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Submitted to:
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Group No. 09
Section A BBA 18th Batch Department of Finance University of Dhaka
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GROUP PROFILE
Group No. 09 Section A BBA 18th Batch Department of Finance University of Dhaka
SL No. 01. 02. 03. 04. 05. 06. 07. 08. Farhana Islam Ajanta Khandakar Fazle Rabbi Farid Molla Sadia Sharmin Bristy Md. Nowshad Molla Sirazum Munira Haque Noor Mohammad Md. Zobayer Hossain
Name
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LETTER OF TRANSMITTAL
April 23, 2012 Ms. Nusrat Khan Lecturer Department of Finance University of Dhaka
This report has also given us an opportunity to sharpen our views, ideas, and communication skills which will be a good head start for our future professional career.
We have tried our best to put up a good report with as much information as we could gather during the short time span allotted for writing this report. Thank you for your kind support and help throughout the course, we remain. We hope you will appreciate this sincere effort. Sincerely, Group: 09 Sec: A, 18TH Batch (BBA) Department of Finance, University of Dhaka.
Name Farhana Islam Ajanta Khandakar Fazle Rabbi Farid Molla Sadia Sharmin Bristy Md. Nowshad Molla Sirazum Munira Haque Noor Mohammad
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Signature
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18-141
Table of Contents
Topics Page No.
Executive Summary 06 Plant and Equipment..07 Plant Assets Compared to Other Types of Assets ....07 Cost of a plant Asset .......08-09 Nature of Depreciation ..09 Service Life of a Plant Asset..10 Salvage Value....10-11 Allocating Depreciation ....11-14 Depreciation For Partial Years14 Depreciation On the Balance Sheet 15 Revising Depreciation Rates .15-16 Accelerated Depreciation...16-18 Revenue And Capital Expenditures...18-20 Plant Asset Disposals.....20-21 Exchanging Plant Assets21-24 Using The Information Total Asset Turnover25-26 Problem Solve....27-28 Conclusion & Findings29 Bibliography30
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Executive Summary:
Plant assets are long-lived assets acquired for use in the business and not for resale to customers. The matching principle of accounting requires that we include in the plant and equipment accounts those costs that will provide services over a period of years. During these years, the use of the plant assets contributes to the earning of revenues. The cost of a plant asset includes all expenditures reasonable and necessary in acquiring the asset and placing it in a position and condition for use in the operations of the business. The cost of a plant asset is allocated among the service life of that asset. This process is called depreciation. There are basically three ways of recording depreciation. They are:
1) Straight-line method: Straight-line depreciation assigns an equal portion of an asset's
relatively high) depreciation rate is applied to the remaining book value of the asset.
3) Units of output method: The depreciation is calculated on the usage of the asset.
Capital and revenue expenditures are related with plant assets. Capital expenditures include any material expenditure that will benefit several accounting periods. Therefore, these expenditures are charged to asset accounts (capitalized) and are recognized as expense in future periods. Revenue expenditures are charged directly to expense accounts because either (1) there is no objective evidence of future benefits or (2) the amounts are immaterial. When plant assets are disposed of, depreciation should be recorded to the date of disposal. The cost is then removed from the asset account and the total recorded depreciation is removed from the accumulated depreciation account. The sale of a plant asset at a price above or below book value results in a gain or loss to be reported in the income statement. Because different depreciation methods are used for income tax purposes, the gain or loss reported in income tax returns may differ from that shown in the income statement. It is the gain or loss shown in the financial statement that is recorded in the company's general ledger accounts. Most companies that prepare financial statements in conformity with generally accepted accounting principles use the straight-line method of depreciation. Other accepted methods
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include the units-of-output method, sum-of-the-years' digits, and in rare circumstances, decelerated depreciation methods.
The main difference between plant assets and merchandise is that plant assets are held for use while merchandise is held for sale. For example, a business that buys a computer for the purpose of reselling it should report the computer on the balance sheet as merchandise inventory. If the same retailer owns another computer that is used to account for business operations and to prepare reports, it is classified as plant and equipment. The characteristic that distinguishes plant assets from current assets is the length of their useful lives. For example, supplies are usually consumed within a short time after they are placed in use. Thus their cost is assigned to the single period in which they are used. By comparison, plant assets have longer useful lives that extend over more than one accounting period. Plant assets are also different than the items that are reported on the balance sheet as long-term investments. Although both are held for more than one accounting period, long-term investments are not used in the primary operations in the business. For example, land is held for future expansion is classified as a long-term investment. On the other hand, land on which the companys factory is located is a plant asset. In addition, standby equipment held for use in case
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of a breakdown or during peak periods of production is a plant asset. However, equipment that is removed from service and held for sale is no longer considered a plant asset.
Land Improvements
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Land improvements are structural additions made to land. Examples are driveways, parking lots, fences, landscaping, and underground sprinklers. The cost of land improvements includes all expenditures necessary to make the improvements ready for their intended use.
Buildings Buildings are facilities used in operations, such as stores, offices, factories, ware-houses, and airplane hangers. When a building is purchased, such costs include the purchase price, closing costs, and real estate brokers commissions. Cost to make the building ready for use include expenditures for remodeling and replacing or repairing the roof, floors, electrical wiring and plumbing. When a new building is constructed, cost consists of the contract price plus payments for architects fees, building permits, and excavation costs. Equipment Equipment includes assets used in operations, such as store check-out counters, office furniture, factory machinery, delivery trucks and airplanes. The cost of equipment, such as renta-wreck, vehicles, consists of the cash purchase price, sales taxes, freight charges, and insurance during transit paid by the purchaser. It also includes expenditures required in assembling, installing and testing the unit.
Nature of Depreciation:
The expiration of a plant assets quantity of usefulness is generally described as depreciation. In accounting, this term describes the process of allocating and charging the cost of the usefulness to the accounting period that benefit from the assets use. For example, when a company buys an automobile for use as a plant asset, it acquires a quantity of usefulness in the sense that it obtains a quantity of transportation. The total cost of the transportation is the cost of the car less the expected proceeds to be received when the car is sold or traded in at the end of its service life. The net cost must be allocated to the accounting periods that benefit from the cars use. In other words, the assets cost must be depreciated. Under generally accepted accounting principles, depreciation is a process of allocating a plant assets cost to income statements of the years in which it is used.
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During a depreciable asset's useful life its revenue-producing ability declines because of wear and tear. When the capacity of an assets become too limited for the productive demands of the business it is called Inadequacy. Obsolescence is the process by which an asset becomes out of date before it physically wears out.
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If you expect an asset to be traded in on a new asset, the salvage value is the expected trade- in-value . Sometimes, a company incur additional costs to dispose of plant assets. In this case, the estimated salvage value is the expected proceeds from the sale of the asset less the additional costs.
Example: A company may plan to clean and paint an old machine before offering it for sale.
Allocating Depreciation:
Depreciation is the process of allocating the cost of a plant asset to expense in the accounting periods that benefit from its use.
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Straight-line method: Charges the same amount of expense to each period of the assets useful life. Two Step Process 1. compute the depreciable cost of the asset. 2. depreciable cost is divided by the number of accounting periods in the assets useful life. Example: An asset purchased by Bill's Pizzas on January 1, 2007. Cost $13,000 Expected salvage value $1,000 Estimated useful life (in years) 5 Illustration 1 shows the computation of depreciation expense in the first year for Bill's Pizzas' asset.
Illustration 1
At present, most companies use the straight-line method of depreciation in their financial accounting records for presentation in their financial statements. For example, such large companies as Campbell Soup, Marriott, and General Mills use the straight-line method. It is simple to apply, and it matches expenses with revenues appropriately when the use of the asset is reasonably uniform throughout the service life.
Bills Pizzas Computation Year 2007 2008 2009 2010 2011 End of Year Accumulated Depreciation $2,400 $4,800 $7,200 $9,600 $12,000 Book Value $10,600 $8,200 $5,800 $3,400 $1,000
Depreciable * Depreciation = Annual Depraciartion Cost Rate Expense $12,000 20% $2,400 $12,000 20% $2,400 $12,000 20% $2,400 $12,000 20% $2,400 $12,000 20% $2,400
Illustration 2
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Note that the depreciation expense of $2,400 is the same each year. The book value at the end of the useful life is equal to the estimated $1,000 salvage value.
Units-of-Production Method: Charges a varying amount to expense for each period of an assets useful life depending on its usage. Examples of capacity measurements: miles driven, product outputs, hours used.
Two steps process 1. Compute depreciation per unit 2. Compute depreciation expense for the period Example: A small delivery truck purchased by Bill's Pizzas on January 1, 2007. Cost $13,000 Expected salvage value $1,000 Estimated useful life (in miles) 100,000 Illustration 3 shows the computation of depreciation expense in the first year for Bill's Pizzas' asset. Step 1 Depre. Per unit= Cost Salvage value total units of mileage = $13,000- $1,000 100,000 miles = 0.12 miles
Step 2 Depre. Expense= Depre. Per unit * Units produced in period 0.12 miles * 15,000 miles = $1,800 Illustration 3 Formula For Units-of-Production Method
The units-of-activity method is ideally suited to factory machinery: Companies can measure production in terms of units of output or in terms of machine hours used in operating the machinery. It is also possible to use the method for such items as delivery equipment (miles driven) and airplanes (hours in use). The units-of-activity method is generally not suitable for such assets as buildings or furniture because activity levels are difficult to measure for these assets. Illustration 4 shows depreciation over the five-year life based on an assumed mileage pattern. The appendix that follows presents the computations used to arrive at these results:
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Bills Pizzas Year 2007 2008 2009 2010 2011 Units of Activity $15,000 $30,000 $20,000 $25,000 $10,000 Illustration 4 Annual Depraciartion Expense $1,800 $3,600 $2,400 $3,000 $1,200 Accumulated Depreciation $1,800 $5,400 $7,800 $10,800 $12,000 Book Value $11,200 $7,600 $5,200 $2,200 $1,000
DEPRECIATION FORMULAS
STRAIGHT LINE
UNITS OF PRODUCTION
1) Calculate Depreciation/unit = Cost Estimated Salvage Total Units of Production 2) Calculate Depreciation Expense = Depreciation/unit * units produced in period
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machine for the part of the year. Using straight-line depreciation method the six month depreciation of $1000 is calculated as follows:
Plant and equipment Land and building Machinery and equipment Office furniture and equipment Leasehold improvement
205 $1492
237 $1452
781 711
785 667
Notice that Sharif reported only the total amount of accumulated depreciation for all plant and equipment. This the usual practice in published financial statement. To satisfy full disclosure principle, companies also describe the depreciation method.
A revision of the predicted useful life of a plant asset is an example of Change in accounting Principle
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from the asset's use with the firm. When a firm decides to change its depreciation on an asset, the Financial Accounting Standards Board considers this a change in accounting estimate. Changes in accounting estimates are treated prospectively and do not affect any previous financial statements. Instructions
1.
Calculate the book value of the asset at the time of the change in depreciation. For example, a firm buys an asset for $50,000 with no residual value, a five-year useful life and the firm uses straight-line depreciation. After three years, the firm decides the asset has a $4,000 residual value. The book value after three years is the cost, $50,000, minus total accumulated depreciation, $30,000, which equals a $20,000 book value.
2. Recalculate the new depreciation with the revised depreciation figures. In the example, $20,000 minus $4,000 divided by 2 years, which equals a new depreciation of $8,000 per year.
3. Debit Depreciation Expense and credit Accumulated Depreciation for the amount of the new depreciation for the year. In the example, debit Depreciation Expense $8,000 and Accumulated Depreciation $8,000 to record depreciation for Year 4.
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Declining Balance Method Uses a depreciation rate that is a multiple of the straight line rate and applies it to the assets beginning of period book value. DDB in three steps 1. compute the assets straight line depre. Rate 2. double the straight line rate 3. compute depreciation expense; by multiplying this rate by the assets beginning of period book value. Step 1 Straight line rate= 100% / Useful life = 100% / 5 years = 20% Step 2 Double declining balance rate= 2 * straight line rate = 2 * 20% = 40% Step 3 Depreciation expense= DDBR * Beginning period book value 40%* $10,000 = $4,000 (for 2004) Example: An asset costing $20,000 has estimated useful life of 5 years and salvage value of $4,500. Calculate the depreciation for the first year of its life using double declining balance method. Solution Straight-line Depreciation Rate Declining Balance Rate = Depreciation = 40% $20,000 = $8,000 = 2 1/5 = 0.2 20% = = 20% 40%
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Asset class
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Year 1 2 3 4 5 6 7 8
100.00%
The information in the financial statement is affected for several years by the choice made between recording costs as revenue expenditures or as capital expenditures. Managers must be careful in deciding how to classify them. In making these decisions, it is hopeful to identify the items as follows: ordinary repairs, extraordinary repairs, betterments etc.The short description of these items are given bellow: Ordinary repairs: repairs made to keep a plant asset in normal ,good operating condition, treaded as a revenue expenditure. For example: machine must be clean, lubricate, and adjusted and small parts must be replaced when they wear out. These ordinary repairs typically are made every year, and accounts treat
2,100 2,100
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them as revenue expenditures. Extraordinary repairs: major repairs that extend the service life of a plant asset beyond original expectations; treated as capital expenditure. For example: a machine was purchased for $8,000 and depreciated under the assumption it would last eight years and have no salvage value. At the beginning of the machines seventh year, when the machines book value is $2,000, it is given a major overhaul at a cost of 18,000 Machinery Jan-2 Cash (To record the installation of the automatic control system) $2,100.The overhaul extends the machines estimated useful life tree years. Thus, the company now predicts that the machine will be used more five years. The $2,100 cost of the extraordinary repairs should be recorded as follows: This entry increases the book value of the asset from $2000 to $4,100.For the remaining five years of the asset life. Depreciation should be based on this new book value. Betterments: A modification to an asset to make it more efficient, usually by replacing one of its components with an improved or superior component. For example: Suppose that a company paid $80,000 for a machine with an eight year service life and no salvage value. On January 2, after three years and $30,000 of depreciation, it adds to automatic control system to the machine at a cost of $18,000. As a result, the companys labor cost to operate the machine in future period will be reduced. The cost of betterment is added to the machinery account with the entry: 18,000
At this point, the remaining cost to be depreciated is &80,000+$18,000&30,000=$68,000.Because five years remain in the useful life, the annual depreciation expense hereafter will be $13,600 per year ($68,000/5 years).
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Assume the owner of the machine carried insurance against fire loses and received a $4,400 cash settlement for the loss. The following entry records the loss of the machine and the cash settlement:
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Jan-25
Cash Loss on fire Accumulated depreciation, machinery Machinery (To record the destruction of machinery, the receipt of insurance settlement. and the net loss resulting from the fife)
Notice that the two entries accomplish all four of the necessary changes that occurred as a result of the asset disposal. Of course, an asset disposal might involve a gain instead of a loss. Also a disposal might involve a cash payment instead of a receipt. Regardless of the specific facts, entries similar to these must be made so that income statement shows any gain or loss resulting from the disposal and the balance sheet reflects the necessary changes in the asset and accumulated depreciation accounts.
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If Gain: Only recognize if assets are dissimilar Steps of recording Plant asset exchanges: 1. Update depreciation 2. Compute gain or loss by comparing book value of asset given up with the fair value of asset given up 3. Prepare journal entry to record the transaction
Dissimilar assets: Gains and losses are always recognized when the exchange involves dissimilar assets Example 1: on May 31, 2006, ABC company exchanged a used Airplane and $25000 for a new truck worth $31000. The Airplane originally cost $50000, had accumulated depreciation of $40000, and a fair value of $6000. The exchange results in: Cost Accumulated depreciation Book value Fair value Loss Journal: Truck Accumulated depreciation Loss on exchange Airplane Cash 31000 40000 4000 50000 25000 $50000 40000 $10000 6000 $ 4000
Example 2: On June 30,2007, ABC company exchanged equipment and $30000 for land worth $130000. The equipment originally cost $200000, had up to date accumulated depreciation of $120000 and a fair value of $100000.
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The exchange results in: Cost Accumulated Depreciation Book value Fair value Gain Journal: Land Accumulated Depreciation Gain on exchange Equipment Cash To record exchange of equipment 130000 120000 20000 200000 30000 $200000 120000 80000 100000 $ 20000
Similar Assets: When the exchange involves similar assets, losses are always recognized, but gains are never recognized. Example 1: On May 30,2009, Huge Company exchanged a used airplane and $35000 cash for a new airplane worth $39000. The old airplane originally cost $40000. had up to date accumulated depreciation of $30000, and a fair value of $4000. The exchange results in: Cost Accumulated depreciation Book value Fair value Loss Journal: New Airplane Accumulated Depreciation Loss on exchange Old Airplane Cash 39000 30000 6000 40000 35000
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Example 2: On July 1, 2009 Huge Company exchanged a used airplane and $100000 cash for a new Airplane. The old airplane originally cost $4000000, had up to date accumulated depreciation of $3000000 and a fair value of $1400000. The exchange indicates a gain of: Cost Accumulated Depreciation Book value Fair value Indicated gain Journal: New Airplane Accumulated Depreciation Old Airplane Cash 1100000 3000000 4000000 100000 $4000000 3000000 1000000 1400000 $ 400000
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Related Definition Asset A resource with economic value that an individual, corporation or country owns or controls with the expectation that it will provide future benefit. 2. A balance sheet item. Inventory Turnover A ratio showing how many times a company's inventory is sold and replaced over a period. The days in the period can then be divided by the inventory turnover formula to calculate the inventory turnover. Turnover 1. In accounting, the number of times an asset is replaced during a financial period. 2. The number of shares traded for a period as a percentage of the total shares in a portfolio.
Net Sales The amount of sales generated by a company after the deduction of returns, allowances for damaged or missing goods and any discounts allowed. The sales number reported on a company's ... Average Total Asset "Average Total Assets" is the average of the values of "Total assets" from the company' balance sheet in the beginning and the end of the fiscal period.
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There are several general rules that should be kept in mind when calculating asset turnover. First, asset turnover is meant to measure a company's efficiency in using its assets. The higher the number, the better, although investors must be sure compare a business to its industry. It is fallacy to compare completely unrelated businesses. The higher a company's asset turnover, the lower its profit margin tends to be (and visa vesa)
In 2001 , Alcoa (Aluminum Company of America) had a beginning assets of $28,355,000,000 and a ending assets of $31,691,000,000 , meaning there were average assets of $30,023,000,000 ($28.355 billion + $31.691 billion divided by 2 = $30.023 billion). In 2001, the company generated revenue of $22,859,000,000. When applied to the asset turnover formula, we find that Alcoa had a turn rate of .76138. That tells you that for every $1 in assets Alcoa owned during 2001, it sold $.76 worth of goods and services. $22,859,000,000 revenue $30,023,000,000 average assets for period = .76138, or $0.76 for every $1 in revenue.
Problem Solve:
On January 1, 20X1, The Daylight Bakery purchased a new production oven. The oven has an expected life of 6 years. The system cost $230000. shipping, installation and set up was an additional $40000. At the end of the useful life, the company expects to dispose of the oven for $54000. They further anticipates total output of 24000000 loaves of bread over the useful life.
a) Assuming the use of straight-line depreciation method, prepare a schedule showing annual depreciation expense, accumulated depreciation and related calculations for each year. b) Assuming use of the units-of-output depreciation method, prepare a schedule showing annual depreciation expense, accumulated depreciation and related calculations for each
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year. Actual output in bottles was 320000 (20X1), 360000 (20X2), 400000 (20X3), 420000 (20X4), 460000(20X5) and 440000 (20X6). c) Assuming use of the double-declining balance depreciation method, prepare a schedule showing annual depreciation expense, accumulated depreciation and related calculations for each year. d) Assuming use of the straight-line method, prepare revised depreciation calculations if the useful life estimate was revised at the beginning of 20X4, to anticipate a remaining useful life of 4 additional years ( in other words, a total life of 7 years). The revised useful life was accompanied by a change in estimated salvage value to $27000. Solution Straight-line Accumulated Year Annual Expense X1 0 X2 0 X3 0 X4 0 X5 0 X6 0 $3600 $3600 $3600 $3600 $3600 $3600 Accumulated depreciation $36000 $72000 $108000 $144000 $180000 $216000
Ye ar X1 X2
Units of Output Accumulated Annual Expense $28800 $32400 Accumulated Depreciation Annual expense Calculation (270000$28800 54000)*320000/240000 (270000$61200 54000)*360000/240000
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Ye ar X1 X2 X3 X4 X5 X6
Double-declining balance Annual expense Accumulated Annual expense depreciation calculation At the end of the year 90000 90000 270000*33.33% 60000 150000 (27000090000)*33.33% 40000 190000 (270000150000-)*3 3.33% 26000 216000 (270000190000)*33.33% 0 216000 n/a 0 216000 n/a
The amount calculated for year X4 (26667) would cause a accumulated depreciation to exceed the depreciable base (216000) and depreciation expense is therefore capped (26000). Straight-line revised Accumulated Ye ar X1 X2 X3 X4 X5 Annual expense 36000 36000 36000 33750 33750 Accumulated Annual Expense Depreciation calculation At the year end 36000 (270000-54000) / 6 72000 (270000-54000) / 6 108000 (270000-54000) / 6 141750 (270000-10800027000) / 4 175500 (270000-10800029
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X6 X7
33750 33750
Conclusion &Findings
This chapter primarily discusses the recording process of plant and equipment in financial statements. These plant and equipment represent a major category of investment by business. Learning fundamental concepts of accounting for plant and equipment will enable one to recognize the direct financial statement impact of business activities like purchasing allocating depreciation disposal and betterment of plant and equipments. By studying this chapter we learned to distinguish plant and equipment from other type of assets, how to determine their cost and how companies allocate their costs to the periods that benefit from their use. In future while working as an accountant or manager in a company this knowledge will come handy and will definitely help us to treat plants, assets and equipments properly in financial statements. Plants and equipments are distinguished from other types of assets. When a plant asset is purchased it is recorded at cost and this cost includes all normal and reasonable expenditures to get the asset in place and ready to use. Definition of the terms depreciation, service life, inadequacy, salvage value, obsolescence etc. Different methods of depreciation and their impact on financial statements. Accelerated depreciation for tax purpose method MACRS method. Difference among ordinary repairs and extra ordinary repairs and betterments. Processing plant assets with low costs. Exchange of similar assets and dissimilar assets and their recording procedure. Plant and assets disposal process. Total asset turnover ratio to measure the efficiency of using plant and assets.
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B I B L I O G R A P H Y
We have prepared our report by collecting data and take help from the Following sources Essential of financial Accounting- Kermit D. Larson Long-term assets- Larry M. Walther; Christopher J. Skousen Financial and Managerial Accounting- The Basis for Business Decisions, 12/e Jan R. Williams, University of Tennessee Susan F. Haka, Michigan State University Mark S. Bettner, Bucknell University Robert F. Meigs
Principle of Accounting- Belverd E. Needles, Marian Powers, Susan V. Crosson in Books Accounting Principles by Jerry J. Weygandt, Paul D. Kimmel, Barbara Trenholm, Donald E. Kieso
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