf cost does not provide a future benefit, then expense

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All costs spent to ready an asset to perform its intended function are capitalized (debited to the asset account). All repairs that neither extend the asset’s life nor improve its efficiency are expensed.Depreciation recovers the cost invested in an asset over the asset’s useful life. In this section we illustrated three methods: straight-line, UOP, and double-declining-balance. Although the three methods allocate the cost differently, when the asset’s life is over, the net book value is always equal to the asset’s residual value. Asset impairments also can reduce the value recorded on the books for the asset. Impairments recognize decline in an asset’s value for issues other than normal depreciation.


Asset trades or disposals are as common as asset acquisitions. The key to recording the trade/disposal is to first make sure the depreciation is current on the asset. Then, record the value of items given up or received in the trade/disposal based on whether the trade is like-kind (no gain/loss) or not (potential gain/loss).Depletion is the word we use instead of depreciation to attach to recovering the cost of natural resources. UOP is the most common method used in depletion accounting.

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Intangible assets are assets whose value is not represented by their physical form but from their original creativity. The cost invested in intangibles is recovered using amortization, usually using the straight-line method since the intangible’s life is the best measure of its decline in value.Ethical issues regarding the recording of assets should revolve around the definition of an asset. That is, does this item provide future economic benefit? If so, it’s an asset.

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Copyright

All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of the publisher. Printed in the United States of America.

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Plant Assets and Intangibles

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