1. Plant and Intangible Assets
Chapter 9
Chapter 9: Plant and Intangible Assets

2. Plant Assets as a “Stream of Future Services”
Plant assets represent a bundle of future services, and can be thought of as long-term prepaid expenses.
Plant assets represent a bundle of future services, and can be thought of as long-term prepaid expenses. They 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 in the Lives of Plant Assets
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
Cost
Asset price = +
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 a 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. 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

7. Special Considerations
Costs incurred for remodeling 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 these 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

8. 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.
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.

9. 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 Capital Expenditures and charge the amounts to an asset account on the balance sheet. In some cases, the expenditures may be treated as Revenue Expenditures and charged to current period income as expenses.
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 expenses. 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.

10. Purchase cost as assets purchased as the services are received
Depreciation
The allocation of the cost of a plant asset to expense in the periods in which services are received from the asset.
Balance Sheet
Purchase cost as assets purchased
Assets:
Plant and
equipment
Depreciation is a process of cost allocation. The cost of an asset is allocated to expense over its useful life in some rational and systematic manner. Do not confuse asset valuation, an economic concept, with allocation.
The unused portion of the asset’s cost appears on the balance sheet. A portion of the cost is allocated to expense on the income statement each accounting period.
as the services are received
Income Statement
Revenues:
Expenses:
Depreciation

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
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.

12. 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.

13. Straight-Line Depreciation
On January 2, S&G Wholesale Grocery buys a new delivery truck. The truck cost $24,000, has an estimated residual value of $3,000, and an estimated useful life of 5 years.
Compute annual depreciation using the straight-line method.
On January 2, S&G Wholesale Grocery buys a new delivery truck. The truck cost $24,000, has an estimated residual value of $3,000, and an estimated useful life of 5 years. Compute annual depreciation using the straight-line method.
This calculation was relatively easy. Did you get the annual depreciation of $4,200? Now let’s look at a schedule of the annual depreciation over the life of the asset.

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:
Notice that depreciation expense is the same amount in each of the 5 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

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.
Thus far, this chapter has covered the depreciation of an asset purchased on January 1st. However, relatively few assets will actually be purchased on January 1st. One way to determine depreciation for assets purchased throughout the year is to use the half-year convention. Using this convention, in the year of acquisition, a company would record half a year, or six months, of depreciation.

16. Half-Year Convention
Using the half-year convention, calculate the straight-line depreciation on December 31st, for equipment purchased in during the period. The equipment cost $75,000, has a useful life of 10 years and an estimated residual value of $5,000.
In this example, a company purchased equipment for $75,000 on some date in the current accounting period. The equipment has a useful life of 10 years and an estimated residual value of $5,000. This company uses straight-line depreciation for all of its plant assets.
Using straight-line depreciation, the depreciation expense for an entire year would be $7,000. This amount is determined by taking cost less residual value and dividing it by the useful life. Since the company uses the half-year convention, divide the annual depreciation in half for the first year. The depreciation expense for current period would be $3,500.
Depreciation = ($75,000 - $5,000) ÷ 10
= $7,000 for a full year
Depreciation = $7,000 × 1/2 = $3,500

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

18. Declining-Balance Method
On January 2nd , S&G buys a new delivery truck paying $24,000 cash. The truck has an estimated residual value of $3,000 and an estimated useful life of 5 years.
Compute depreciation for the first year using the double-declining balance method.
On January 2nd, S&G Wholesale Grocery purchased a truck for $24,000. The estimated useful life is 5 years and the estimated residual value is $3,000.
The first step is to calculate the straight-line depreciation rate. Recall that this is done by dividing 100% by the asset’s useful life. In this case divide 100% by the 5-year useful life to get a straight-line rate of 20%.
The second step is to calculate the double-declining-balance rate. Do this by multiplying the straight-line rate times 2. In this case that would be 20% times two, or 40%.
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 $24,000 by 40%. Depreciation expense for 2009 is $9,600.
Remember, under the double-declining-balance method ignore estimated salvage value.

19. 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.
While book value should always be equal to the 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 the fifth year needs to be equal to $3,000, 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.
Depreciation expense will be recorded at $110 in the fifth year. This amount is determined by subtracting the salvage value of $3,000 from the book value at the end of fourth year, $3,110.
Notice that no matter which depreciation method is used, the 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 $21,000.

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.
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.

21. 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 warrant a revision of a previous estimate.
Over the life of an asset, new information may come to light that indicates the original estimates need to be revised.

22. Revising Depreciation Rates
On January 1st, equipment was purchased that cost $30,000, has a useful life of 10 years and no salvage value. Three years later, the useful life was revised to 8 years total (5 years remaining).
Calculate depreciation expense for the year ended December 31st of the fourth year, using the straight-line method.
In this example, a company purchased equipment on January 1st, for $30,000. The equipment is estimated to have a 10-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.
During the fourth year, 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, 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, 2009, 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 2009.

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 –
The asset had a cost of $30,000 and a ten-year useful life with no salvage value. Under straight-line depreciation, $3,000 of expense is recorded in each of the first three years.
The original cost of the asset was $30,000. Accumulated depreciation has a balance of $9,000 at the beginning of of the third year. The remaining book value is $21,000 and the remaining useful life of the asset is five years, so depreciation for each of those five years will be $4,200.

24. Impairment of Plant Assets
If the cost of an asset cannot be recovered through future use or sale, the asset should be written down to its net realizable value.
If an asset’s value decreases and cannot be recovered through future use or sale, the asset is considered to be impaired and should be written down to its net realizable value.

25. Disposal of Plant and Equipment
Update depreciation to the date of disposal.
Journalize disposal by:
Recording cash received (debit).
Recording a gain (credit)
or loss (debit).
When a plant asset is disposed of, the first thing to do is update depreciation to the date of disposal. After completing the update, the journal entry can be created. The journal entry begins by the recording of a debit to the cash account, if cash was received, or credit to the cash account, if cash was paid by the company. In addition, it must be determined whether a gain or loss is associated with the disposal. A gain is recorded with a credit, just like revenue, and a loss is recorded with a debit, just like an expense account. The entry is completed by removing the plant asset’s cost from the books with a credit, and removing the related accumulated depreciation with a debit. Let’s see how to calculate the gain or loss associated with the disposal.
Removing accumulated depreciation (debit).
Removing the asset cost (credit).

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 cash received (debit).
Recording a gain (credit)
or loss (debit).
If the amount of cash received is greater than the book value of the asset (cost less accumulated depreciation), a gain is associated with the disposal.
If the cash received is less than the book value of the asset, a loss will be recorded.
When the amount of cash is exactly equal to the book value of the asset, there will be no gain or loss in connection with the disposal.
Now let’s look at a specific example of disposal of a plant asset.
Removing accumulated depreciation (debit).
Removing the asset cost (credit).

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.
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.
Remember that to determine gain or loss on disposal of an asset we compare the asset’s book value to the proceeds from the disposal. In our case, the cash received was more than the book value of the asset, so we have a gain on the sale of this machine of $1,000. Now, let’s look at the entry to record the sale of the assets.
Cost of machine
$ 10,000
Accumulated depreciation
(8,000)
Book value at time of sale
2,000
Cash received
3,000
Gain on sale of machine
$ 1,000

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.
To record the disposal of the machine we debit Cash for $3,000, debit to Accumulated Depreciation on the machine for $8,000, a credit to Gain on Disposal of Plant Asset for $1,000, and a credit to Machinery for $10,000. Whenever we dispose of a depreciable asset, the entry to record the disposal will always have a debit to accumulated depreciation and a credit to the asset.

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 up-to-date accumulated depreciation of $30,000, and a fair value of $4,000.
Assume that Essex Company exchanges a used earthmover and $35,000 cash for a new earthmover. The old earthmover given up has a historical cost of $40,000 dollars, accumulated deprecation to the date of exchange of $30,000, and a fair value of $4,000. The first thing we need to determine is whether a gain or loss will result.
+ $35,000

30. Trading in Used Assets for New Ones
Because there were no cash proceeds from the disposal of this equipment, we determine the gain or loss by comparing the asset’s book value to its fair market value. In our case, the earthmover has a book value of $10,000 and a fair market value of $4,000. Because fair market value is lower than book value, we have a $6,000 loss on the disposal of the old earthmoving equipment.
Begin by recording the parts of the journal entry that are known. The old earthmover is being given up, so we debit Accumulated Depreciation for $30,000, and credit the old Equipment account for $40,000. Next, we credit Cash for $35,000 because it is being given up in the exchange, and we debit Loss on Disposal of Asset for $6,000. Now, just debit the new Equipment account for $39,000. This $39,000 represents the fair value of the assets given up in the exchange: Cash of $35,000 plus the fair market value of the old earthmover of $4,000.

31. 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.

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
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.

33. 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.

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.
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.

35. 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.

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.
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.

37. 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.

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.
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 70 years. Most copyrights are amortized over a short period of time using the straight-line method.

39. 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.

40. 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 to be covered in this presentation—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

41. 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.

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.
Cash payments for plant assets appear as cash outflows for investing activities on the statement of cash flows. Remember, depreciation is a non-cash charge to income and is added back to net income under the indirect method of calculating cash flows from operating activities.

43. End of Chapter 9
End of Chapter 9.