Chapter 1

Plant Assets

Natural Resources

Intangible Assets

Depreciation

Depletion

Amortization

Held for use in business Full cost includes several expenditures Last several years Can be sold or traded in

LO1 - Measure the cost of a plant asset The Cost Principle

Land

Land improvements

Buildings

Machinery & equipment

Furniture & fixtures

NOT depreciated Costs included in Land

Purchase price Brokerage fees Survey and legal fees Property taxes in arrears Title transfer Costs of clearing and removing unwanted buildings

Subject to depreciation Examples:

Fencing Paving Sprinkler systems Lighting Signs

Cost includes:
Purchase price Architectural fees Contractor charges Materials, labor, and overhead

If self-constructed, interest on loans may be included If existing structure is purchased, repairs and renovations are included

Cost includes:
Purchase price (less any discounts) Transportation charges Insurance while in transit Sales tax Installation costs Cost of testing before asset is used

Purchase price (less any discounts) Shipping charges Costs to assemble

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Company purchases a group of plant assets for a single price

Also called basket purchase

Assign cost to individual assets based on relative sales values

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Fair value

Percent

Allocated cost

Land Building Equipment

$75,000 $60,000 $15,000

50% 40% 10%

$70,000 $56,000 $14,000

Multiply percent by total cost of $140,000

Total

$150,000

100%

$140,000

Divide fair value of each asset by the total fair value of $150,000
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Capital expenditures

Expenses

Debited to an asset account Increase assets capacity of efficiency OR Extend useful life

Debited to an expense account Maintain asset in working order

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If a capital expenditure is incorrectly recorded as an expense:

Overstates expenses Understates net income Understates Capital Understates assets (equipment)
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Allocation of a plant assets cost to expense over its useful life Matches expense against revenue generated using the asset
$40,000 cost

10-year life

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Wear and tear from use Physical factors Obsolescence

Computers and other technology

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Cost Estimated useful life

Expressed in years, units, miles, or output

Estimated residual value

Also called salvage value Expected cash value at end of useful life

Cost

Useful Life

Residual Value

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Straightline

Units-of production

Decliningbalance

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(Cost residual value)

1 Life

# 12

Depreciation expense

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Increases over time

Cost

Accumulated depreciation

Book value
Decreases over time

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Depreciation per unit = (Cost Residual value) x 1 Life in units

Depreciation expense = Depreciation per unit x activity during the period

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Accelerated method
Writes off more depreciation near the start of an assets life

Residual value is not in formula

Ignored until last year

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(Cost Accumulated depreciation)

2 Life

# 12

Book value

Twice the straightline rate

Depreciation expense
Decreases over the assets life
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The cost of an equipment is $41,000. ABC Company expects the equipment to remain useful for 5 years (10,000 units) and to have a residual value of $1,000. The company expects the equipment to be used 3,000 units the first year; 2,500 units the second year; 2,000 units the third year; 1,500 units the fourth year and 1,000 units the fifth year. To compute depreciation for all 5 years using the straight-line method, Units-of- production method and Double-declining-balance method.

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Depreciation for the year

Value at the Year beginning of the year

Depreciation expense

Accumulated depreciation

Book value

1 2 3 4 5

$41,000 $33,000 $25,000 $17,000 $9,000

$8,000 $8,000 $8,000 $8,000 $8,000

$8,000 $16,000 $24,000 $32,000 $40,000

$33,000 $25,000 $17,000 $9,000 $1,000

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Depreciation for the year

Value at the Year beginning of the year

Depreciation expense

Accumulated depreciation

Book value

1 2 3 4 5

$41,000 $29,000 $19,000 $11,000 $5,000

$12,000 $10,000 $8,000 $6,000 $4,000

$12,000 $22,000 $30,000 $36,000 $40,000

$29,000 $19,000 $11,000 $5,000 $1,000

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Depreciation for the year Value at the Year beginning of the year Book value

Depreciation expense

Accumulated depreciation

1 2 3 4 5

$41,000 $33,000 $25,000 $17,000 $9,000

$16,400 $9,840 $5,904 $3,542 $4,314*

$8,000 $16,000 $24,000 $32,000 $40,000

$33,000 $25,000 $17,000 $9,000 $1,000

*Last-year depreciation is the plug figure needed to reduce book value to the residual value amount ($5,314 - $1,000 = $4,314).

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Cost = $50,000

Residual value = $5,000

Life = 5 years or 100,000 units

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Straight-line For assets that generate revenue over time

Units-ofproduction For assets that depreciate due to wear and tear

Double-decliningbalance For assets that produce more revenue in their early years

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Straight-line 1st year

(65,000,000 5,000,000) 1 4 12 12

$15,000,000 depreciation, 1st year

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Units-of-Production
1 (65,000,000 5,000,000) x 6,000,000 miles = $10 per mile

1.3 million miles x $10 per mile = $13,000,000 depreciation expense, 1st year

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Double-declining-balance 1st year ($65,000,000 - 0) 2 4 12 12

$32,500,000 depreciation expense, 1st year

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Cost Less: Accumulated depreciation Book value, using straight-line

$65,000,000 15,000,000 $50,000,000

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Considered a change in estimate Businesses must report on the reason and effect of the change Remaining asset book value is depreciated over the remaining life

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Asset has reached the end of its estimated life If still useful, a company will continue to use it Report book value on balance sheet Record no more depreciation Asset never reported below residual value

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Asset wears out or becomes obsolete. Company can:

Sell the asset for cash Scrap the asset for no cash Trade the asset for another asset
Non-like property exchange Like-kind exchange
Result in a gain or loss

No gain or loss

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Bring depreciation up to date Remove old asset from books

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

Record the value of any cash paid or received

If money is borrowed, credit Notes payable

Determine difference between total debits and total credits

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If asset was traded for a like-kind asset

Difference will be recorded as a debit to the new asset account

If the asset was sold or exchanged for a dissimilar asset

Gain or loss will be recorded

If debits > credits

If debits < credits

If debits = credits

GAIN

LOSS

NO GAIN OR LOSS
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On January 2, 2011, Ditto Clothing Consignments purchased showroom fixtures for $16,000 cash, expecting the fixtures to remain in service 5 years. Ditto has depreciated the fixtures on a double-declining-balance basis, with zero residual value.

On August 31, 2012, Ditto sold the fixtures for $7,600 cash.

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When a plant asset is sold during the year, depreciation must be updated. First-year double-declining-balance depreciation was computed by multiplying the book value (same as cost in year one) by 2 over the life of the asset. $16,000 x 2/5 = $6,400.

End of year book value equaled $9,600 ($16,000 - $6,400).

For 2012, the book value is multiplied by 2/5, resulting is $3,840 for a full year of depreciation. Since the sale took place on August 31, this amount is multiplied by 8/12. Depreciation expense is $2,560.
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GENERAL JOURNAL
DATE DESCRIPTION
REF

DEBIT

CREDIT

8 31

Depreciation expense Accumulated depreciation

2,560 2,560

Year

Depreciation expense $6,400 2,560

Accumulated depreciation 6,400 8,960

Book value $16,000

2011 2012

9,600 7,040

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GENERAL JOURNAL
DATE DESCRIPTION
REF

DEBIT

CREDIT

8 31

Cash Accumulated depreciation Fixtures Gain on sale of plant assets

7,600 8,960 16,000 560

Book value $16,000

Year

Depreciation expense $6,400 2,560

Accumulated depreciation 6,400 8,960

2011 2012

9,600 7,040
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Plant assets extracted from the natural environment

Iron, oil, coal

Expensed through depletion using the units-ofproduction method Accumulated depletion is a contra-asset account to the natural resource

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Depletion per unit =

(Cost Residual value) x

1
Estimated total units of natural resource

Depletion expense = Depletion per unit x number of units removed

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Non-current assets with no physical form Provide exclusive rights or privileges Expensed through amortization using the straightline method
Credit to the asset directly If intangible has indefinite life, it is not amortized

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Patent

Copyright

Trademarks and brand names

Exclusive 20year right to produce & sell an invention

Exclusive right to sell a book, musical work, film, art, software, or intellectual property

Represent distinctive products or services

Issued by the federal government

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Franchises & licenses Allows purchaser to sell goods or services under specific conditions

Goodwill Excess of the cost to purchase another company over the market value of its net assets

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Only recorded when a company purchases another business Not amortized

Current value measured each year
If value increases, no entry If value decreases, a loss is recorded

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Important to several industries, such as pharmaceutical companies Not an intangible

Expensed as incurred

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Capitalize Results in higher asset value and larger net income

Looks better to investors

Expense Results in lower net income

Less taxes

If cost provides a future benefit, then capitalize

If cost does not provide a future benefit, then expense

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