2. Property, Plant, and Equipment
Chapter 18
Property, Plant, and Equipment
Section 1: Acquisition and
Depreciation
Section Objectives
Chapter 17 concluded the discussion of current assets. Chapter 18 focuses on capital assets—assets that will be used by the business for a time frame longer than a year. Chapter 18 concludes the presentation of the basic concepts governing assets and liabilities of a business.
Long term assets are the focus of this chapter. Long term assets have a life greater than one year and are reported below current assets on the balance sheet. Long term assets fall into three major categories:
Property, Plant and Equipment (Buildings, Equipment, Land Improv., etc)
Natural Resources (Oil wells, Timber tracts, Diamond Mines, etc.)
Intangible Assets (Copyrights, Trademarks, Goodwill, etc.)
In this chapter we will learn how to allocate a portion of the costs of these long term assets over the periods they benefit. Section 1 deals with the acquisition costs of long term assets and depreciation of those costs.
Determine the amount to record as an asset’s cost.
Compute and record depreciation of property, plant, and equipment by commonly used methods.
Apply the Modified Accelerated Cost Recovery System (MACRS) classes for federal income tax purposes.
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3. Determine the amount to record as an asset’s cost.
Objective 1
Determine the amount to record as an asset’s cost.
Setting up and maintaining a business often requires a large investment in fixed assets or capital assets (property, plant, and equipment).
Property, plant and equipment includes:
real property (land and land improvements) and
tangible personal property (machinery, furniture, computers, vehicles) which is currently being used in the business.
Real property consists of assets such as land, land improvements, buildings, and other structures attached to the land. Tangible personal property includes assets such as machinery, equipment, furniture, and fixtures that can be removed and used elsewhere.
The recorded cost of an asset would include all the costs necessary to get that asset ready for use.

4. Cost of Tangible Personal Property
Gross purchase price less discounts.
Transportation costs.
Installation costs.
Costs of adjustments or modifications needed to prepare the asset for use.
Cost of Real Property
Costs would include: transportation, installation, and any costs to modify the asset for use in the business. The recorded cost including all of the additional capitalized costs, is the cost that will be depreciated over the equipment’s useful life. The cost of Land includes the purchase price, legal costs to acquire the land, title fees, etc.
Purchase price.
Legal costs.
Other costs related to the acquisition.

5. Objective 2
Compute and record depreciation of property, plant, and equipment by commonly used methods.
Because buildings, equipment, etc. are used for more than one year, their cost is allocated over the periods they benefit. (utilizes the matching principle)

6. Depreciation
Long term assets, like buildings, machinery, equipment, furniture, and fixtures are depreciated because they have a limited life and get used up over time.
Depreciation refers to the loss of usefulness, and not necessarily to a decrease in the market value.
The account Depreciation Expense is debited, and the account accumulated depreciation is credited to record the depreciation for a period.
Depreciation is necessary to record the loss of usefulness of an asset because assets have limited lives and are used up over time. Depreciation does not refer to a decrease in the market value of an asset. Assets that are used for more than a year are originally capitalized. As time passes, we depreciate or allocate the cost of the asset over it’s useful life. The process of doing so is referred to as depreciating an asset. As you will see, there are various methods to do this.

7. Depreciation Methods Straight-Line Declining-Balance
Sum-of-the-Years’-Digits
Units-of-Output
You may remember how to depreciate an asset using the straight-line method but there are several other common depreciation methods which we will cover in this chapter. These methods include:
Straight-Line
Declining-Balance
Sum-of-the-Years’-Digits
Units-of-Output

8. Straight-Line Method Cost – Salvage Value Estimated Useful Life
Formula: Depreciation =
Cost – Salvage Value Estimated Useful Life
The same dollar amount of depreciation is taken each year as an expense.
The straight-line method of depreciation was explained in an earlier chapter. The formula for straight-line depreciation is:
Depreciation = Cost – Salvage Value
Expense Estimated Useful Life
Both the salvage value and estimated useful life are based on estimates. This method results in an equal amount of depreciation being taken each year.

9. Declining-Balance Method
The book value of an asset at the beginning of the year is multiplied by a percentage to determine depreciation for the year.
This is an accelerated method of depreciation.
This method ignores salvage value.
The double-declining balance method is also referred to as the 200 percent declining-balance method.
The formula for computing depreciation expense using the DDB method is:
Depreciation = Book value at x twice SL
Expense beg. of period rate.
The declining balance method of depreciation is an accelerated method. (The write-off of depreciation is larger in earlier years.)
In the DDB method, the salvage value of the asset is not considered in the calculation until the last year the asset is depreciated. You never want to depreciate an asset below its estimated salvage value.

10. Double-Declining-Balance Method
Step 1 Calculate the straight-line rate.
100% %
Useful Life years =
20% (straight-line rate)
Step 2 Calculate the double-declining rate.
Straight-line rate x 2 =
20% x 2 = 40%
The DDB rate is twice the Straight-line rate. If the straight-line rate is 1/5 (20%) then twice the straight-line rate is 2/5 or 40% .

11. Double-Declining-Balance Method
Step 3 Compute depreciation for the period by multiplying the book value by the double declining rate. Repeat over asset’s useful life.
Beginning Depreciation Accumulated
Year Book Value Percentage for the Year Depreciation
$2, % $ $960.00
(–960.00)
, % ,536.00
( )
In year one, the beginning book value of the asset is $2,400. If you multiply this amount times 40% (the DDB rate) we would get depreciation in year one equal to $960. In year 2, the remaining book value is $1,440. Again we multiply this number times the DDB rate of 40% and we would get depreciation expense in year 2 of $576. In the final year of the asset’s depreciation, take only the amount of depreciation that will reduce the asset’s net book value to its salvage value. %

12. Sum-of-the-Years’-Digits Method
This is an accelerated depreciation method.
The denominator is sum of the useful life years added together.
(If the useful life is 5 years, then denominator is 15 ( ).
The numerator is the number of years remaining in the useful life of the asset.
Year 1: The fraction is 5/15.
Year 2: The fraction is 4/15.
Year 5: The fraction is 1/15.
The fraction is multiplied by the acquisition cost less the net salvage value.
The SYD method of depreciation is another accelerated method of depreciation.
The Sum-of–the-years digits method formula is:
Depr = Remaining years to depr x (Cost- Salvage Value)
Exp Sum of all years of useful life.

13. Units-of-Output Method
Calculates depreciation at the same rate for each unit produced.
Unit of production can be measured by:
Physical quantities of production.
Number of hours the asset is used.
Other measures.
This method depreciates an asset based on its USE.
This method is often used to depreciate the cost of cars, trucks, and other motor vehicles, using miles as a measure of production. It is similar to the straight-line method of figuring depreciation except the depreciation is figured per unit of output instead of per year.

14. Depreciation for Federal Income Tax Purposes
Apply the Modified Accelerated Cost Recovery System (MACRS) for federal income tax purposes
Objective 3
Depreciation for Federal Income Tax Purposes
A different set of rules is used for depreciation for income tax purposes.
MACRS = Modified Accelerated Cost Recovery System
MACRS is used for federal income tax reporting. Another depreciation method (perhaps one of the methods discussed earlier in the chapter) can be used for financial statements.
Many depreciation policies have been made and modified by the U.S. Congress since the federal government began collecting income taxes. Congress has set up useful lives for all assets and devised depreciation tables to be used in computing depreciation expense for income tax purposes. These tables are used to help determine MACRS (Modified Accelerated Cost Recovery System) depreciation for income tax purposes.
MACRS results in higher depreciation expense in early years which results in tax savings. It is NOT however acceptable for financial statement preparation.
“Cost Recovery” refers to the amount of depreciation expense used in computing taxable income.

15. Adjustments and the Worksheet
Chapter 18
Adjustments and the Worksheet
Section 2: Disposition
of Assets
Section Objectives
Section 2 of the chapter explains how to dispose of long term assets.
Record sales of plant and equipment.
5. Record asset trade-ins using financial accounting rules and income tax requirements.
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16. Methods of Disposition Proceeds – Book Value = Gain or loss
Businesses routinely sell or dispose of plant assets that are no longer useful to the business.
When assets are disposed of, the business often incurs a gain or loss.
Assets may be disposed of in several ways by a business including being thrown away, sold outright, or traded for another item. When an asset is disposed of, the transaction may result in a gain or loss. A gain is the disposition of an asset for more than its book value. A loss is a disposition of an asset for less than its book value.
Proceeds – Book Value = Gain or loss

17. Methods of Disposition
Scrapping or discarding
Sale
Trade-in for a similar asset
When we dispose of an asset, all of its related accounts must be removed from the books (the asset account itself and any accumulated depreciation associated with it.) A business can dispose of an asset in several ways. . .
Scrapping or discarding
Sale
Trade-in for a similar asset

18. Disposal by Scrapping or Discarding
When an asset is worn out, often it is simply discarded.
If the discarded asset is not fully depreciated, depreciation is recorded up to the date of disposal.
Prior to removing a capital asset from your books, all depreciation expense needs to be recorded up to the date of the disposal. A loss may be incurred upon disposal if the book value of the asset is less than the proceeds.

19. Disposal by Sale Record sales of plant and equipment Objective 4
Step 1. Record depreciation to the date of disposition.
Step 2. Remove the cost of the asset.
Step 3. Remove the accumulated depreciation.
Step 4. Record the proceeds.
Step 5. Determine and record the gain or loss, if any.
A business may dispose of an asset by selling it. Before taking an asset off of the business’s books because it was sold, we need to update depreciation expense up to the date of the sale. A loss or a gain may result on the sale if the proceeds received are less than (loss), or greater than (gain) the book value of the asset. When recording the sale, the asset account should be removed from the books as well as its associated accumulated depreciation.

20. Sale at Book Value Income Statement
If the asset is sold for the same amount as the book value, there is no gain or loss.
Sale at Book Value
Income Statement
Balance Sheet
No change in net income
If the asset is sold for same amount as the book value, there is no gain or loss. There would be no change in net income for the period and total assets would stay the same.
No change in equity

21. Gain on Sale Net Income Assets Equity Sale Above Book Value
If the asset is sold for more than book value, there is a gain.
Sale Above Book Value
Income Statement
Balance Sheet
Gain on Sale
Net Income
If the asset is sold for more than book value, there is a gain. The gain would be reported on the income statement and total assets and equity would go up on the balance sheet.
Assets
Equity

22. Loss on Sale Net Income Assets Equity Sale Below Book Value
If the asset is sold for less than book value, there is a loss.
Sale Below Book Value
Income Statement
Balance Sheet
Loss on Sale
Net Income
If the asset is sold for less than book value, there is a loss. The loss would be reported on the income statement and total assets and total equity would go down on the balance sheet.
Assets
Equity

23. Objective 5
Record asset trade-ins using financial accounting rules and income tax requirements.
Businesses often trade in old equipment when they purchase new equipment.

24. Disposal by Trade-in Disposing of Fixed Assets by Exchange
Step 1. Record the depreciation up to the date of trade-in.
Step 2. Record the trade-in of the old asset and the purchase of the new asset. Use either:
When recording a trade-in it is very similar to a sale except we have to add a new asset as well as remove an old one. Always remember to update the depreciation account up to the date of the sale then record the trade-in of the old asset and the purchased of the new asset. If a gain or loss occurs involving the trade-in of another asset we have to determine if the trade was for a similar asset or a non-similar asset. To record the transaction we use either:
the financial accounting rules, or
the income tax rules
the financial accounting rules, or
the income tax rules.

25. What are the financial accounting
QUESTION:
What are the financial accounting
rules for trade-ins of similar assets?
The financial accounting rules allow a loss to be recognized on the trade-in of a similar asset.
ANSWER:
The Financial Accounting Rules for Trade-Ins are:
All losses are recorded.
Only gains on non-similar asset trades are recorded.
Gains on similar asset trades reduce the recorded cost of the new asset.
A gain is not recognized!!

26. Applying the Financial Accounting Rules if there is a loss on the trade-in:
Step 1. Remove the cost of the old asset.
Step 2. Remove the accumulated depreciation for the old asset.
Step 3. Record the payment.
Step 4. Record the new asset at its fair market value.
Step 5. Determine and record the loss.
If there is a loss on the trade-in, we would follow these steps:

27. Financial Accounting Rules
Formula for determining loss or gain:
Trade-in allowance
– (Book value)
= (Loss) or gain
If the trade in allowance is greater than the book value of the asset, then their exists a gain. If however, the trade-in allowance is less than the book value of the asset, then there is a loss on the exchange.

28. Financial Accounting Rules
Gain: (Trade in > Book Value of old.)
Gain not recognized!!
New asset’s recorded cost:
Book value of old asset
+ Cash Payment
= Recorded cost of new asset
If there is a gain on the trade in then no gain is recognized. Instead, the recorded cost of the new asset is the book value of the old asset + any cash payment made upon the exchange. If a loss occurs on the trade in, then recognize and record the loss in the books in the new account called “Loss on Trade-in of Plant Asset”.
Loss: (Trade in < Book Value of old)
Recognize loss in Loss on Trade-in of Plant Asset.

29. What is the income tax method?
QUESTION:
What is the income tax method?
The income tax method records the trade-in of an asset according to income tax rules.
ANSWER:
For income tax purposes, the exchange of similar assets (e.g., a car for a car) results in no recognition of a gain or loss on the books.
Income tax rules do not recognize gain or loss on a trade-in.

30. Income Tax Method Step 1. Remove the cost of the old asset.
Step 2. Remove the accumulated depreciation for the old asset.
Step 3. Record the payment.
Step 4. Determine and record the cost of the new asset.
These are the steps used to record the exchange using the income tax method.

31. Income Tax Method Formula for the new asset:
Book Value of the old asset
+ Payment for the new asset
= Cost of the new asset
The cost or tax basis of the new asset is: the book value of the old asset + the amount paid for the new asset.

32. Income Tax Method Gain: Not recognized.
A gain simply reduces the new asset’s cost.
Loss: Not recognized.
A loss simply increases the tax basis (historical cost for tax purposes).
Using the rules for Income tax purposes of a Trade-In if Gain is Realized on the transaction there is no gain recorded.
Using the rules for Income tax purposes of a Trade-In if Loss is Realized on the transaction there is no loss recorded.

33. Income Tax Method
Recall that conservatism requires that the method that is least likely to overstate income should be used.
Therefore, under GAAP, a loss must be recorded.
However, some argue that the income tax method is acceptable (no loss recorded) if the loss is not material.
Recall that conservatism requires that the method that is least likely to overstate income should be used. Therefore, under GAAP, a loss must be recorded.

34. Property, Plant, and Equipment
Chapter 18
Property, Plant, and Equipment
Section 3: Special Topics in
Long-Term Assets
Section Objectives
Other long term assets are Natural resources and Intangible assets. This last section explains how to expense their cost over their useful lives.
Compute and record depletion of natural resources.
Recognize asset impairment and understand the general concepts of accounting for impairment.
Compute and record amortization of intangible assets.
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35. Compute and record depletion of natural resources.
Objective 6
Compute and record depletion of natural resources.
Depletion matches an asset’s costs with the benefits derived from its use.
Natural Resources: Iron ore
Oil
Gold
Coal
Let’s see how to compute periodic depletion of natural resources. Depletion matches an asset’s costs with the benefits derived from its use. The concept of depletion relates to the process of physically removing natural resources from the land. (e.g.. coal mining, oil drilling, cutting timber, etc.) A natural resource does not get depreciated.
Depletion is calculated for both book purposes and tax purposes.
Types of Depletion
Depletion for Financial Statement Purposes.
Depletion for Federal Income Tax Purposes.

36. Depletion for Financial Statement Purposes
Depletion of natural resources for financial statement preparation is called cost depletion.
Formula for cost depletion:
Depletion for Financial Statement Purposes is calculated in the same manner as the calculation for the units-of-production method of depreciation.
Depletion per unit =
Cost of natural resource
Estimated units of the resource

37. Depletion for Federal Income Tax Purposes
Depletion for federal income tax purposes is the larger of cost depletion or percentage depletion.
Formula for percentage depletion:
The calculation to compute the amount of depletion for Federal Income Tax Purposes is based on the larger of cost depletion or percentage depletion.
Cost depletion is computed the same way for financial accounting purposes as for tax purposes.
Percentage depletion is computed by applying a specified percentage rate, depending on the natural resource, to the gross income from the sale of minerals.
Gross income from sale of resource X a percentage

38. Impairment of Property, Plant, and Equipment
Recognize asset impairment and understand the general concepts of accounting for impairment.
Objective 7
Impairment of Property, Plant, and Equipment
Three steps are used to determine whether an asset is impaired.
Step 1. Review circumstances that suggest impairment may have occurred.
Step 2. Apply the recoverability test.
Step 3. Compute the amount of the impairment.
Let’s discuss the guidelines for recording impairment of assets. Impairment of an asset will exist when the “book value” of an asset is greater than its “fair market value”.
These are the steps to determine the amount of impairment:
Review circumstances under which impairment may have occurred.
Apply the recoverability test (a comparison of estimated net cash flow from future use of the asset with the book value of the asset).
Compute the amount of the impairment.
The recoverability test compares the asset’s net book value with the estimated net cash flows from the asset’s useful life.

39. Types of Intangible Assets
Objective 8
Compute and record amortization of intangible assets.
Types of Intangible Assets
Patent
Copyright
Franchises
Trademarks, trade names, brand names
Computer software
Goodwill
The word intangible means the opposite of tangible. The word tangible means you can physically touch an item, so an intangible item is one that you cannot physically touch. These are examples of intangible assets. Goodwill is one of the most common intangible assets whose cost is recorded in financial records.
Intangible assets are amortized. Amortization is the process of periodically transferring the acquisition cost of an intangible asset to an expense account.

40. Internal Control of Property, Plant, and Equipment
Authorize and justify the purchase of assets.
Assign identification number to each asset.
Maintain an asset register listing.
Assign responsibility for safekeeping, maintaining, and operating each asset to a specific person.
Take a physical inventory count periodically.
Establish procedures to authorize asset retirement, sale, or other disposition.
You should now be familiar with the general concept of protecting a company’s assets.
Internal control procedures for protecting capital assets center around record keeping and safeguarding original documents, purchase agreements, patents, and so forth. Formulas, such as the formula for Coca Cola, are extremely valuable and are highly safe-guarded.
Physical inventory should be taken at least once a year of all capital assets.

41. College Accounting, 12th Edition
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College Accounting, 12th Edition
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