1. Plant and Intangible Assets
Chapter Nine:
Plant and Intangible Assets

2. Plant Assets
Long-lived assets acquired for use in business operations.
Plant assets are tangible assets that are used actively in the operations of an entity. It’s fully expected that these assets, sometimes referred to as property, plant, and equipment, will benefit future periods.
When a plant asset is acquired, it is recorded at its historical cost. Once the asset is placed in service, a portion of the asset’s cost is allocated to depreciation expense as the asset becomes older.
As years pass, and the services are used, the cost is transferred to depreciation expense.
The cost of plant assets is the advance purchase of services.

3. Major Categories of Plant Assets
There are three major categories of plant assets: Tangible plant assets are long-term assets that have physical substance. Examples include land, buildings, equipment, furniture, and fixtures. Intangible assets are noncurrent assets with no physical substance. Examples include patents, copyrights, trademarks, franchises, and goodwill. Natural resources are acquired for extracting valuable resources to be used in the business. Examples include oil reserves, timber, and other minerals.
This chapter will review the accounting issues related to these three categories.

4. Accountable Events Acquisition.
Allocation of the acquisition cost to expense over the asset’s useful life (depreciation).
Sale or disposal.
There are three accountable events to discuss.
When a plant asset is acquired, it is recorded at its historical cost. The next slide will show how this cost is determined.
Once the asset is placed in service, a portion of the asset’s cost is allocated to depreciation expense as the asset becomes older.
Finally, at the end of an asset’s useful life, it’s disposed of and removed from the books and records. The accounting for plant assets usually covers several accounting periods.

5. Acquisition of Plant Assets
Asset price
Cost = +
Reasonable and necessary costs . . .
The cost of a plant asset includes the purchase price as well as all costs necessary to get the asset in place and ready for its intended use. The purchase price net of any cash discounts available is recorded.
Finance charges are not included in the cost of an asset. If purchase is financed over a period of time, the interest cost is charged as an expense when incurred.
Let’s see how to determine the cost of a plant asset on the next slide.
. . . for getting the asset to the desired location.
. . . for getting the asset ready for use.

6. Compute the cost of Heat Co.’s new machine.
Determining Cost
On May 4, Heat Co., a stove maker, buys a new machine from Supply Co. The new machine has a price of $52,000. Sales tax is 8%.
Heat Co. pays $500 shipping cost to get the machine to its plant. After the machine arrives, set-up costs of $1,300 are incurred, along with $4,000 in testing costs.
Compute the cost of Heat Co.’s new machine.
On May fourth, Heat Company buys a new machine for fifty-two thousand dollars. Sales tax is eight percent. Heat Company also pays five hundred dollars in shipping costs, one thousand three hundred dollars in set-up costs, and four thousand dollars in testing costs.
What is the cost of the machine?

7. Determining Cost Part I
Remember that the cost of an asset includes the purchase price plus any cost that is necessary to get the asset in place and ready for use. The cost of the new machine is sixty one thousand nine hundred sixty dollars.
Part II
The entry to record the purchase includes a debit to the asset account and a credit to Cash.

8. Special Considerations
Cost includes real estate commissions, escrow fees, legal fees, clearing and grading the property.
Land
When purchasing land, the cost includes the purchase price and other costs generally incurred in connection with land acquisitions. Many of these costs are related to obtaining legal title to the land. Also remember that land is not a depreciable plant asset.
Land improvements include parking lots, driveways, fences, sidewalks, landscaping, and any outdoor lighting systems. Land improvements are depreciated over their useful life.
Improvements to land such as driveways, fences, and landscaping are recorded separately.
Land Improvements

9. Special Considerations
Repairs made prior to the building being put in use are considered part of the building’s cost.
Buildings
Whether we purchase or construct a building, the cost should include the purchase price plus any attorney fees, title fees, and repairs made prior to using the building. If the building is built, the cost will include all the necessary construction costs as well as the costs just mentioned.
Machinery and equipment are recorded at their purchase price less any available cash discount. If the company pays delivery charges on a truck, these costs are included in the cost of the truck. If any special parts need to be installed to make the machinery or equipment ready for its intended use, these costs will be included in the price of the assets. Insurance and property taxes are expenses in the current period; they are not part of the acquisition cost of an asset.
Related interest, insurance, and property taxes are treated as expenses of the current period.
Equipment

10. Special Considerations
Allocation of a Lump-Sum Purchase
The allocation is based on the relative Fair Market Value of each asset purchased.
The total cost must be allocated to separate accounts for each asset.
I think I’ll buy the whole thing; building, land, and contents.
It is not uncommon to have a lump-sum purchase of assets. The most common example may be when purchasing a building and land.
Remember, the land is not depreciable but a building is. A portion of the purchase price must be assigned separately to the building and to the land. When faced with this type of problem, accountants normally divide the cost between the assets on the basis of relative fair market values.

11. Capital Expenditures and Revenue Expenditures
Any material expenditure that will benefit several accounting periods.
Expenditure for ordinary repairs and maintenance.
After a plant asset is purchased, the company may incur additional expenditures on that asset. These expenditures may be for repairs and maintenance, overhauls, upgrading the asset, and similar expenditures. One way to handle these types of expenditures is to treat them as a Capital Expenditure and charge the amount to a asset account on the balance sheet. In some cases, the expenditures may be treated as Revenue Expenditures and charged to current period income as an expense.
For each expenditure subsequent to acquisition of a plant asset, decide if the expenditure is to be treated as a Capital or Revenue expenditure.
Generally, subsequent expenditures for ordinary repairs are treated as revenue expenditures and charged to current period income as an expense. Subsequent expenditures that are for betterments are classified as extraordinary repairs. These should be treated as capital expenditures and charged to the asset account.
To capitalize an expenditure means to charge it to an asset account.
To expense an expenditure means to charge it to an expense account.

12. 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
When dealing with depreciation, there are several terms and concepts to understand.
Book value is calculated as the historical cost of the asset minus the accumulated depreciation. Book value is the undepreciated cost of the asset.
Accumulated depreciation represents the depreciation taken on the asset since its purchase. Accumulated depreciation is a contra-asset account and is subtracted from the asset account to determine book value.
Assets are depreciated as we use them to help earn revenue. As assets are used, they incur physical deterioration and obsolescence.
Now, let’s look at some common methods of calculating depreciation expense.

13. Depreciation Methods Time Based Methods: Straight line (SL)
Accelerated methods:
Sum-of-the-years’-digits (SYD).
Double-declining-balance (DDB).
Activity Based Method:
Units-of-Production
Also, there are depreciation methods for tax purposes and methods of calculating group or composite depreciation

14. Straight-Line Depreciation
Cost - Residual Value Years of Useful Life
Depreciation
Expense per Year =
Regardless of the method used to calculate depreciation expense, three variables must be known: (1) the asset’s cost; (2) the estimated residual value expected to be received at the end of its useful life, and (3) the estimated useful life of the asset.
When using the straight line method, depreciation expense is calculated by taking cost minus residual value and dividing by the years of useful life.
Let’s see how this works.

15. Straight-Line Depreciation
On January 1, 2006, Bass Co. buys new equipment. Bass pays a total of $24,000 for the equipment. The equipment has an estimated residual value of $3,000 and an estimated useful life of 5 years.
Compute depreciation for 2006 using the straight-line method.
Part I
On January first, 2006, Bass Company purchased a boat for twenty-four thousand dollars. The estimated useful life is five years and the estimated residual value is three thousand dollars.
Can you calculate the amount of annual depreciation?
Part II
This calculation was relatively easy. Did you get the annual depreciation of four thousand two hundred dollars? Now let’s look at a schedule of the annual depreciation for over the life of the asset.

16. Straight-Line Depreciation
Bass Co. will record $4,200 depreciation each year for five years. Total depreciation over the estimated useful life of the equipment is:
Notice that depreciation expense is the same amount in each of the five years. If this amount was plotted on a graph, it would be a straight-line. That is how the name for this method was determined.
Accumulated depreciation increases by four thousand two hundred dollars each year. The cost of the asset less accumulated depreciation at the end of any year is called book value. Book value decreases by four thousand two hundred dollars each year.
At the end of the asset’s useful life, the book value is equal to the estimated residual value. This should be true regardless of the method used.
Salvage Value

17. Accelerated Depreciation
Accelerated depreciation methods . . .
Match higher depreciation expense with higher revenues in the early years of an asset’s useful life when the asset is more efficient.
Accelerated Methods include:
1. Sum-of-the-Years’-Digits 2. Double-Declining Balance

18. Sum-of-Years’-Digits (SYD)
Annual depreciation is calculated with the following formula:
(Cost - Residual Value) × Remaining Years of Useful Life
Sum-of-the-Years’ Digits

19. Sum-of-Years’-Digits (SYD)
The sum-of-the-years’ digits may be computed as follows for an asset with a five-year life:
= 15
However, the following convenient formula is often more useful:
SYD = [n x (n + 1)]/2
Where n=total useful life in years

20. Declining-Balance Method
Depreciation in the early years of an asset’s estimated useful life is higher than in later years.
The double-declining balance depreciation rate is 200% of the straight-line depreciation rate of (1÷Useful Life).
There are several appealing reasons to use a declining-balance method for depreciation. One reason to consider the declining-balance method is to better match depreciation expense with revenue generated. The idea is that a newer asset will generate more revenue in early years rather than later years, so depreciation expense should be higher in the early years of ownership and less in later years. Another reason that the declining-balance method is appealing to use for financial statement reporting is that it is similar to the depreciation method used for tax purposes.
Calculating depreciation expense under the double-declining-balance method is a three step process. The first step is to calculate the straight-line depreciation rate. Do this by dividing one hundred percent by the asset’s useful life.
The second step is to calculate the double-declining-balance rate. Do this by multiplying the straight-line rate times two.
The third and final step is to determine depreciation expense. Multiply the double declining rate times the book value of the asset at the beginning of the period. Under the double-declining-balance method estimated residual value is ignored.
Let’s look at an example.

21. Declining-Balance Method
On January 1, 2006, Bass Co. buys a new delivery truck. Bass Co. pays $24,000 for the truck. The truck has an estimated residual value of $3,000 and an estimated useful life of 5 years.
Compute depreciation for 2006 using the double-declining balance method.
Part I
On January first, 2006, Bass Company purchased a boat for twenty-four thousand dollars. The estimated useful life is five years and the estimated residual value is three thousand dollars.
Can you calculate the amount of annual depreciation using the double-declining balance method?
Part II
The first step is to calculate the straight-line depreciation rate. Recall that this is done by dividing one hundred percent by the asset’s useful life. In this case divide one hundred percent by the five-year useful life to get a straight-line rate of twenty percent.
The second step is to calculate the double-declining-balance rate. Do this by multiplying the straight-line rate times two. In this case that would be twenty percent times two, or forty percent.
The third and final step is to determine depreciation expense. Multiply the double declining rate times the book value of the asset at the beginning of the period. In this case multiply the beginning book value (cost less accumulated depreciation) of twenty-four thousand dollars by forty percent. Depreciation expense for 2006 is nine thousand six hundred dollars.
Remember, under the double-declining-balance method we ignore estimated salvage value.

22. Declining-Balance Method
Total depreciation over the estimated useful life of an asset is the same using either the straight-line method or the declining-balance method.
Compute depreciation for the rest of the truck’s estimated useful life.
Part I
While book value should always be equal to estimated salvage value at the end of an asset’s useful life, it just will not work properly using the double-declining-balance method.
In this case, the book value at the end of 2010 needs to be equal to three thousand dollars, the estimated residual value. The only way that can work is to force depreciation expense in the last year to be the amount needed to bring book value down to residual value.
In 2010, depreciation expense will be recorded at one hundred ten dollars. This amount is determined by subtracting the salvage value of three thousand dollars from the book value at the end of 2009, three thousand one hundred ten dollars.
Part II
Notice that no matter which depreciation method is used, total depreciation taken at the end of an asset’s life will be the same. In this case, for both the straight-line method and the double-declining-balance method total depreciation taken is twenty-one thousand dollars.

23. Units-of-Production
Depreciation rate = Acquisition Cost – Residual Value
Per unit of output Estimated Productive Output in Units
Depreciation = Depreciation X Number of units
Expense rate per unit produced
Note there is no depreciation expense if the asset is idle

24. 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.
Auditors review management’s estimates for useful lives and residual values for reasonableness.
The principle of consistency ensures that companies avoid switching depreciation methods from period to period, unless there is a compelling reason for the change.

25. Revising Depreciation Rates
Predicted salvage value
Predicted useful life
So depreciation is an estimate.
You know that salvage value and useful life of a plant asset are both estimates. Like all estimates, new information may come to light that will a revision of a previous estimate. Let’s see how accountants handle the revision of previous estimates.
Over the life of an asset, new information may come to light that indicates the original estimates need to be revised.

26. Revising Depreciation Rates
On January 1, 2003, equipment was purchased that cost $30,000, has a useful life of 10 years and no salvage value. During 2006, the useful life was revised to 8 years total (5 years remaining).
Calculate depreciation expense for the year ended December 31, 2006, using the straight-line method.
In this example, a company purchased equipment on January first, 2003 for thirty thousand dollars. The equipment is estimated to have a ten-year useful life and no salvage value at the end of its useful life. The company uses the straight-line method for all plant assets and begins recording depreciation on this equipment in 2003.
The original computations for 2003 through 2005 are continued. During 2006, new information is learned about the equipment that causes a revision of the estimate of the equipment’s useful life. The equipment is now believed to have a total useful life of eight years. Depreciation expense for three years has already been recorded (2003, 2004, and 2005), so there are five years remaining in the equipment’s useful life. In this case, accountants take the book value at the date of revision of the estimate, that is, 2006, and subtract any estimated salvage value at the time of revision. This total is to be divided by the remaining useful life of the asset at the date of revision. Let’s calculate the proper depreciation expense for 2006.

27. 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 –
Part I
The asset had a cost of thirty thousand dollars and a ten-year useful life with no salvage value. Under straight-line depreciation, three thousand dollars of expense is recorded in each of the years 2003, 2004, and Let’s calculate the depreciation expense at December thirty-first, 2006.
Part II
The original cost of the asset was thirty thousand dollars. Accumulated depreciation has a balance of nine thousand dollars at the beginning of The remaining book value is twenty one thousand dollars and the remaining useful life of the asset is five years, so depreciation for each of those five years will be four thousand two hundred dollars.

28. Intangible Assets Characteristics
Noncurrent assets without physical substance.
Often provide exclusive rights or privileges.
Characteristics
Let’s change the subject from disposals of plant assets to intangible assets.
Intangible assets lack physical substance and that makes it difficult to determine the asset’s useful life or any residual value. Many intangible assets involve exclusive rights or privileges. Let’s review the major types of intangible assets and the related accounting on the next slides.
Useful life is often difficult to determine.
Usually acquired for operational use.

29. 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
This is a list of the intangible assets to be discussed. Intangible assets are normally recorded at the purchase price plus any legal or related fees.

30. Amortization
Amortization is the systematic write-off to expense of the cost of intangible assets over their useful life or legal life, whichever is shorter.
Use the straight-line method to amortize most intangible assets.
Amortization is the systematic write-off of the cost of an intangible asset over its useful or legal life, whichever is shorter. Amortization is the same concept as depreciation only it’s called a different name because it refers to intangible assets.
The entry to record amortization includes a debit to Amortization Expense and a credit to the specific intangible asset account involved.

31. 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.
An intangible asset called goodwill can be created when one company buys another company. If the purchase price of the company is greater than the fair value of the net assets acquired, goodwill is associated with the transaction. Goodwill is not amortized. Each year there must be a test to see if there has been any impairment in the carrying value of the goodwill. If an impairment is determined to exist, the goodwill account will be reduced and the loss in value recognized.
Goodwill is NOT amortized. It is tested annually to determine if there has been an impairment loss.

32. Patents
Exclusive right granted by federal government to sell or manufacture an invention.
Cost is purchase price plus legal cost to defend.
Amortize cost over the shorter of useful life or 20 years.
A patent gives the holder the exclusive right to manufacture and sell an item or process for twenty years. Patents are amortized (a process just like depreciation) using the straight-line method over their useful lives, but never more than twenty years. Most companies amortize patents over a very short period of time.

33. Trademarks and Trade Names
A symbol, design, or logo associated with a business.
Purchased trademarks are recorded at cost, and amortized over shorter of legal or economic life.
Internally developed trademarks have no recorded asset cost.
A trademark or trade name is any symbol, name, phrase, or jingle that is identified with a company, product, or service. No other party may use the trademark or trade name without the permission of the holder. Many trade marks are extremely valuable. The name “Mercedes-Benz” is quite valuable, as is the name “Harley-Davidson.” We normally amortize the cost of trademarks over a short period of time using the straight-line method.

34. Franchises
Legally protected right to sell products or provide services purchased by franchisee from franchisor.
The holder of a franchise has the right to deliver a product or service under conditions granted by the franchisor. It’s almost impossible to drive down any major street without finding a number of franchise operations. The accounting for franchises can become quite complex. At this point it is sufficient to be able to define the nature of a franchise.
Purchase price is intangible asset which is amortized over the shorter of the protected right or useful life.

35. 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.
A copyright grants to the holder the exclusive right to publish and sell musical, literary, or artistic work for the life of the creator plus seventy years. Most copyrights are amortized over a short period of time using the straight-line method.

36. Research and Development Costs
All expenditures classified as research and development should be charged to expense when incurred.
All of these R&D costs will really reduce our net income this year!
According to generally accepted accounting principles, or GAAP, research and development costs should be expensed as incurred.

37. Examples: oil, coal, gold
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.
Now let’s turn to the last major subject we will cover in the presentations natural resources.
Natural resources abound. There are accounting issues associated with oil, coal, timber, gold, gravel, and a wide variety of other natural resources. In general, natural resources can be thought of as anything extracted from our natural environment. Accountants report natural resources at their cost less accumulated depletion.
Depletion is the allocation of the cost of a natural resource over its useful life. The depletion studied in this text is very similar to straight-line depreciation.
The cost of any natural resource must include all exploration and development costs as well as extraction costs. A portion of these total costs are charged to income each period through the depletion expense account.
Let’s see how the accounting rules for natural resources work.
Examples: oil, coal, gold

38. Depletion of Natural Resources
Depletion is calculated using the
units-of-production method.
Unit depletion rate is calculated as follows:
Total Units of Natural Resource
Cost – Residual Value
Begin the process of calculating depletion expense by determining the depletion expense per unit of natural resource. The numerator of the equation contains the resource cost less any estimated residual value. The denominator of the equation is the estimated total capacity of the natural resource expected to be extracted. For oil, the denominator is expressed in terms of barrels, for coal in tons, for timber in board feet, and the like for other resources.

39. Depletion of Natural Resources
Total depletion cost for a period is:
Unit Depletion
Rate
Number of Units
Extracted in Period ×
Unsold Inventory
Cost of goods sold
Total depletion cost
The second step to determine the current period’s depletion expense is calculated by multiplying the depletion expense per unit, determined on the previous slide, by the number of extracted units sold during the period. Depletion expense, which becomes part of cost of goods sold, is based on the number of units sold, not the number of units extracted.
To determine the unsold inventory balance at the end of the current period, multiply the depletion expense per unit by the number of units on hand at the end of the period.
Inventory for sale

40. Depletion of Natural Resources
Specialized plant assets may be required to extract the natural resource.
These assets should be depreciated over their normal useful lives or over the life of the natural resource, whichever is shorter.
The development and extraction of many types of natural resources require highly specialized plant assets. Just think of the use of off-shore drilling platforms for oil and gas production. These specialized assets are recorded in a separate account from the natural resource and depreciated over their useful lives.

41. Use of Depreciation Methods
As this slide indicates, the straight-line method is used by the majority of companies. This is because of the simplicity of the calculation and ease of use.

42. End of Chapter Nine
Depreciation of plant assets, amortization of intangible assets, and depletion of natural resources present unique problems.