1. Plant Assets, Natural Resources, and Intangibles
Chapter 9
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2. Long-lived, tangible assets used in the operation of the business.
What Are Plant Assets?
Long-lived, tangible assets used in the operation of the business.
Cost Principle
The actual cost of a plant asset is its purchase price plus all the costs necessary to get the asset ready for its intended use.
Land
Buildings
Equipment
Furniture
Automobiles
Plant Assets are sometimes referred to collectively as Property, Plant, and Equipment (PP&E). Plant Assets are long-lived, tangible assets used in the operation of the business. These assets include Land, Buildings, Equipment, Furniture, Fixtures, and Automobiles. When these assets are acquired, they are recorded at cost, in accordance with the Cost Principle. Generally, the cost consists of acquisition price plus all the costs necessary to get the asset in place, and ready for its intended use.

3. Land is not depreciable.
The Cost of Land
Land is not depreciable.
Includes:
Purchase price
Brokerage commissions
Survey and legal fees
Delinquent property taxes
Title transfer fees
Cost of clearing the land
Cost of removing old buildings
The cost of land includes the purchase price, brokerage commissions, survey and legal fees, delinquent property taxes, title transfers fees, the cost of clearing the land, and the cost of removing old buildings from the land. Land is a unique kind of plant asset that is never depreciated.

4. The Cost of Land Does Not Include:
Fencing
Paving
Sprinkler systems
Lighting
Signs
These costs are referred to as Land Improvements. Land Improvements ARE depreciated.
The cost of land does not include fencing, paving, sprinkler systems, lighting, signs, and other improvements to the land such as landscaping. These costs are collectively referred to as Land Improvements. These costs are separately identified from the land itself and they are depreciated.

5. The Cost of Land
Smart Touch Learning purchases land on August 1, 2015, for $50,000 with a note payable. Other costs related to this transaction include $4,000 in delinquent property taxes, $2,000 in transfer taxes, $5,000 to remove an old building, and a $1,000 survey fee. The additional costs are paid in cash. What is the cost of the land on Smart Touch Learning’s books?
Assume that Smart Touch Learning buys some land on August 1 for $50,000 and pays for it with a note payable. Other costs related to this transaction include $4,000 in delinquent property taxes, $2,000 in property transfer taxes (or fees), $5,000 to remove an old building from the site, and $1,000 for a survey of the property.
What is the cost of the land on Smart Touch Learning’s books?

6. The Cost of Land
As you can see from the computation in Exhibit 9-2, the cost of the land is not only the acquisition cost of $50,000. It also includes an additional $12,000 of costs that bring the total cost of the land on the books to $62,000.

7. Prepare the journal entry to record the purchase of the land.
The Cost of Land
Prepare the journal entry to record the purchase of the land.
The journal entry to record the acquisition of the land would include a debit to Land for $62,000 and credits to Notes Payable for $50,000 and to Cash for $12,000 (related to the additional costs).

8. When a Building is constructed, the costs include:
The Cost of Buildings
When a Building is constructed, the costs include:
Site excavation
Building permits
Contractor charges
Materials
Labor
A company can acquire a building one of two ways: the building can be constructed or a finished building can be purchased. When a building is constructed, the cost of the building includes the excavation of the site to prepare for the construction of the building. In addition, architectural fees are included in the cost of the building. Other costs include building permits, contractor charges, materials, and labor.

9. When a Building is purchased, the costs include:
The Cost of Buildings
When a Building is purchased, the costs include:
Purchase Price
Brokerage fees
Renovation Costs
When a building is acquired, the cost includes the purchase price, any brokerage fees and delinquent taxes, and any renovation costs necessary to prepare the building for occupancy.

10. The Cost of Machinery and Equipment and Furniture and Fixtures
The costs include:
Purchase Price
Transportation Charges
Insurance during transit
Sales Taxes
Purchase commission
Installation costs
Testing cost prior to use of asset
The cost of machinery and equipment (and furniture and fixtures) includes the purchase price, any purchase commission, transportation costs necessary to get the equipment to the site where it will be used, installation and testing costs once the equipment is on site, insurance on the equipment while it is in transit, and any sales taxes on the purchase of the equipment.

11. Lump-Sum Purchases Purchasing several assets for a single price.
Sometimes called a “basket purchase”
Each asset must be recorded separately.
Allocate total cost to each asset based on relative market value.
On August 1, Smart Touch Learning purchased land and building with a $100,000 note. The land is appraised at $30,000 and the building is appraised at $90,000.
Sometimes, a company pays one price for several assets. This is sometimes called a “basket purchase.” Accounting principles require that companies must assign a cost to each uniquely identifiable asset that is acquired. In the case of a basket purchase, or lump-sum purchase, the total cost must be allocated to each of the assets acquired. This is accomplished by allocating the cost to each asset based on its market value relative to the total market value of the assets acquired.
Smart Touch Learning paid $100,000 on August 1 for land and a building. The $100,000 must be allocated; some to the land and some to the building. The land has an appraised market value of $30,000 and the building is appraised at $90,000, for a total market value of $120,000.
How much cost should be allocated to the land and to the building?

12. Lump-Sum Purchases
As noted, the total market value is $120,000. The land represents 25% ($30,000 ÷ $120,000) of the purchase, and the building represents 75% ($90,000 ÷ $120,000) of the purchase. Next, we will apply these percentages to allocate the cost of $100,000.

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Lump-Sum Purchases
In our example, 25% of the cost should be allocated to the land (25% * $100,000 = $25,000) and 75% of the cost should be assigned to the building (75% * $100,000 = $75,000).
Next prepare the journal entry to record the acquisition of the land and building.
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14. Land is not depreciable.
What Is Depreciation?
Plant assets are recorded as assets when purchased.
Depreciation is the process of allocating an asset’s cost to expense over its useful life.
To record depreciation, we debit Depreciation Expense and credit Accumulated Depreciation (a contra-asset).
The plant assets are recorded as assets when they are purchased. Over time, the usefulness of those assets is consumed. To account for the “using up” of the plant assets and in accordance with the Matching Principle, we will need to periodically and systematically allocate the cost of the plant assets from the balance sheet to the income statement. This process is referred to as Depreciation.
As discussed earlier, the depreciation process is part of the end-of-period adjustment process. Depreciation Expense will be debited and a contra-account called Accumulated Depreciation will be credited.
Land is not depreciable.

15. Factors in Computing Depreciation
The Depreciation computation requires three main factors:
Estimated useful life
Capitalized Cost
Estimated residual value
The estimated expected use from an asset.
The estimated value of the asset at the end of its useful life.
To compute depreciation for a period, we will need to consider three primary factors: estimated useful life, the capitalized cost of the asset, and the estimated residual value of the asset at the end of its estimated useful life.
Total amount of cost to be allocated.

16. Depreciation Methods Straight-Line Units-of-Production
There are three common depreciation methods:
Straight-Line
Units-of-Production
Declining-Balance
Smart Touch Learning purchases a truck on January 1, 2014
There are three common depreciation methods: straight-line depreciation, units-of-production depreciation, and declining-balance depreciation.
As we work through each method, we will use the following information. Smart Touch Learning purchases a truck on January 1, The truck has a cost of $41,000 and an estimated residual value of $1,000. The estimated useful life of the truck is 5 years, or 100,000 miles.

17. Equal amounts per period Different amounts; based upon usage
Depreciation Methods
Straight-line
Units-of production
Declining- balance
Equal amounts per period
Different amounts; based upon usage
Decreasing amount over time as it ages
There are many depreciation methods, but three are used most commonly. They are straight-line, units-of-production and double-declining-balance.
These methods work differently in how they derive the yearly depreciation amount, but they all result in the same total depreciation over the total life of the asset.

18. The most widely used and most easily understood method.
Straight-Line Method
The most widely used and most easily understood method.
Results in the same amount of depreciation in each year of the asset’s service life.
Under the Straight-Line Method, residual value is deducted from the depreciable cost and then divided by the estimated useful life of the asset. Straight-Line is the most widely used method in business today. The result is that, for each year of an asset’s estimated useful life, the depreciation computation will be the same each year of the asset’s estimated useful life.

19. Straight-Line Method
The journal entry to record the depreciation for the truck will include a debit to Depreciation Expense for $8,000 and a credit to Accumulated Depreciation for $8,000.

20. Net Book Value The carrying value of an asset as it depreciates
Calculated as: Cost – Accumulated depreciation
As an asset is used
Accumulated depreciation increases
Net book value decreases
An asset’s book value equals its cost less accumulated depreciation. As an asset is used, accumulated depreciation increases and book value decreases.

21. Units-of-Production Method
Depreciation is a function of how much an asset is USED, rather than its age.
Less predictable than other methods.
Smart Touch Learning purchases a truck on January 1, 2014
The Units-of-Production Method requires us to compute depreciation based on how much an asset is actually used relative to its expected productivity over it estimated useful life. This is less predictable than other methods.

22. Units-of-Production Method
Assuming Smart Touch Learning drives the truck 20,000 miles in the first year, how much depreciation should be recorded?
Assume that in the first year of its use, the truck was driven 20,000 miles. The first step is to compute the depreciation per unit of use. In this case, the asset is expected to have a useful life of 100,000 miles. The depreciable cost of the truck is $40,000. So, the truck will be depreciated $0.40 per mile for every mile driven.

23. Units-of-Production Method
Assuming Smart Touch Learning drives the truck 20,000 miles in the first year, how much depreciation should be recorded?
In Step 2, we compute the amount of depreciation for the current period based on the depreciation per unit of use and the actual use. In this case, $0.40 per mile for 20,000 miles results in depreciation in year 1 of $8,000. That this is the same depreciation amount as the straight-line method is only a coincidence. Because this method is so unpredictable, we have no idea how much depreciation will be in year 2. It might be as much as $32,000 (if the truck is driven as much as 80,000 miles in year 2) or $0 (if the truck is not used at all in year 2).

24. Units-of-Production Method
Depreciation amount changes per year
In UPO, the depreciation amount changes per year based upon changing output per period. The journal entry accounts are the same for the different amount each period.

25. Double-Declining Balance Method
An accelerated method.
More depreciation early in an asset’s life.
Total depreciation the same over the asset’s full life.
Smart Touch Learning purchases a truck on January 1, 2014
The Double-Declining Balance Method is called an “accelerated” method. Although the total depreciation on the asset over its estimated useful life is the same under all three methods, in the double-declining balance method, more depreciation is taken in the early years of its estimated useful life, while taking less depreciation in the later years of the asset’s estimated useful life.

26. Double-Declining Balance Method
Multiply an asset’s declining book value by twice the straight-line depreciation rate.
The book value of the asset as of the beginning of each period is multiplied by twice the straight-line depreciation rate. Each year, the book value of the asset will be lower than the book value the previous year. For example, in year 1, Smart Touch Learning’s truck will have $16,400 of depreciation, compared to only $8,000 depreciation using the straight-line method.
40%

27. Double-Declining Balance Method
Multiply an asset’s declining book value by twice the straight-line depreciation rate.
In year 2 of the asset’s useful life, the depreciation will be computed as $9,840. At the beginning of year 1, the book value was $41,000. At the beginning of year 2, the book value is now only $24,600. We will continue to change the book value of the asset each year until book value reaches the estimated residual value. Once book value reaches residual value, we cease computing any additional depreciation.
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28. Double-Declining-Balance Method
2 times straight line rate
Book value declines
Book value becomes period’s depreciable cost
Depreciation expense declines
The formula to compute double-declining-balance is as follows:
The cost minus accumulated depreciation (book value) is multiplied by 2 divided by the life of the asset multiplied by the number of months/12. (Hence, the name “double”.)
Since book value decreases each year, the amount of depreciation expense will decrease over the asset’s life.
Final year’s expense leaves book value equal to residual value, no lower

29. Comparing Depreciation Methods
Residual value = $1,000
Life = 5 years or 100,000 units
Cost = $41,000
This graph shows the pattern of each depreciation method over an asset’s life. In this example, an asset cost $41,000 and was assigned a residual value of $1,000 and a life of 5 years or 100,000 units. The straight-line method (blue) results in a constant amount of depreciation each year. The units-of-production (red) results in varying amounts per year because the activity varies from year to year. The double-declining-balance (green) begins with large amounts in the first two years and then quickly decreases each successive year.

30. Accounting for Partial-Year Depreciation
Only for methods using months
Straight-line
Double-declining balance
Period of time used changes the formula for time
Only the methods that utilize #/12 (number of months of the year) in the formula would change for partial year depreciation, which means only straight-line and double-declining-balance would change. Units-of-production does not consider years in its formula; so, that calculation remains the same.
Since we used the asset for six months of the year, we only record 6/12 of straight-line depreciation expense.

31. Issues in Accounting for Plant Assets
Changes in Useful Life
The asset’s remaining depreciable book value is spread over the asset’s remaining life
Truck has been used for 2 years, and we think it will last for 6 more years making useful life 8 years
Change in residual value
When a company makes an accounting change, generally accepted accounting principles require the business to report the nature, reason, and effect of the accounting change. For a change in either estimated asset life or residual value, the asset’s remaining depreciable book value is spread over the asset’s remaining life.

32. Fully Depreciated Assets
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
A fully depreciated asset is one that has reached the end of its estimated useful life. No more depreciation is recorded for the asset. If the asset is no longer useful, it is disposed of. If the asset is still useful, the company may continue using it. The asset account and its accumulated depreciation remain on the books, but no additional depreciation is recorded. In short, the asset never goes below residual value.

33. Discarding Plant Assets
When an asset is disposed, sold, or retired, it must be removed from the books.
All related Accumulated Depreciation must also be removed from the books.
Gains/Losses on disposal are recorded.
STEPS
Bring depreciation up to date.
Remove original cost of asset and accumulated depreciation from the books.
Record any cash received.
Record the difference between book value and the cash received as a gain or loss.
At some point, a plant asset will cease to be useful. Perhaps, it is obsolete, or it is just so old that it no longer runs efficiently. Whatever the reason, a company will discard previously useful long-lived assets. When that happens, the asset must be removed from the books. In addition, any accumulated depreciation related to the discarded asset will also be removed from the books. If cash is received from the discarding of the asset, it is necessary to record the receipt of it. It may be necessary to record either a gain or loss on disposal of the asset.

34. Discarding Plant Assets Example #1
On July 1, Smart Touch Learning discards equipment that cost $10,000. The accumulated depreciation on the asset is $10,000.
The journal entry to record depreciation for the period will include a credit to Equipment to remove its original cost. In addition, a debit to Accumulated Depreciation will remove the related balance from the books. Because there is no cash involved, this journal entry is now balanced.

35. Discarding Plant Assets Example #2
On July 1, Smart Touch Learning discards equipment that cost $10,000. As of December 31 the previous year, the accumulated depreciation on the asset was $8,000. Annual depreciation per year is $1,000.
Depreciation for half a year is computed as the normal annual depreciation x 6/12 ($1,000 * 6/12 = $500). The entry to record the depreciation is a debit to Depreciation Expense for $500 and a credit to Accumulated Depreciation for $500. This will change the Accumulated Depreciation balance from $8,000 to $8,500.
First, we have to update the depreciation.

36. Discarding Plant Assets Example #2
On July 1, Smart Touch Learning discards equipment that cost $10,000. As of December 31 the previous year, the accumulated depreciation on the asset was $8,000. Annual depreciation per year is $1,000.
Second, record the disposal.
The entry will require a debit to Accumulated Depreciation for $8,500 and a credit to Equipment to $10,000. The difference of $1,500 is debited to Loss on Disposal.

37. Discarding Plant Assets Example #3
On July 1, Smart Touch Learning sells equipment for $4,000. The equipment cost $10,000. As of December 31 the previous year, the accumulated depreciation on the asset was $8,000. Annual depreciation per year is $1,000.
The entry to record the additional depreciation will require a debit to Depreciation Expense for $500 and a credit to Accumulated Depreciation for $500. This will bring the Accumulated Depreciation balance to $8,500.
First, update depreciation.
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38. Discarding Plant Assets Example #3
Second, record the sale.
On July 1, Smart Touch Learning sells equipment for $4,000. The equipment cost $10,000. As of December 31 the previous year, the accumulated depreciation on the asset was $8,000. Annual depreciation per year is $1,000.
The entry includes a debit to Cash for the amount of cash received ($4,000), a debit to Accumulated Depreciation to take that account off the books ($8,500), and a credit to Equipment for $10,000 to remove the equipment from the books. At this point the journal entry is not balanced. We have $12,500 in debits and $10,000 in credits. To make the entry balance, we record a credit to Gain on Sale of Equipment for $2,500.

39. Discarding Plant Assets
Cost = $10,000 (asset)
Accumulated Depreciation = $8,500(contra asset)
Book Value = $1,500
When sold for cash(no exchange for new asset)
Cash received = Book Value (no gain or loss)
Cash received $1,500 (Cash received = BV $1,500)
Cash received > Book Value (gain)
Cash Received $2,000 (gain of $500)
Cash Received < Book Value (loss)
Cash received $1,000 (loss of $500)

40. Natural Resources Assets that come from the earth and are consumed.
The value of the “reserves” that a company owns/controls is a long-term asset.
Includes:
Iron ore
Oil
Natural Gas
Coal
Timber
Diamonds
Gold and silver
In addition to long-lived assets, there is another type of asset referred to as Natural Resources. Natural Resources are like inventory because we will sell them. However, they are also a long-term asset that will take years to extract from the environment. Natural Resources include iron ore, oil, natural gas, coal, timber, diamonds, gold and silver, and other important minerals.
When the right to extract Natural Resources is acquired, the acquiring company will record the cost of the reserves as a long-lived asset.

41. Natural Resources
As the resources are extracted, Depletion Expense is recorded.
A contra-asset Accumulated Depletion is also recorded.
Steps (similar to Units-of-Production)
Compute Depletion per Unit (based on estimated reserves)
Compute Depletion for the period (based on actual extraction)
As the Natural Resources are extracted, we have to move part of the cost of the reserves to the income statement. This process is called Depletion. Depletion Expense is computed based on the units-of-production method. A cost per unit of resource is determined based on the cost paid for the reserves and the estimated amount of reserves available to be extracted. Once we determine the amount of resources extracted in a period, we can multiply that by the depletion expense per unit of natural resource to arrive at Depletion Expense. The other side of the entry will be a credit to Accumulated Depletion.

42. Prepare the journal entry for Depletion Expense.
Natural Resources
A company owns oil reserves that cost $700,000 and is estimated to contain 70,000 barrels of oil. During the year, 3,000 barrels of oil are extracted.
A company acquires the rights to 70,000 estimated barrels of oil for $700,000. During the year, 3,000 barrels of oil are extracted from the reserves.
Prepare the journal entry for Depletion Expense.

43. Step 1: Compute Depletion per Unit.
Natural Resources
The depletion per barrel is computed at $10 per barrel.
Step 1: Compute Depletion per Unit.

44. Step 2: Compute Depletion for the Period.
Natural Resources
In step 2, we will multiply the depletion per barrel ($10) by the number of barrels extracted during the period (3,000) for Depletion Expense of $30,000.
Step 2: Compute Depletion for the Period.
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45. Prepare the journal entry for Depletion Expense.
Natural Resources
The entry will require a debit to Depletion Expense for $30,000 and a credit to Accumulated Depletion for $30,000.
Prepare the journal entry for Depletion Expense.
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46. Exxon Mobil Partial Income Statement

47. Exxon Mobil Partial Balance Sheet

48. Intangible Assets Assets that have no physical substance.
Usual convey rights to the owner.
Recorded at cost.
Research and development costs are NOT included.
Includes
Patents
Copyrights
Trademarks
Franchise Agreements
Licenses
Goodwill
The final group of long-lived assets are Intangible assets. These are assets that have no physical substance. In some cases, but not all cases, the intangible asset is represented by a piece of paper that cedes ownership of the intangible asset to the owner.
Intangible assets include patents, copyrights, trademarks, franchise agreements, licenses, and goodwill.

49. Intangible Assets
As intangible assets “expire,” they must be “amortized.”
Amortization expense is recorded:
Based on the straight-line method
Use the shorter of the useful life or the legal life
Only for intangible assets with definite life
For purposes of amortization, the life of an intangible asset is usually defined by the shorter of its legal life or useful life. However, only definite-life intangible assets are amortized. Intangible assets with an indefinite life are not amortized.
Amortization is similar to straight-line depreciation.

50. Types of Intangibles Patent Copyright Trademarks - brand names
Exclusive 20-year right to produce & sell an invention
Amortized over its useful life
Exclusive right to sell a book, musical work, film, art, software, or intellectual property (70 years beyond the authors life)
Amortized over its useful life
Represent distinctive products or services
Nike - swoosh, Chevrolet – “Like a Rock”
Amortized over its useful life
A patent is an intangible asset that is a federal government grant conveying an exclusive 20-year right to produce and sell an invention. The invention may be a product or a process—for example, the Dolby noise-reduction process.
A copyright is the exclusive right to reproduce and sell a book, musical composition, film, or other work of art or intellectual property. Copyrights also protect computer software programs. Issued by the federal government, a copyright extends 70 years beyond the author’s life. A company may pay a large sum to purchase an existing copyright.
Trademarks and brand names (also known as trade names) are assets that represent distinctive products or services, such as the NIKE “swoosh” or the NASCAR number 3 for Dale Earnhardt. Legally protected slogans include Chevrolet’s “Like a Rock” and Avis Rent A Car’s “We try harder.” The cost of a trademark or trade name is amortized over its useful life.
Issued by the federal government

51. Types of Intangibles Franchises & licenses Goodwill
Privilege to sell goods or services under specific conditions
Examples: McDonalds, Holiday Inn,
Dallas Cowboys
Amortized over its useful life
Excess of cost to purchase another company over market value of its net assets
Recorded only by an acquiring company
Goodwill is not
amortized, current value is adjusted
Franchises and licenses are privileges granted by a private business or a government to sell goods or services under specified conditions. The Dallas Cowboys football organization is a franchise granted by the National Football League. McDonald’s restaurants and Holiday Inns are well-known business franchises. The acquisition cost of a franchise or license is amortized over its useful life.
Goodwill in accounting has a different meaning from the everyday phrase “goodwill among men.” In accounting, goodwill is the excess of the cost to purchase another company over the market value of its net assets (assets minus liabilities). Goodwill is recorded only by an acquiring company when it purchases another company. An outstanding reputation may create goodwill, but that company never records goodwill for its own business.
According to generally accepted accounting principles (GAAP), goodwill is not amortized. Instead, the acquiring company measures the current value of its goodwill each year. If the goodwill has increased in value, there is nothing to record. But if goodwill’s value has de-creased, then the company records a loss and writes the goodwill down.

52. Intangible Assets
There is no contra-asset account used with the amortization process.
The intangible asset is credited directly.
Each year the asset’s book value will decrease by the amount of the amortization.
Unlike the depreciation or depletion processes, amortization does not utilize a contra-asset account to “store” the accumulated amortization. Rather, as amortization expense is incurred, it is credited directly against the intangible asset.

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Asset Turnover Ratio
Used to measure how well a company is using its assets to generate sales revenue.
The asset turnover ratio is used to measure how well a company utilizes its assets in generating sales. It is a simple calculation of:
Net Sales (after deducting sales discounts and sales returns and allowances) ÷ Average Total Assets
Average Total Assets = (Beginning of Period Total Assets + End of Period Total Assets) ÷ 2
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