ACCOUNTING 101 CHAPTER 8: LONG-TERM ASSETS

Plant assets
Plant assets, also known as fixed assets or property, plant and equipment, have three defining characteristics. They are 1. Tangible 2. sed in business operations, and

!. "ave useful lives greater than one year. #n $hapter %, we will study the lifecycle of a plant asset. The lifecycle of a plant asset can be summari&ed as follows' 1. The purchase of a plant asset and determining its cost 2. The allocation of the plant asset(s cost to the periods benefitted )depreciation* !. +ccounting for repairs and improvements to the plant asset ,. +ccounting for the disposal of the plant asset. Determinin t!e "#st #$ a %lant asset Plant assets are recorded at cost. This is consistent with the cost principle. $osts include not only the purchase price, but all costs necessary to get the plant asset ready for its intended use. The following summari&es many of the expenditures that are capitalized )added to the purchase price of the plant asset* to determine the cost of the plant asset. Plant asset -and Capitalized costs Purchase price. real estate commissions. title fees. legal fees. accrued property taxes paid by the buyer. $osts paid for surveying, grading, and removing existing structures are also capitali&ed. $osts for parking lot surfaces, driveways, fencing, plants and shrubs, and lighting systems. Purchase price. brokerage fees, taxes, title fees, attorney fees, and necessary renovations. 0esign or architectural fees are also capitali&ed. Purchase price, taxes, freight, and installation and testing the equipment. #n a lump sum purchase, various assets are
1

-and improvements /uildings

1achinery and 2quipment -ump34um Purchase

purchased for a single price. $osts are allocated to each asset based on relative market values. +ny costs paid to repair assets damaged during installation are recorded as expense. De%re"iati#n Met!#&s The factors that determine depreciation are cost, salvage value and useful life. The three most widely used methods that are acceptable under generally accepted accounting principles are )1* the straight3line method, )2* the units3 of3 production method, and )!* the declining3balance method. They are described below. Straight-Line Method The same amount of depreciation expense is charged each full year the asset is used. Units-of-Production Method + different amount of depreciation is recorded depending on the plant asset(s usage. Declining-Balance Method This method is called an accelerated method as it results in more depreciation expense in the early years of a plant asset(s life and less depreciation in the latter years of its life. + three3step process is needed to compute depreciation' )1* $alculate the straight3 line rate )percentage* )2* 0ouble the straight3 line rate )percentage* )!* 1ultiply the rate )percentage* determined in step 2 by the asset(s book value. The book value is its cost less accumulated depreciation. 4alvage value is not considered. "owever, depreciation stops once the book value equals the salvage value.

The formula for straight3line depreciation is' )$ost34avage 5alue* divided by useful life in periods.

+ two3step process is needed to compute depreciation' )1* $alculate depreciation per unit' )$ost34alvage 5alue* divided by total units of production. )2* 1ultiply depreciation per unit by the number of units produced.

E'am%le: 6n 7anuary 1( "ori&on $orporation installs a machine costing 89:,;;;. The machine has an estimated useful life of ten years, or ,2;,;;; units of product, and a 8,,;;; salvage value. 0uring the year, the machine produced 2<,<;; units of product. 0epreciation for the year ended 0ecember !1using each of these methods would be calculated as follows. 4traight3line' )89:,;;; 3 8,,;;;* = 1; > 89,!;; nits of Production' )1* 0epreciation per unit > )89:,;;; 3 8,,;;;*=,2;,;;; units > 8.1? )2* 0epreciation expense > 8.1? @ 2<,<;; units produced > 8,,,%? 0ouble30eclining /alance' )1* 4traight3line rate > 1=1; years > 1;A )2* 0eclining balance rate > 1;A @ 2 > 2;A )!* 0epreciation expense > 2;A @ /ook 5alue > 2;A @ )89:,;;; 3 8; accumulated depreciation* > 2;A @ 89:,;;; > 81!,,;; 0epreciation is recorded with a debit to 0epreciation 2xpense and a credit to a contra3asset account called +ccumulated 0epreciation. #f management changes its estimated useful life or estimated salvage value of a plant asset, the change is accounted for as a change in accounting estimate. 0epreciation in the years following the change in estimate would be calculated as follows' /ook value in year of change in estimate B revised salvage value = Cevised remaining life A&&iti#nal e'%en&it)res The accounting for costs to maintain, repair, or improve plant and equipment is summari&ed below. 6rdinary repairs and maintenance, sometimes called revenue expenditures, are recorded as expense. #mprovements )betterments* are expenditures to make a plant asset more efficient or productive. They are capitali&ed )added to the cost of the plant asset*. 2xtraordinary repairs extend the asset(s life beyond its original estimated useful life. Their costs are capitali&ed or charged to accumulated depreciation.

Dis%#sals #$ %lant assets + plant asset may be disposed of in three ways' 1. 0iscarded, with no cash received 2. 4old for cash !. Traded in #n +$$T 1;1 we will review the accounting for assets discarded or sold for cash. +ccounting for assets traded in will not be covered. The accounting for plant asset disposals requires two Dournal entries' 6ne to bring depreciation up to date and )2* a second Dournal entry to record the disposal. pon disposal, the plant asset(s cost and related accumulated depreciation should be removed from the books. +ny cash received is recorded. #f the cash received is greater than the book value of the asset disposed, the company will record a gain. #f the cash received is less than the book value of the asset disposed, the company will record a loss. These gains or losses are reported as E6ther #ncome Eor E6ther 2xpense,F respectively, in the income statement. E'am%le: + company owns equipment that cost 8%,;;;, and that had accumulated depreciation of 89,;;; as of 7anuary 1. This equipment is depreciated at a rate of 81,;;; annually. 6n 7uly 1, it is sold for 8!,?;; cash. +fter depreciation is updated, the equipment has a book value of 81,?;; )cost of 8%,;;; less accumulated depreciation of 89,?;;*. The company would record a gain of 82,;;; )cash received of 8!,?;; less book value of 81,?;;*. The necessary Dournal entries to bring depreciation up to date and to record the sale would be'

7uly 1 0epreciation 2xpense +ccumulated 0epreciation )1=2 year @ 81,;;; annual depreciation* 7uly 1 $ash +ccumulated 0epreciation )89,;;; G 8?;;* 2quipment )cost* Hain on 0isposal of 2quipment

?;; ?;;

!,?;; 9,?;; %,;;; 2,;;;

Nat)ral Res#)r"es +ssets that are physically consumed when used are called natural resources. They include timber, mineral deposits such as copper, and oil and gas. +ll costs necessary to acquire the natural resource asset, and prepare it for its intended use, are capitali&ed. 6nce activity begins, the natural resource asset is depleted on the books. 0epletion is similar to depreciation for fixed assets. Iatural resource assets are depleted using the units3of3 production method discussed earlier. The Dournal entry to record depletion debits 0epletion 2xpense and credits +ccumulated 0epletion. Intan i*le Assets #ntangible assets are nonphysical assets, used in operations, which provide rights, privileges, or competitive advantage to their owners. Jor example, a patent issued by the federal government gives the patent holder an exclusive right to sell the product under patent. #f the intangible asset has a limited life, it is amortized over that life. +morti&ation is similar to depreciation for fixed assets. #ntangible assets are amorti&ed using the straight3line method. The Dournal entry to record amorti&ation debits +morti&ation 2xpense and credits +ccumulated +morti&ation. The following intangible assets are amorti&ed. Intangible asset Patent Description +n exclusive right granted to the patent holder to sell a patented item. The maximum legal life of a patent is 2; years. +n exclusive right to publish and sell a musical, literary or artistic work. Cights given by a company to deliver a product of service, under specified conditions. 2xamples include Pi&&a "ut and 1c0onald(s. 1ost franchise agreements have limited lives. #mprovements to leased property.

$opyrights Jranchises and -icenses

-easehold improvements

4ome intangible assets do not have a limited life. Jor example, a trademark, such as the Iike Eswoosh,F gives Iike the exclusive right to use the swoosh on its products and in its marketing. +lthough the trademark has a limited life, it is easily renewable and is not amorti&ed. +nother intangible that is not amorti&ed is goodwill. Hoodwill is recorded when one company purchases another company. Hoodwill is calculated as the cost paid to purchase the company, less the acquired company(s net asset values. Jor example, if Parent $ompany paid 81,;;;,;;; to acquire 4ubsidiary $ompany(s net assets of 8<;;,;;;, the remaining 81;;,;;; would be recorded as Hoodwill on Parent $ompany(s books. Hoodwill is not amorti&ed but is tested for impairment, a subDect covered in #ntermediate +ccounting courses.