ACG 2021
Financial Accounting
Plant Assets, Natural Resources,
and Intangibles
Learning Objectives
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Determine the cost of a plant asset
Account for depreciation
Select the best depreciation method
Analyze the effect of a plant asset disposal
Account for natural resources and depletion
Account for intangible assets and amortization
Report plant asset transactions on the statement
of cash flows
The Asset Rules
How To Determine Cost of the
Asset
Types of Assets
• Land
– Cost, commissions, survey fees, legal fees, taxes, costs for
grading land, demolish buildings
• Buildings, machinery, equipment
– Cost, taxes, interest (if building vs. buying), architectural fees,
permits, commissions, taxes, repairs, etc.
• Land improvements and leasehold improvements
– Fences, pavement, additions to leased property
• Lump-sum (or basket) purchases of assets
– Multiple Assets are purchased together for ONE overall price
• For example, Building and the equipment inside it
Determining the Cost of Land
A business signs a $300,000 note payable to purchase
land for a new store site. It also pays:
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$10,000 in back property tax
$8,000 in transfer taxes
$5,000 for removal of an old building
$1,000 survey fee
$260,000 to pave the parking lot.
What is the cost of the land?
Determining the Cost of Land
Purchase price of land
Add related costs:
Back property taxes
Transfer taxes
Removal of buildings
Survey fees
Total cost of land
$300,000
$10,000
8,000
5,000
1,000
– What about $260,000 for Paving?
– Land Improvements
24,000
$324,000
Land 324,000
Note Payable 300,000
Cash
24,000
Determining the Cost of
Buildings: Construction
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Architectural fees
Building permits
Contractor’s charges
Materials
Labor
Overhead
Cost of interest
Determining the Cost of
Buildings: Purchase
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Purchase price
Brokerage commissions
Sales and other taxes
Repairing or renovating building for its
intended purpose
Determining the Cost of
Machinery and Equipment
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Purchase price less discounts
Transportation charges
Insurance in transit
Sales and other taxes
Purchase commission
Installation costs
Expenditures to test the asset
Special platforms
Determining the Cost of Land and
Leasehold Improvements
• Land improvements
– Paving
– Fences
– Sprinkler systems
– Lights in parking lot
Determining the Cost of Land and
Leasehold Improvements
• Leasehold Improvement: Cost of
improvements to leased assets
• Depreciate (amortize) over term of the
lease.
Exercise 7-1
Allocate Costs
Lump-Sum (or Basket)
Purchase of Assets
• Multiple Asset Purchases
– One Price paid for set of assets
• Land and Building
• Land, Building, Equipment, etc.
A Corporation paid $2,800,000 for a combined
purchase of land and a building.
The land is appraised at $300,000 and the building
at $2,700,000.
How much of the purchase price is allocated to
land and how much to the building?
Steps to Calculate Lump-Sum
Purchase
1. Determine Separate Market Value of each
Asset
2. Calculate Total Market Value of all assets
purchased
3. Divide each Asset’s Market Value by Total
Market Value
4. Multiply % calculated in #3 for each asset, by
the Total Cost Paid for the Asset
5. Allocate the Result of #4 to that Asset
Lump-sum Purchases
• Total cost divided among assets based on their
relative sales value.
Market
Total
Percentage
(Sales)
Market
of Total
Total
Cost of
Asset
Value
Value
Market Value
Cost
Each Asset
Land
$ 300,000 ÷ $3,000,000
= 10% X $2,800,000 = $ 280,000
Building
2,700,000 ÷ 3,000,000
= 90% X 2,800,000 = 2,520,000
Total
$3,000,000
100%
$2,800,000
Land
Building
Cash
Purchased land and building
280,000
2,520,000
2,800,000
ACG 2021
Financial Accounting
The Expense Rules
How To Account for the Asset
Deterioration
Depreciation
• Depreciation results from
– Physical wear and tear
– Obsolescence
• Depreciation is an allocation of the cost of an asset over its useful
life.
• We accumulate the assets depreciation in a Contra-Asset account
– Accumulated Depreciation or Accumulated Depletion
– The Asset account minus the Accumulated account = Book Value of the
Asset
• Depreciation MATCHES the reduction in usefulness of Assets
(Depreciation Expense) with Revenue that the Assets produced
• Depreciation is NOT a process of valuation.
• Depreciation does NOT mean setting aside cash to replace assets
as they wear out.
Asset Deterioration
Assets = Liabilities + Paid In Capital + Revenue – Expenses - Dividends
Balance Sheet (Assets)
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Income Statement (Expenses)
Depreciation
Accumulated Depreciation
• Contra-Asset Account
– Opposite normal balance from assets
• Credit Balance
– Related to normal Asset Account
• Property, Plant & Equipment
• Reduction in Usefulness
– Does not lower value of Asset
– Increases Accumulated Depreciation
• Contra Asset
• Book Value of Asset
– Asset Value – Accumulated Depreciation
• Always can tell the historical cost of PP&E
Depreciation
• To estimate depreciation expense you
need to know:
– Cost
– Estimated useful life
– Estimated residual value
Depreciation Methods
• Straight-line
• Units-of-production
• Double-declining-balance
Recording Entries
Depreciation
Debit Depreciation Expense
Credit Accumulated Depreciation
Depletion
Debit Depletion Expense
Credit Accumulated Depletion
Amortization
Debit Amortization Expense
Credit Intangible Asset (e.g. Patents)
Straight-Line Depreciation
Straight-line
depreciation per year
=
Cost – Residual Value
Useful Life in years
Units-of-Production
Units-of-production
depreciation
per unit of output
=
Cost – Residual Value
Useful life in units
of production
Double-Declining Balance
DDB Depreciation
rate per year
=
1
X
2
Useful life years
Rate X Book Value = Annual Depreciation Expense
Depreciation Example
Data Items
Cost of truck
Estimated residual value
Depreciable cost
Estimated useful life
Units of production
Amount
$41,000
( 1,000)
$40,000
5 years
100,000 miles
Straight-Line Method
(Cost – Residual value) ÷ Years of useful life
($41,000 – $1,000) ÷ 5 = $8,000
Year 1 depreciation:
Year 2 depreciation:
Year 3 depreciation:
Year 4 depreciation:
Year 5 depreciation:
Total depreciation:
$ 8,000
8,000
8,000
8,000
8,000
$40,000
Units-of-Production Method
($41,000 – $1,000) ÷ 100,000 = $.40/mile
Year 1: 20,000 miles × $.40 = $ 8,000
Year 2: 30,000 miles × $.40 = 12,000
Year 3: 25,000 miles × $.40 = 10,000
Year 4: 15,000 miles × $.40 =
6,000
Year 5: 10,000 miles × $.40 =
4,000
$40,000
Double-Declining-Balance Method
Straight-line rate per year: 100% ÷ 5 = 20%
Double-declining balance:
2 times the straight-line rate = 40%
Book value of truck at the end of the first year:
$41,000 × 40% = $16,400
$41,000 – $16,400 = $24,600
What is Depreciation at the end of year 2?
What is Book Value at the end of year 2?
Year 3?
Year 4?
Year 5?
Comparing Depreciation Methods
Amount of Depreciation per Year
Year
SL
UOP
DDB
1
$ 8,000 $ 8,000 $16,400
2
8,000 12,000
9,840
3
8,000 10,000
5,904
4
8,000
6,000
3,542
5
8,000
4,000
4,314
Total $40,000 $40,000 $40,000
Depreciation Methods Used
by 600 Companies
5% Units-of-production
1% Other
10% Accelerated
84% Straight-line
ACG 2021
Financial Accounting
PP&E Other Issues:
Tax Consequences
Changes in Estimates
Disposal or Exchange of Asset
Plant Assets - Other Issues
• Depreciation for Tax Purposes
– Companies may use different depreciation methods
for tax and book.
– MACRS (Modified Accelerated Cost Recovery
System) is an accelerated method used for tax.
• Depreciation for partial years
• Changing the useful life of a depreciable asset
(change in accounting estimate)
• Fully depreciated assets
Relationship Between Depreciation and Taxes
Cash revenues
Cash operating expenses
Cash provided by
operations before tax
Depreciation expense
Income before income tax
Income tax expense (30%)
Net income
Straight-line
Accelerated
$400,000
300,000
$400,000
300,000
$100,000
8,000
$ 92,000
27,600
$ 64,400
$100,000
16,400
$ 83,600
25,080
$ 58,520
Relationship Between Depreciation and Taxes
Straight-line
Accelerated
Cash-flow analysis
$100,000
$100,000
Income tax expense
27,600
25,080
Cash provided by
operations after taxes $ 72,400
$ 74,920
Extra cash available for
investment if DDB is used
($74,920 – $72,400)
$ 2,520
Depreciation for Partial Years
Full-year depreciation:
($500,000 – $80,000) ÷ 20 = $21,000
Partial-year depreciation:
$21,000 × 9/12 = $15,750
Changing the Useful Life of a Depreciable
Asset
• Assume an asset cost $50,000, has a ten-year
useful life with no residual value, and we use the
straight-line method.
$50,000 ÷ 10 = $5,000 depreciation per year
What is the book value after four years?
$50,000 – $20,000 = $30,000
5,000 x 4 =
20,000
Changing the Useful Life of a Depreciable
Asset
• Management determines that the asset will be
useful for an additional ten years. How much
depreciation expense would be recognized each
year starting in year five?
Book value at
end of year 4
$30,000 / 10 years = $3,000
Steps for Disposal of Plant Assets
• First, record depreciation to the date of
disposal.
• Remove the asset and related
accumulated depreciation from the books.
• Record the asset received in exchange
(may be cash or other assets).
• Record the gain or loss on the disposal.
Disposing of an Asset
To dispose of a fully depreciated asset with cost and
accumulated depreciation of $60,000:
Accumulated Depreciation - Machinery 60,000
Machinery
60,000
To dispose of fully depreciated machine
To dispose of an asset with cost of $60,000 and accumulated
depreciation of $50,000:
Accumulated Depreciation - Equipment 50,000
Loss on Disposal of Equipment
10,000
Equipment
To dispose of equipment
60,000
Selling an Asset
UPS sells equipment on Sep 30, 20X4 for $7,000 cash. The
equipment cost $10,000 when purchased on Jan 1, 20X1
and has been depreciated on a straight-line basis (10 year
useful life, no residual value). First update depreciation then
record the sale.
Depreciation expense (10,000 / 10 x 9/12)
750
Accumulated Depreciation – Equipment
To update depreciation
Accumulated Depreciation - Equipment
Cash
Equipment
Gain on sale of equipment
To dispose of equipment
750
$3,750
7,000
10,000
750
Exercise 7-11
Selling an Asset
Computing Gain or Loss
Exchanging an Asset
Mazzio Pizzeria traded its delivery car with cost of $9,000
and accumulated depreciation of $8,000 and $10,000 cash
for a new car.
Delivery Auto (new)
Accumulated Depreciation (old)
Delivery Auto (old)
Cash
Traded in old delivery car for new auto.
11,000
8,000
9,000
10,000
ACG 2021
Financial Accounting
Capitalizing Asset Costs vs.
Expensing Costs Directly
Capital Expenditure versus
an Immediate Expense
Does expenditure
increase capacity or
efficiency or
extend useful life?
YES
Capitalize
Capital
Record an asset
NO
Expenses
Record an expense
Capital Expenditures - Vehicle
Record an Asset for
Capital Expenditures
• Extraordinary repairs:
– major engine overhaul
– modification of body
for new use of truck
– addition to storage
capacity of truck
Record Repair and
Maintenance Expense
for an expense:
– Repair of transmission
or other mechanism
– Oil change, lubrication,
etc.
– Replacement of tires
and windshield or a
paint job
Capital Expenditures
• General rule:
– Capitalize the cost if it increases an asset’s
capacity or efficiency or extends its useful life
ACG 2021
Financial Accounting
Natural Resources
&
Intangible Assets
Natural Resources
• Natural resources are expensed through
depletion.
• Depletion rate is calculated similar to
units-of-production method for
depreciation.
• Accumulated depletion is the contra
account used for natural resources.
Accounting for Natural Resources and
Depletion
Assume an oil lease cost $100,000 and contains an
estimated 10,000 barrels of oil.
Depletion rate:
$100,000 ÷ 10,000 = $10 per barrel.
If 3,000 barrels are extracted during the
year, depletion expense is $30,000.
Accumulated Depletion is a contra account
similar to Accumulated Depreciation
Exercise 7-13
Depletion
Intangible Assets
• Intangible assets are long-lived assets with no
physical form.
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patents
copyrights
trademarks
franchises
goodwill
• Intangible assets are expensed through
amortization over the expected useful life of
the intangible.
Intangible Assets
• Amortization expense - can be written off
directly against asset account
– That is, there is no contra-asset for
accumulated Amortization
• Assets with an indefinite useful life are not
amortized.
• All intangible assets are subject to
impairment
Types of Intangible Assets
• Patents – amortized over useful life
• Copyrights – amortized over useful life
• Trademarks and Trade Names – not
amortized, review for impairment
• Franchises and Licenses – not amortized,
review for impairment
• Goodwill - not amortized, review for
impairment
Intangible Assets: Patents
• Federal government grants giving holder the
right to produce and sell an invention.
• Suppose a company pays $170,000 to acquire a
patent on January 1. The company believes that
its expected useful life is 5 years.
Intangible Assets: Patents
Date
Jan 1
General Journal
Accounts and Explanations
PR
Patents
Cash
To record acquisition of patent.
Dec 31 Amortization Expense
Patents
To amortize cost of patent
©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren
Debit
Credit
170,000
170,000
34,000
34,000
Exercise 7-14
Amortizing Intangibles
Research and Development Costs
• R&D costs are expensed as incurred.
Statement of Cash Flows
• Acquisition cost (cash paid) is reflected in the
investing section.
• Sales price (cash received) is reflected in the
investing section.
• Depreciation expense is not a cash flow, but
would appear in operating section if indirect
method is used.
• Gains and losses related to disposals appear in
the operating section if the indirect method is
used.
End of Chapter 7