CH 9

ACCT 2301 CH 9

Depreciation

The allocation of a plant asset’s cost over its useful life. Follows the matching principle.

The Matching Principle

Ensures all expenses are matched against the revenues of the period.

Which plant asset is not depreciated?

Land

Why are plant assets classified that way?

Plant assets are used in the operation of the business. Not specifically acquired for resale, they are to help create business’ revenue. Ex a vacant building owned by a business that is not currently being used is a long-term investment because it is sitting idle and not being used in operations of the business.

Life Cycle of a Plant Asset

1. Acquisition of asset

2. usuage of asset

3. disposal of asset

Cost Principle

Acquired assets (and services) should be recorded at their actual cost.

How are plant assets recorded?

Recorded at historical cost(the amount paid for the asset). This includes the purchase price plus taxes, purchase commissions, and all other amounts paid to ready the asset for its intended use.

Land Improvements

Unlike land they are subject to depreciation. Things like fencing, paving, sprinkler systems, lighting and signs.

Capitalized

An asset account was debited(increased) because the company acquired an asset.

“Company capitalized the cost of the land at 62k.”

“The company debited the land account for 62k, the capitalized cost of the asset.”

When are equipment asset costs no longer capitalized?

Once the asset is up and running things like insurance, taxes, repairs, and maintenance to the Equipment account are recorded as expenses.

Lump-Sum Purchase

AKA basket purchase. Several assets bought as a group.

Relative-fair-value Method

When lump-sum purchases occur the company must identify the cost of each asset. The total cost is divided among the assets according to their relative fair values.

Calculating Fair Value

Total Fair Value = Asset 1 Fair Value + Asset 2 Fair Value

Percentage of total value = Asset FV / Total Fair Value x Total Purchase Price

Capital Expenditures

AKA balance sheet expenditure. Debited to an asset account because it increases the asset’s capacity or efficiency or extends the asset’s useful life. Reported on the balance sheet as an asset.

Examples of Capital Expenditures

Purchase price of asset plus all the other costs to bring asset to its intended use. Extraordinary repairs.

Extraordinary Repair

Capital expenditure that extends the asset’s capacity or useful life. ex: spending 3k to rebuild the engine of a five year old truck. Debited to the asset account.

Revenue Expenditures

AKA income statement expenditures. Ordinary repairs to maintain an asset like changing the oil filter and replacing tires. Debited to an expense account. Reported on income statement as expense in period incurred.

Obsolete

When a newer asset can perform the job more efficiently, therefore an asset’s useful life may be shorter than its physical life. In all cases, the asset;s cost is depreciated over its useful life.

What is NOT depreciation?

1. not a process of valuation. Businesses do not record this based on change’s in asset’s fair value.

2. Does not mean that the business sets aside cash to replace an asset when it is used up. It has nothing to do with cash.

3 Main Factors of Depreciation

1. Capitalized cost (known cost)

2. Estimated useful life (estimate)

3. Estimated residual value (estimate)

Useful Life (estimate)

How long the company expects it will use the asset. May be expressed in time or usage.

Estimated Residual Value (Salvage Value)

The asset’s expected value at the end of its estimated useful life. The amount the company expects to receive when it disposes of the asset. Not depreciated since it is expected to be received at the end.

Depreciable Cost

The amount of the capitalized cost that will be depreciated.

Depreciable Cost Equation

Cost - Estimated Residual Value