Plant
Assets
1.
(S.O. 1) Plant assets are tangible resources that are used in the
operations of a business and are not intended for sale to customers.
Plant assets are subdivided into four classes:
(a) land, (b) land improvements, (c) buildings, and (d) equipment.
Cost of
Plant Assets
2.
Plant assets are recorded at cost in accordance with the cost principle of accounting. Cost consists of all expenditures
necessary to (1) acquire the asset and (2) make it ready for its intended use.
3.
The cost of land includes the
cash purchase price plus other related costs.
The cost might include closing costs such as title and attorney's fees,
real estate brokers' commissions, and accrued property taxes and other liens on
the land assumed by the purchaser. All
necessary costs incurred in making land ready for its intended use are debited
to the Land Account.
4.
The cost of land improvements includes
all expenditures needed to make the improvements ready for their intended use
such as the cost of a new parking lot, fencing, and lighting.
5.
The cost of buildings includes
all necessary costs related to the purchase or construction of a building:
a.
When a building is purchased, such costs include the purchase price,
closing costs, and real estate broker's commission.
b.
Costs to make the building ready for its intended use include
expenditures for remodeling and replacing or repairing the roof, floors, wiring,
and plumbing.
c.
When a new building is constructed, cost consists of the contract price
plus payments for architects' fees, building permits, interest payments during
construction, and excavation costs.
6.
The cost of equipment consists
of the cash purchase price, sales taxes, freight charges, and insurance paid by
the purchaser during transit. Cost
includes all expenditures required in assembling, installing, and testing the
unit. Recurring costs such as
licenses and insurance are expensed as incurred.
Depreciation
7.
(S.O. 2) Depreciation
is the process of allocating to expense the cost of a plant asset over its
useful (service) life in a rational and systematic manner.
a.
The cost allocation is designed to provide for the proper matching of
expenses with revenues in accordance with the matching
principle.
b.
During an asset's life, its usefulness may decline because of wear and
tear or obsolescence.
c.
Recognition of depreciation does not result in the accumulation of cash
for the replacement of the asset.
8.
Three factors that affect the computation of depreciation are (1) cost,
(2) useful life, and (3) salvage value.
9.
Three methods of recognizing depreciation are (a) straight-line, (b)
units of activity, and (c) declining-balance.
a.
Each method is acceptable under generally accepted accounting principles.
b.
Management selects the method that is appropriate in the circumstances.
c.
Once a method is chosen, it should be applied consistently.
Straight-Line
Method
10.
Under the straight-line method
depreciation is the same for each year of the asset's useful life.
a.
The formula for computing annual depreciation expense is:
Depreciable Cost
Useful Life (in years) = Depreciation Expense
b.
To illustrate the computation, assume that the Benson Company purchased a
delivery truck for $11,000 on January 1 with an estimated salvage value of
$1,000 at the end of its four-year service life.
Annual depreciation is $2,500 [($11,000 - $1,000
4)].
c.
The straight-line method predominates in practice.
d.
This method is simple to apply and it matches expenses and revenues
appropriately when the use of the asset is reasonably uniform throughout the
service life.
Units-of-Activity Method
11.
Under the units-of-activity
method, service life is expressed in terms of the total units of production
or expected use from the asset, rather than time.
a.
The formulas for computing depreciation expense are:
(1)
Depreciable Cost
Total Units of Activity = Depreciation Cost per Unit
(2)
Depreciation Cost per Unit X Units of Activity During the Year =
Depreciation
Expense
b. To
illustrate the computation, assume that Benson Company expects to drive the
truck purchased in (10b) above for 100,000 miles and that 30,000 miles are
driven in the first year. Depreciation
for the first year is $3,000.
(1) $10,000
100,000 = $.10 per mile.
(2) $.10 X 30,000 = $3,000.
c. In using
this method, it is often difficult to make a reasonable estimate of total
activity.
d. When
the productivity of an asset varies significantly from one period to another,
this method results in the best matching of expenses with revenues.
Declining-Balance Method
12. The
declining-balance method produces a decreasing annual depreciation expense
over the useful life of the asset.
a.
The formula for computing depreciation expense is:
Book Value at Beginning of Year X Declining Balance Rate = Depreciation Expense
b.
To illustrate the computation, assume that Benson Company uses a
declining-balance rate that is double the straight-line rate of 25%.
Depreciation in the first year is $5,500 ($11,000 X 50%).
c.
Under this method, the depreciation rate remains constant from year to
year, but the book value to which the rate is applied declines each year.
d.
This method is compatible with the matching principle because the higher
depreciation in early years is matched with the higher benefits received in
these years.
13. Taxpayers must use on their
tax returns either the straight-line method or a special accelerated
depreciation method called the Modified Accelerated Cost Recovery System
(MACRS).
Revising Periodic Depreciation
14. (S.O. 4)
If wear and tear or obsolescence indicate that annual depreciation is
inadequate or excessive, a change in the periodic amount should be made.
a.
When a change is made, (1) there is no correction of previously recorded
depreciation expense, and (2) depreciation expense for current and future years
is revised.
b.
To determine the new annual depreciation expense, the depreciable cost at
the time of the revision is divided by the remaining useful life.
Expenditures During Useful Life
15. (S.O. 5)
Ordinary repairs are
expenditures to maintain the operating efficiency and expected productive life
of the plant asset. They are debited to Repairs Expense as incurred and are
often referred to as revenue
expenditures.
16. Additions
and improvements are costs incurred to increase the operating efficiency,
productive capacity, or expected useful life of the plant asset. These expenditures are usually material in amount and occur
infrequently during the period of ownership.
17. Capital
expenditures increase the company's investment in productive facilities.
These expenditures include additions and improvements.
Plant Asset Disposals
18. (S.O. 6)
Plant assets may be disposed of by (a) retirement, (b) sale, or (c)
exchange.
19. At the time of disposal, it is necessary to
determine the book value of the plant
asset.
a.
If the disposal occurs during the year, depreciation for the fraction of
the year to the date of disposal must be recorded.
b.
The book value is then eliminated by debiting the Accumulated
Depreciation account for the total depreciation to the date of disposal and
crediting the asset account for the cost of the asset.
Retirement of Plant Assets
20. In accounting for a disposal by retirement,
a.
if the asset is fully depreciated, the entry is a debit to Accumulated
Depreciation and a credit to the plant asset account.
b.
if the asset is retired before it is fully depreciated and no scrap or
salvage value is received, a loss on disposal occurs.
c.
the loss on disposal is reported in the Other Expenses and Losses section
of the income statement.
Sale of Plant Assets
21. In a disposal by sale,
the book value of the asset is compared with the proceeds received from the sale.
a.
If the proceeds of the sale exceed the book value, a
gain on disposal occurs which is reported in the Other Revenues and Gains
section of the income statement.
b.
If the proceeds of the sale are less than the book value of the asset, a loss on disposal occurs which is reported in the Other Expenses and
Losses section of the income statement.
Exchanges of Plant Assets
22. An exchange
of similar assets involves assets of the same type.
In this type of exchange, the new asset performs the same function as the
old asset. The accounting depends
on whether there is a gain or loss on the old asset.
a.
When a gain occurs in the exchange of similar assets:
(1) The acquisition cost of the new asset is equal to the fair market
value of the old asset exchanged plus any cash or other consideration given up.
(2) The gain or loss is the difference between the fair market value and
the book value of the asset given up.
(3) The gain is then offset against the cost of the new asset (instead of
being credited to Gain on Disposal).
b.
When a loss occurs in the exchange of similar assets, the loss is
recognized immediately
it is not deferred.
Natural Resources
23. (S.O. 7)
Natural resources consist of
standing timber and underground deposits of oil, gas, and minerals.
These assets are frequently called wasting assets.
Acquisition Cost
24. The acquisition cost of a natural resource is
the price needed to acquire the resource and prepare it for its intended use.
Depletion
25. Depletion
is the systematic write-off of the cost of natural resources.
The units of activity method is
generally used to compute depletion because periodic depletion is generally a
function of the units extracted during the year.
The formulas for computing depletion expense are:
a.
Total Cost minus Salvage Value
Total Estimated Units = Depletion Cost per
Unit.
b.
Depletion Cost per Unit X Number of Units Extracted and Sold = Depletion
Expense.
26. To record depletion expense, Depletion
Expense is debited and a contra asset account, Accumulated Depletion, is
credited.
a.
Depletion expense is reported as a cost of producing the product.
b.
Accumulated Depletion is deducted from the cost of the natural resource
in the balance sheet.
Intangible Assets
27. (S.O. 8)
Intangible assets are rights,
privileges, and competitive advantages that result from the ownership of long
lived assets that do not possess physical substance. Intangibles may arise from government grants, acquisition of
another business, and private monopolistic arrangements.
28. In general,
accounting for intangible assets parallels the accounting for plant assets.
Intangible assets are (a) recorded at cost, (b) cost is written off over
useful life in a rational and systematic manner, and (c) at disposal, book value
is eliminated and gain or loss, if any, is recorded.
29. Differences between the
accounting for intangible assets and the accounting for plant assets include:
a.
The systematic write-off of an intangible asset is referred to as amortization.
b.
To record amortization, Amortization Expense is debited and the specific
intangible asset is credited.
c.
The amortization period cannot be longer than 40 years.
d.
Amortization is typically computed on a straight-line basis.
Patents
30. A patent
is an exclusive right issued by the U.S. Patent Office that enables the
recipient to manufacture, sell, or otherwise control his or her invention for a
period of seventeen years from the date of grant.
a.
The initial cost of a patent is the cash or cash equivalent price paid
when the patent is acquired.
b.
When legal costs are incurred in successfully defending the patent, they
are added to the Patent account and amortized over the remaining useful life of
the patent.
c.
The cost of the patent should be amortized over its legal life (20 years)
or useful life, whichever is shorter.
Copyrights
31. Copyrights are granted by
the federal government, giving the owner the exclusive right to reproduce and
sell an artistic or published work.
Trademark or Trade name
32. A trademark
or trade name is a word, phrase,
jingle, or symbol that distinguishes or identifies a particular enterprise or
product.
Franchise
33. A
franchise is a contractual arrangement under which the franchisor grants the
franchisee the right to sell certain products, to render specific services, or
to use certain trademarks or trade names, usually within a designated
geographical area. Another type of
franchise, commonly referred to as a license
or permit, is entered into
between a governmental body and a business enterprise and permits the enterprise
to use public property in performing its services.
Goodwill
34. Goodwill
is the value of all favorable attributes that relate to a business enterprise
such as exceptional management, desirable location, good customer relations,
high-quality products, fair pricing policies, and harmonious relations with
labor unions.
a.
Goodwill can be identified only with the business as a whole.
b.
Goodwill is recorded only when there is an exchange transaction that
involves the purchase of an entire business.
c.
When an entire business is purchased, goodwill is the excess of cost over
the fair market value of the net assets (assets less liabilities) acquired.
35. Goodwill is written off over its useful life,
not to exceed 40 years. The
amortization entry generally results in a debit to Goodwill Expense and a credit
to Goodwill.
Research and Development
36. Research
and development costs are costs that are spent on developing new products
and processes. Such costs are
usually recorded as an expense when incurred.
Financial Statement Presentation
37. (S.O. 9)
In the balance sheet, plant assets and natural resources are usually
combined under Property, Plant, and Equipment and intangibles are shown
separately under Intangible Assets.
a.
There should be disclosure of the balances in the major classes of assets
and accumulated depreciation of major classes of assets or in total.
b.
Depreciation and amortization methods used should be described and the
amount of depreciation and amortization expense for the period disclosed.