Plant and intangible assets. (Chapter 9)

1. Plant and Intangible Assets

Chapter 9
McGraw-Hill/Irwin
Copyright © 2010 by The McGraw-Hill Companies, Inc. All

2. Plant Assets as a “Stream of Future Services”

Plant assets represent a bundle of future
services, and can be thought of as longterm prepaid expenses.
The cost of plant assets is the
advance purchase of services.
As years pass, and the
services are used, the cost is
transferred to depreciation
expense.
9-2

3. Major Categories of Plant Assets

T a n g ib le P la n t
A s s e ts
In ta n g ib le
A s s e ts
N a tu ra l
R e so u rc e s
L o n g -te rm
a s s e t s h a v in g
p h y s ic a l s u b s t a n c e .
N o n c u rre n t a s s e ts
w it h n o p h y s ic a l
s u b s ta n c e .
S it e s a c q u ir e d fo r
e x t r a c t in g v a lu a b le
re s o u rc e s .
L a n d , b u ild in g s ,
e q u ip m e n t ,
fu r n it u r e , fix t u r e s .
P a t e n t s , c o p y r ig h t s ,
tra d e m a rk s ,
fr a n c h is e s , g o o d w ill.
O il r e s e r v e s ,
t im b e r , o t h e r
m in e r a ls .
9-3

4. Accountable Events in the Lives of Plant Assets

Acquisition.
Allocation of the acquisition
cost to expense over the
asset’s useful life
(depreciation).
Sale or disposal.
9-4

5. Acquisition of Plant Assets

Cost
=
Asset
price
+
Reasonable and
necessary costs . . .
......for
forgetting
getting
the
theasset
assetto
tothe
the
desired
desiredlocation.
location.
......for
forgetting
getting
the
theasset
asset ready
ready
for
foruse.
use.
9-5

6. Special Considerations

Land
Land
Land
Land
Improvements
Improvements
Cost includes real estate
commissions, escrow
fees, legal fees, clearing
and grading the property.
Improvements to land
such as driveways,
fences, and landscaping
are recorded separately.
9-6

7. Special Considerations

Buildings
Repairs made prior to the
building being put in use
are considered part of the
building’s cost.
Equipment
Related interest,
insurance, and property
taxes are treated as
expenses of the current
period.
9-7

8. Special Considerations

Allocation of a Lump-Sum Purchase
The total cost
must be
allocated to
separate
accounts for
each asset.
The allocation
is based on
the relative
Fair Market
Value of each
asset
purchased.
9-8

9. Capital Expenditures and Revenue Expenditures

Capital
Capital
Expenditure
Expenditure
Revenue
Revenue
Expenditure
Expenditure
Any
Any material
material expenditure
expenditure
that
that will
will benefit
benefit several
several
accounting
accounting periods.
periods.
Expenditure
Expenditure for
for
ordinary
ordinary repairs
repairs
and
and maintenance
maintenance..
To
To capitalize
capitalize an
an expenditure
expenditure
means
means to
to charge
charge itit to
to an
an
asset
asset account
account..
To
To expense
expense an
an expenditure
expenditure
means
means to
to charge
charge itit to
to an
an
expense
expense account
account..
9-9

10. Depreciation

The
The allocation
allocation of
of the
the cost
cost of
of aa plant
plant asset
asset to
to
expense
expense in
in the
the periods
periods in
in which
which services
services are
are
received
received from
from the
the asset.
asset.
Balance
BalanceSheet
Sheet
Cost of
plant
assets
Assets:
Assets:
Plant
Plantand
and
equipment
equipment
Income
IncomeStatement
Statement
as the services are
received
Revenues:
Revenues:
Expenses:
Expenses:
Depreciation
Depreciation
9-10

11. Depreciation

Book Value
Cost – Accumulated Depreciation
Depreciation
Contra-asset
Represents the portion of an asset’s
cost that has already been allocated
to expense.
Causes of Depreciation
Physical deterioration
Obsolescence
9-11

12. Straight-Line Depreciation

Depreciation
=
Expense per Year
Cost - Residual Value
Years of Useful Life
9-12

13. Straight-Line Depreciation

On
On January
January 2,
2, S&G
S&G Wholesale
Wholesale Grocery
Grocery buys
buys aa new
new
delivery
delivery truck.
truck. The
The truck
truck cost
cost $24,000,
$24,000, has
has an
an
estimated
estimated residual
residual value
value of
of $3,000,
$3,000, and
and an
an
estimated
estimated useful
useful life
life of
of 55 years.
years.
Compute
Compute annual
annual depreciation
depreciation using
using the
the straight-line
straight-line
method.
method.
9-13

14. Straight-Line Depreciation

S&G will record $4,200 depreciation each year for five
years. Total depreciation over the estimated useful life
of the equipment is:
Salvage Value
9-14

15. Depreciation for Fractional Periods

When an asset is acquired during the year,
depreciation in the year of acquisition must
be prorated.
Half-Year Convention
In the year of
acquisition, record six
months of
depreciation.
½
9-15

16. Half-Year Convention

Using the half-year convention, calculate
the straight-line depreciation on
December 31, 2009, for equipment
purchased in 2009. The equipment cost
$75,000, has a useful life of 10 years and
an estimated residual value of $5,000.
Depreciation =
=
($75,000 - $5,000) ÷ 10
$7,000 for a full year
Depreciation =
$7,000 × 11/22 = $3,500
9-16

17. Declining-Balance Method

Depreciation in the early years of an asset’s
estimated useful life is higher than in later years.
The
The double-declining
double-declining balance
balance depreciation
depreciation
rate
rate is
is 200%
200% of
of the
the straight-line
straight-line depreciation
depreciation
rate
rate of
of (1÷Useful
(1÷Useful Life).
Life).
9-17

18. Declining-Balance Method

On
On January
January 2,
2, S&G
S&G buys
buys aa new
new delivery
delivery truck
truck
paying
paying $24,000
$24,000 cash.
cash. The
The truck
truck has
has an
an
estimated
estimated residual
residual value
value of
of $3,000
$3,000 and
and an
an
estimated
estimated useful
useful life
life of
of 55 years.
years.
Compute
Compute depreciation
depreciation for
for the
the first
first year
year using
using
the
the double-declining
double-declining balance
balance method.
method.
9-18

19. Declining-Balance Method

Total depreciation over the estimated useful life of an
Compute
depreciation
for
the
rest
of
the
Compute
depreciation
for
the
rest
of
the
asset is the same using either the straight-line
truck’s
life.
truck’s
estimated useful
usefulmethod.
life.
method
or the estimated
declining-balance
9-19

20. Financial Statement Disclosures

Estimates of Useful Life and Residual
Value
•May differ from company to
company.
•The reasonableness of
management’s estimates is
evaluated by external auditors.
Principle of Consistency
•Companies should avoid
switching depreciation methods
from period to period.
9-20

21. Revising Depreciation Rates

Predicted
salvage value
Predicted
useful life
So depreciation
is an estimate.
Over the life of an asset, new
information may come to light
that indicates the original
estimates need to be revised.
9-21

22. Revising Depreciation Rates

On January 1, 2006, equipment was
purchased that cost $30,000, has a
useful life of 10 years and no
salvage value. During 2009, the
useful life was revised to 8 years
total (5 years remaining).
Calculate depreciation expense for
the year ended December 31, 2009,
using the straight-line method.
9-22

23. Revising Depreciation Rates

When our estimates change,
depreciation is:
Book value at
date of change
–
Salvage value at
date of change
Remaining useful life at date of change
9-23

24. Impairment of Plant Assets

IfIf the
the cost
cost of
of an
an asset
asset
cannot
cannot be
be recovered
recovered
through
through future
future use
use or
or
sale,
sale, the
the asset
asset should
should
be
be written
written down
down to
to its
its
net
net realizable
realizable value.
value.
9-24

25. Disposal of Plant and Equipment

Update depreciation
to the date of disposal.
Journalize disposal by:
Recording
Recording cash
cash
received
received (debit).
(debit).
Removing
Removing accumulated
accumulated
depreciation
depreciation (debit).
(debit).
Recording
Recording aa
gain
gain (credit)
(credit)
or
or loss
loss (debit).
(debit).
Removing
Removing the
the
asset
asset cost
cost (credit).
(credit).
9-25

26. Disposal of Plant and Equipment

If Cash > BV, record a gain (credit).
If Cash < BV, record a loss (debit).
If Cash = BV, no gain or loss.
Recording
Recording cash
cash
received
received (debit).
(debit).
Removing
Removing accumulated
accumulated
depreciation
depreciation (debit).
(debit).
Recording
Recording aa
gain
gain (credit)
(credit)
or
or loss
loss (debit).
(debit).
Removing
Removing the
the
asset
asset cost
cost (credit).
(credit).
9-26

27. Disposal of Plant and Equipment

Assume that a machine costing $10,000,
had accumulated depreciation of $8,000
and book value of $2,000 (10,000 - $8,000)
at the time it was sold for $3,000 cash.
Determine the gain or loss on sale of this
machine.
Cost of machine
Accumulated depreciation
Book value at time of sale
Cash received
Gain on sale of machine
$ 10,000
(8,000)
2,000
3,000
$ 1,000
9-27

28. Disposal of Plant and Equipment

Assume that a machine costing $10,000,
had accumulated depreciation of $8,000
and book value of $2,000 (10,000 - $8,000)
at the time it was sold for $3,000 cash.
Determine the gain or loss on sale of this
machine.
9-28

29. Trading in Used Assets for New Ones

Assume that Essex Company exchanges a
used earthmover and $35,000 cash for a
new earthmoving machine. The old
machine originally cost $40,000, had upto-date accumulated depreciation of
$30,000, and a fair value of $4,000.
+ $35,000
9-29

30. Trading in Used Assets for New Ones

9-30

31. Intangible Assets

Noncurrent assets
without physical
substance.
Often provide
exclusive rights
or privileges.
Characteristics
Useful life is
often difficult
to determine.
Usually acquired
for operational
use.
9-31

32. Intangible Assets

Record at
current cash
equivalent cost,
including
purchase price,
legal fees, and
filing fees.
Patents
Copyrights
Leaseholds
Leasehold
Improvements
Goodwill
Trademarks and
Trade Names
9-32

33. Amortization

•• Amortization
Amortization is
is the
the systematic
systematic writewrite-
off
off to
to expense
expense of
of the
the cost
cost of
of
intangible
intangible assets
assets over
over their
their useful
useful life
life
or
or legal
legal life,
life, whichever
whichever is
is shorter.
shorter.
•• Use
Use the
the straight-line
straight-line method
method to
to
amortize
amortize most
most intangible
intangible assets.
assets.
9-33

34. Goodwill

Occurs when one
company buys
another company.
Only purchased
goodwill is an
intangible asset.
The amount by which the
purchase price exceeds the fair
market value of net assets acquired.
Goodwill is NOT amortized. It is tested
annually to determine if there has been
an impairment loss.
9-34

35. Patents

Exclusive
Exclusive right
right granted
granted
by
by federal
federal government
government to
to sell
sell
or
or manufacture
manufacture an
an invention.
invention.
Cost is purchase
price plus legal
cost to defend.
Amortize cost
over the shorter of
useful life or 20 years.
9-35

36. Trademarks and Trade Names

A symbol, design, or logo
associated with a business.
Internally
developed
trademarks
have no
recorded
asset cost.
Purchased
trademarks
are recorded
at cost, and
amortized over
shorter of legal
or economic life.
9-36

37. Franchises

Legally protected right to sell products or
provide services purchased by franchisee
from franchisor.
Purchase price is intangible
asset which is amortized over
the shorter of the protected
right or useful life.
9-37

38. Copyrights

Exclusive right granted by the
federal government to protect
artistic or intellectual
properties.
Legal life is
life of creator
plus 70 years.
Amortize cost
over period
benefited.
9-38

39. Research and Development Costs

All expenditures classified as research
and development should be charged
to expense when incurred.
All
All of
of these
these R&D
R&D costs
costs
will
will really
really reduce
reduce our
our
net
net income
income this
this year!
year!
9-39

40. Natural Resources

Total cost,
including
exploration and
development,
is charged to
depletion expense
over periods
benefited.
Extracted from
the natural
environment
and reported
at cost less
accumulated
depletion.
Examples: oil, coal, gold
9-40

41. Depletion of Natural Resources

Depletion is calculated using the
units-of-production method.
Unit depletion rate is calculated as follows:
Cost – Residual Value
Total Units of Natural
Resource
9-41

42. Plant Transactions and the Statement of Cash Flows

Cash payments for plant assets represent a
cash outflow for investing activities on the
statement of cash flows. A disposal of a plant
asset for cash results in a cash inflow to the
company.
Depreciation is a
non-cash charge to
income and has no
effect on cash flows.
9-42

43. End of Chapter 9

9-43