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What are plant assets?
Resources that have 3 characteristics
What are plant assets also referred to as?
Property, plant, and equipment; plant and equipment; and fixed assets
What is the expected life span of plant assets?
Plant assets are expected to be of use to the company for a number of years. Plant assets, except land, decline in service potential over their useful lives
How does the historical cost principle require companies to record plant assets?
They must record it as cost. Cost consists of all expenditures necessary to acquire an asset and make it ready for its intended use
What is the cash equivalent price?
Another way to record cost of a plant asset. It’s an amount equal to the fair value of the asset given up or the fair value of the asset received, whichever is more clearly determinable.
What is the cost of land?
What entries are made for land?
A debit (increase) to the land account for all necessary costs incurred to make land ready for its intended use. And a credit (decrease) to cash
What are land improvements?
Structural additions with limited lives that are made to land
The cost of land improvements include all expenditures necessary to make the improvement ready for their intended use
What is the costs for buildings that are purchased?
What is the costs of constructed buildings?
How do interest cost come into play for purchased and constructed buildings?
Interest cost incurred to finance the projects are included in the cost of the building when a significant period of time is required to get the building ready for use
The inclusion of interest costs in the cost of a constructed building is limited to interest costs incurred during the constructed period
What entries are made for buidlings?
Debit (increase) to building account and debit (increase) to interest expense
What are the costs of equipment?
What are the 2 criteria for determining the cost of equipment?
Example of entries for equipment
What are ordinary repairs?
Expenditures to maintain the operating efficiency and productive life of the asset
What are revenue expenditures?
Expenditures that are immediately charged against revenues as expenses
What are additions and improvements?
Cost incurred to increase the operating efficiency, productive capacity, or useful life of a plant asset
What are capital expenditures?
Expenditures that increase the company’s investment in plant assets
What is a lease?
A contractual agreement in which the owner of an asset (the lessor) allows another party (the lessee) to use the asset for a period of time at an agreed price
What are the advantages of leasing?
What is depreciation?
The process of allocating to expense the cost of a plant asset over its useful (service) life in a rational and systematic manner. Such cost allocations are designed to properly record expenses (efforts) with associated revenues (results)
What are the 3 factors in computing depreciation?
What is the factor costs?
The historical cost principle
What is the factor useful life?
Estimate of the expected productive life, also called service life, of the asset for its owner. Can be expressed in terms of time, units of activity (such as machine hours), or units of output.
What is the salvage value?
The estimate of the asset’s value at the end of its useful life for its owner
What are the 3 depreciation methods?
83% of major U.S. companies use the straight-line method
Total depreciation expense is the same no matter what method you use
What is depreciable cost?
It is equal to the cost of the asset less its salvage value
What is the straight-line method?
Companies expense an equal amount of depreciation each year of the asset’s useful life. Management must choose the useful life of an asset based on its own expectations and experience
How is the annual depreciation expense calculated in the straight line method?
Take the depreciable cost and divide it by the useful life (annual rate)
Example of straight line method
What is prorating the annual depreciation?
Taking into account depreciation of a plant asset that was purchased later in the year
What is the declining-balance method?
Computes depreciation expense using a constant rate applied to a declining book value. Produces a decreasing annual depreciation expense over the asset’s useful life
Also referred to as the accelerated-depreciation method because it results in higher depreciation in the early years of an assets life compared to straight-line approach
In early years, declining-balance depreciation expense will exceed straight-line. In later years, it will be less than straight line
How can you calculate the rate for declining-balance>
A common declining balance rate is double the straight line rate
What is the units-of-activity method?
Expresses useful life in terms of total units of production or the use expected from the asset
Amount of depreciation is proportional to the activity that took place during that period
Ideally suited to factory machinery
Also possible to use on items such as delivery equipment (miles driven) and airplanes (hours in use)
When should management revise the depreciation expense amount?
When the annual depreciation is either inadequate or excessive.
When a change in estimate is required, the company makes changes to current and future years, but not to prior periods
What is an impairment?
A permanent decline in the fair value of an asset
What are the 3 methods of plant asset disposal?
Sale, retirement, exchange
What must companies due in their books in order to dispose of plant assets?
They must determine the book value (difference between the cost of plant asset and accumulated depreciation to date) of the plant asset at the time of disposal in order to determine the gain or loss.
The company eliminates the book value by reducing (debiting) accumulated depreciation for the total depreciation association with that asset to the date of disposal and reducing (crediting) the asset account for the cost of the asset
What is the sale of plant assets method?
Equipment is sold to another party
In a disposal by sale, the company compares the book value of the asset with the proceeds received from the sale
Example of gain on sale
1) Record updated depreciation expense
2) Determine the gain on disposal
3) Record sale of office furniture at a gain
Gain on disposal of plant asset is a credit
Example of lose on sale
1) Record updated depreciation expense
2) Determine the lose on disposal
3) Record sale of office furniture at a lose
What is the retirement of plant assets method?
Equipment is scrapped or discarded. Companies record retirement of an asset as a special case of disposal where no cash is received
They decrease (debit) accumulated depreciation for the full amount of depreciation taken over the lief of the asset and decrease (credit) the asset account for the original cost of the asset
What are intangible assets?
Rights, privileges, and competitive advantages, that is, without physical , that result from ownership of long-lived assets
How do companies record intangible assets?
Companies record intangible assets at cost. This cost consists of all expenditures necessary for the company to acquire the right, privilege, or competitive advantage. Intangibles are categorized as having either a limited life or an indefinite life
What do companies do if an intangible asset has a limited life and indefinite?
The company allocates its cost over the asset’s useful life using a process similar to depreciation. The process on allocating the cost of intangibles is referred to as amortization
Indefinite intangibles should not be amortized
How do you record amortization of intangible assets?
Company increases (debits) amortization expense and decreases (credits) the specific intangible asset
Companies amortize the cost of a patent over its 20-year life or its useful life, whichever is shorter
What is the difference between intangible and plant assets in determining cost?
Plant asset cost includes the purchase price and the costs incurred in designing and constructing the asset
Intangible assets only include the purchase price
What is a patent?
An intangible asset that represents an exclusive right issued by the U.S. Patent Office that enables the recipient to manufacture, sell, or otherwise control an invention for a period of 20 years from the date of the grant.
What is a copyright?
Copyrights give the owner the exclusive right to reproduce and sell an artistic or published work. Copyrights last for the life of the creator plus 70 years.
Useful life of a copyright generally is significantly shorter than its legal life
What are trademarks and trade names?
A trademark or trade name is a word, phrase, jingle, or symbol that identifies a particular enterprise or product
Trademarks have indefinite lives so they are note amortized
What is a franchise?
A contractual arrangement between a franchisor and a franchise. The franchisor grants the franchisee the right to sell certain products, to perform certain services, or to use certain trademarks or trade names, usually within a designated geographic area
Another type of franchise is a license. A license granted by a governmental body permits a company to use public property in performing its services
Companies record as operating expenses annual payments made under a franchise agreement in the period in which they are incurred
What is goodwill?
Goodwill represents the value of all favorable attributes that relate to a company that are not attributable to any other specific asset. These include exceptional management, desirable location, good customer relations, skilled employees, high-quality products, and harmonious relations with labor unions
Goodwill is not amortized because it is considered to have an indefinite life
Goodwill must be written down if its value has been permanently impaired
How are intangible assets shown in a typical balance sheet?
They are listed separately under “Intangible assets”
What are 2 measures to analyze plant assets?
Return on assets and asset turnovers
What is return on assets and how is it calculated?
An overall measure of probability
Computed by dividing net income by average total assets
What are asset turnovers?
Indicates how efficiently a company uses its assets to generate sales, that is, how many dollars of sales a company generates for each dollar invested in assets
What is profit margin?
Measures the percentage of each dollar of sales that result in net income
Profit margin can be used to find return on assets by multiplying it with asset turnover
How does the relationship with profit margin and asset turnover to increase return on assets?
1) Increase the margin it generates from each dollar of goods that is sells (the profit margin)
2) Increase the volume of goods that it sells (the asset turnover)