Chapter 10
Property, Plant & Equipment
Property, Plant & Equipment
•
Property, plant, and equipment includes land,
buildings, and equipment (machinery,
furniture, tools).
•
Major characteristics include:
“Used in operations” and not for resale.
Long-term in nature and usually depreciated.
Possess physical substance.
PP&E Historical Cost
• Valued at Historical Cost, reasons include:
At acquisition, cost reflects fair value.
Historical cost is reliable.
Companies should not anticipate gains and
losses but should recognize gains and losses
only when the asset is sold.
Cost of Land
• Includes all costs to acquire land and ready it for use.
Costs typically include:
(1)the purchase price;
(2)closing costs, such as title to the land, attorney’s fees,
and recording fees;
(3)costs of grading, filling, draining, and clearing;
(4)assumption of any liens, mortgages, or encumbrances
on the property; and
(5)Additional land improvements that have an indefinite
life.
Cost of Buildings
•
Includes all costs related directly to acquisition
or construction.
•
Costs typically include:
(1)materials, labor, and overhead costs incurred
during construction and
(2)professional fees and building permits.
Cost of Equipment
Include all costs incurred in acquiring the equipment
and preparing it for use.
• Costs typically include:
(1)purchase price,
(2)freight and handling charges
(3)insurance on the equipment while in transit,
(4)cost of special foundations if required,
(5)assembling and installation costs, and
(6)costs of conducting trial runs.
•
Acquisition Costs
(a) Money borrowed to pay building contractor : Notes
Payable
(b) Payment for construction from note proceeds: Buildings
(c) Cost of land fill and clearing: Land
(d) Delinquent real estate taxes on property assumed: Land
(e) Premium on insurance policy during construction:
Buildings
(f) Refund of 1-month insurance premium because
construction completed early: (Buildings)
Acquisition Costs
•
•
(g) Architect’s fee on building: Buildings
(h)
Cost of real estate purchased as a plant site (land
$200,000 and building $50,000): Land
• (i) Commission fee paid to real estate agency: Land
• (j) Installation of fences around property: Land
Improvements
• (k) Cost of razing and removing building: Land
(l) Proceeds from salvage of demolished building: (Land)
(m) Cost of parking lots and driveways: Land Improvements
(n) Cost of trees and shrubbery (permanent): Land
Self-constructed Assets
• Costs typically include:
(1) Materials and direct labor
(2) Overhead can be handled in two ways:
1. Assign no fixed overhead
2. Assign a portion of all overhead to the construction process.
– Companies use the second method extensively.
Interest Costs During Construction
• Three approaches have been suggested to account for
the interest incurred in financing the construction.
1. Capitalize no interest during construction
2. Capitalize actual costs incurred during construction
(GAAP)
3. Capitalize all cost of funds
GAAP requires — capitalizing actual interest (with
modification).
Consistent with historical cost — all costs incurred to
bring the asset to the condition for its intended use.
Interest Costs During Construction
• Richard Company begins construction on a
building early in 2008 and completes
construction by the end of the year. Richard
incurred total interest costs on borrowing during
2008 in the amount of $325,000. It determines
that $165,000 of these interest costs is
attributable to expenditures on the new building.
Buildings
165,000
Interest Expense 160,000
Cash
325,000
Other Valuation Issues
•
Companies should record property, plant, and
equipment:
at the fair value of what they give up or
at the fair value of the asset received,
whichever is more clearly evident.
• Cash Discounts — whether taken or not —
generally considered a reduction in the cost of
the asset.
•
Acquiring PP&E
•
Lump-Sum Purchases
Allocate the total cost among the various
assets on the basis of their fair market values.
•
Issuance of Stock
The market value of the stock issued is a fair
indication of the cost of the property acquired.
Contributions of PP&E
•
Companies should use:
the fair value of the asset to establish its value
on the books and
should recognize contributions received as
revenues in the period received.
Costs Subsequent to Acquisition
•
In general, costs incurred to achieve greater future benefits
should be capitalized, whereas expenditures that simply
maintain a given level of services should be expensed.
•
To capitalize costs, one of three conditions must be
present:
Useful life of the asset must be increased.
Quantity of units produced from asset must be increased.
Quality of units produced must be enhanced.
Costs Subsequent to Acquisition
• Major Types of Expenditures
Additions
Improvements and replacements
Rearrangement and reinstallation
Repairs
[See Illustration 10-6, in the text, for summary of
normal accounting treatment for these
expenditures.]
Depreciation
• Depreciation is the accounting process of
allocating the cost of tangible assets to expense
in a systematic and rational manner to those
periods expected to benefit from the use of the
asset.
• Allocating costs of long-term assets:
Fixed assets = Depreciation expense
Intangibles = Amortization expense
Natural resources = Depletion expense
Depreciation
• Factors Involved in the Depreciation Process
(1)What depreciable base is to be used?
(2)What is the asset’s useful life?
(3)What method of cost allocation is best?
Depreciation Methods
• The profession requires the method employed
be “systematic and rational.” Examples
include:
(1)Activity method (units of use or production).
(2)Straight-line method.
(3)Sum-of-the-years’-digits.
(4)Declining-balance method.
Calculating Depreciation
• Robert Parish Corporation purchased a new machine
for its assembly process on September 30, 2007. The
cost of this machine was $117,900. The company
estimated that the machine would have a salvage value
of $12,900 at the end of its service life. Its life is
estimated at 5 years and its working hours are
estimated at 1,000 hours. Year-end is December 31.
• (a) Straight-line depreciation.
• (b) Activity method.
• (c) Sum-of-the-years’-digits.
• (d) Double-declining balance.
Straight-line Depreciation
Year
Depreciable
Base
Annual
Expense
2007
$ 105,000
/
5
=
$ 21,000
2008
105,000
/
5
=
2009
105,000
/
5
2010
105,000
/
2011
105,000
2012
105,000
Years
Current
Year
Expense
Partial
Year
x
5,250
$ 5,250
21,000
21,000
26,250
=
21,000
21,000
47,250
5
=
21,000
21,000
68,250
/
5
=
21,000
21,000
89,250
/
5
=
21,000
15,750
105,000
x
3/12
9/12
=
=
$
$ 105,000
Journal entry:
2007
Accum.
Deprec.
Depreciation expense
Accumultated depreciation
5,250
5,250
Activity Method
($105,000 / 1,000 hours = $105 per hour)
Year
(Given)
Hours
Used
Rate per
Hours
Annual
Expense
Partial
Year
Current
Year
Expense
Accum.
Deprec.
2007
200
x
$105
=
$ 21,000
$ 21,000
$ 21,000
2008
150
x
105
=
15,750
15,750
36,750
2009
250
x
105
=
26,250
26,250
63,000
2010
300
x
105
=
31,500
31,500
94,500
2011
100
x
105
=
10,500
10,500
105,000
1,000
$ 105,000
Journal entry:
2007
Depreciation expense
Accumultated depreciation
21,000
21,000
Sum of the Years’ Digits
Year
Depreciable
Base
2007
$ 105,000
x
2008
105,000
2009
Annual
Expense
Years
5/15
=
$ 35,000
x
4.75/15 =
105,000
x
2010
105,000
2011
2012
Partial
Year
3/12
$
$ 8,750
33,250
33,250
42,000
3.75/15 =
26,250
26,250
68,250
x
2.75/15 =
19,250
19,250
87,500
105,000
x
1.75/15 =
12,250
12,250
99,750
105,000
x
.75/15
5,250
5,250
105,000
$ 105,000
Journal entry:
2007
Accum.
Deprec.
8,750
=
x
Current
Year
Expense
Depreciation expense
Accumultated depreciation
8,750
8,750
Double Declining Balance
(note: calculations are incorrect)
Year
Depreciable
Base
Rate
per Year
Annual
Expense
2007
$ 117,900 x
40%
=
2008
106,110 x
40%
=
2009
63,666 x
40%
2010
38,200 x
2011
2012
$ 47,160 x
Partial
Year
3/12
Current
Year
Expense
= $ 11,790
$ 11,790
42,444
42,444
54,234
=
25,466
25,466
79,700
40%
=
15,280
15,280
94,980
22,920 x
40%
=
9,168
9,168
104,148
13,752 x
40%
=
5,501
852
105,000
Plug
$ 105,000
Journal entry:
2007
Accum.
Deprec.
Depreciation expense
Accumultated depreciation
11,790
11,790
Depreciation Issues
(1) How should depreciation be computed for partial periods?
Companies normally compute depreciation on the basis of the nearest
full month.
(2) How are revisions in depreciation rates handled?
•
Changes in Depreciation Rate
Accounted for in the period of change and future periods
(Change in Estimate)
Not handled retrospectively
Not considered errors or extraordinary items
Sale of Plant Assets
• Sim City Corporation owns machinery that cost $20,000 when
purchased on January 1, 2005. Depreciation has been recorded at a
rate of $3,000 per year, resulting in a balance in accumulated
depreciation of $9,000 at December 31, 2007. The machinery is
sold on September 1, 2008, for $10,500. Prepare journal entries to
(a) update depreciation for 2008 and (b) record the sale.
(a) Depreciation Expense ($3,000 x 8/12)
2,000
Accumulated Depreciation
2,000
(b) Cash
10,500
Accumulated Depreciation
11,000
Machinery
20,000
Gain on Sale
1,500
Involuntary Conversion
•
Sometimes an asset’s service is terminated
through some type of involuntary conversion
such as fire, flood, theft, or condemnation.
•
Companies report the difference between the
amount recovered (e.g., from a condemnation
award or insurance recovery), if any, and the
asset’s book value as a gain or loss.
•
They treat these gains or losses like any other
type of disposition.
Exchanges
•
Ordinarily accounted for on the basis of:
the fair value of the asset given up or
the fair value of the asset received,
whichever is clearly more evident.
• Companies should recognize immediately any
gains or losses on the exchange when the
transaction has commercial substance (future
cash flows change as a result of the transaction).
•
Accounting for Exchanges
• * If cash is 25% or more of the fair value of the
exchange, recognize entire gain because earnings
process is complete.
Exchanges—Calculating Gain or Loss
•
Companies recognize a loss immediately whether the exchange has
commercial substance or not.
•
Rationale: Companies should not value assets at more than their cash
equivalent price; if the loss were deferred, assets would be overstated.
Fair value of equipment received
Cash received / paid
Less: Bookvalue of equipment
($28,000-19,000)
($28,000-10,000)
Gain or (Loss) on Exchange
Arruza
$12,500
3,000
LoBianco
$15,500
(3,000)
(9,000)
$6,500
(18,000)
($5,500)
Summary of Gain and Loss Recognition on Exchanges of
Nonmonetary Assets Lacks Commercial Substance
PP&E Disclosures
Depreciating assets, use Accumulated Depreciation.
• Depleting assets may include use of Accumulated
Depletion account, or the direct reduction of asset.
•
Basis of valuation (cost)
Pledges, liens, and other commitments
Depreciation expense for the period.
Balances of major classes of depreciable assets.
Accumulated depreciation.
A description of the depreciation methods used.
Ratio Analysis
Return on Sales:
Net Income
Sales
Asset Turnover:
Sales
Average Total Assets
Return on Assets:
Net income
Average Total Assets
PP&E Disclosure Issues
• Magnitude depends on industry & business
strategy.
• Age of fixed assets can be important; use
average age & other ratios
• Various acquisition, disposal & write-off issues
• Occasionally related to fraud, such as Waste
Management
Average Age Calculations
• Average age = (accumulated depreciation /
depreciation expense)
• Average depreciable life = (ending gross
investment / depreciation expense)
• Average age % = (accumulated depreciation /
ending gross investment)
• Older plants are typically less efficient &
subject to breakdowns