Chapter 9 Notes: Reporting and Analyzing Long-Lived Assets

Plant Asset Expenditures

• Plant assets are resources with:

  • Physical substance (definite size and shape).

  • Use in business operations.

  • Not intended for sale to customers.

  • Expected service for a number of years (except for land).

• Referred to as property, plant, and equipment; plant and equipment; and fixed assets.

Valuing Plant Assets

• Historical cost principle: Companies record plant assets at cost.

• Cost includes all expenditures to acquire an asset and make it ready for its intended use.

• Measured by cash paid or cash equivalent price.

• Cash equivalent price:

  • Fair value of asset given up, or

  • Fair value of asset received; whichever is more clearly determinable.

Cost of Land

• Includes all necessary costs to make land ready for its intended use.

• Increase the Land account with a debit.

• Costs typically include:

  • Cash purchase price.

  • Closing costs (title and attorney’s fees).

  • Real estate brokers’ commissions.

  • Accrued property taxes and other liens assumed by purchaser.

Example: Hayes Company Land Acquisition

• Hayes Company acquires real estate at a cash cost of $100,000$.

• Old warehouse is razed at a net cost of $6,000$ ($7,500$ costs less $1,500$ salvaged materials).

• Additional expenditures: attorney’s fee ($1,000$), real estate broker’s commission ($8,000$).

• Cost of Land Calculation:

  • Cash price: $100,000$

  • Net removal cost: $6,000$

  • Attorney's fees: $1,000$

  • Broker’s commission: $8,000$

  • Total Cost of Land: $115,000$

Cost of Land Improvements

• Includes all expenditures necessary to make improvements ready for their intended use.

• Limited useful lives; expense by depreciating over the useful lives.

• Examples: driveways, parking lots, fences, landscaping, underground sprinklers.

Cost of Buildings

• Includes all costs related directly to purchase or construction.

• Purchase costs:

  • Purchase price, closing costs (attorney’s fees, title insurance), real estate broker’s commission.

  • Remodeling, replacing, or repairing roof, floors, electrical wiring, and plumbing.

• Construction costs:

  • Contract price plus payments for architects’ fees, building permits, and excavation costs.

Cost of Equipment

• Include all costs incurred in acquiring the equipment and preparing it for use.

• Costs typically include:

  • Cash purchase price.

  • Sales taxes.

  • Freight charges.

  • Insurance during transit paid by purchaser.

  • Expenditures for assembling, installing, and testing.

Example: Lenard Company Delivery Truck

• Lenard Company purchases a delivery truck at a cash price of $22,000$.

• Related expenditures: sales taxes $1,320$, painting and lettering $500$, motor vehicle license $80$, a three-year accident insurance policy $1,600$.

• Cost of Delivery Truck Calculation:

  • Cash price: $22,000$

  • Sales taxes: $1,320$

  • Painting and lettering: $500$

  • Total Cost: $23,820$

• Journal Entry:

  • Debit Equipment $23,820$

  • Debit Prepaid Insurance $1,600$

  • Debit License Expense $80$

  • Credit Cash $25,500$

Expenditures During Useful Life

• Ordinary repairs:

  • Expenditures to maintain operating efficiency and productive life.

  • Debited to Maintenance and Repairs Expense.

• Additions and improvements:

  • Costs to increase operating efficiency, productive capacity, or useful life.

  • Debited to the related plant asset account.

Example: Drummond Corp. Delivery Truck Costs

• Invoice cost of $15,000$ (Cost of truck).

• Sales taxes of $900$ (Cost of truck).

• Delivery costs of $500$ (Cost of truck).

• $200$ for painting and lettering (Cost of truck).

• $600$ for an annual insurance policy (Operating expense).

• $80$ for a motor vehicle license (Operating expense).

Depreciation

• Process of allocating to expense the cost of a plant asset over its useful life in a rational and systematic manner.

• Cost allocation, not asset valuation.

• Applies to land improvements, buildings, and equipment (not land).

• Depreciation expense reported on the income statement.

• Accumulated depreciation reported on the balance sheet as a deduction from plant assets.

Factors in Computing Depreciation

• Cost: Expenditures to acquire and prepare the asset for use.

• Useful life: Estimated expected life based on need for repair, service life, and obsolescence.

• Salvage value: Estimated asset value at the end of its useful life.

Selecting a Depreciation Method

• Management selects the method that measures an asset’s revenue contribution the best.

  1. Straight-line method.

  2. Declining-balance method.

  3. Units-of-activity method.

Example: Bill’s Pizzas Delivery Truck

• Purchased January 1, 2022.

• Cost: $13,000$

• Salvage value: $1,000$

• Useful life: 5 years or 100,000 miles.

Straight-Line Method

• Depreciation expense is the same each year.

Straight-Line Method Example with Bill's Pizzas

• Depreciable Cost: $13,000 - 1,000 = 12,000$

• Rate: $1 / 5 = 20\%$

• Journal Entry (Dec. 31):

  • Debit Depreciation Expense $2,400$

  • Credit Accumulated Depreciation $2,400$

Partial Year Depreciation

• If purchased on April 1, 2022:

Example: Iron Mountain Ski Corporation

• Snow-grooming machine purchased for $50,000$ on January 1, 2022.

• Estimated 10-year life with $2,000$ salvage value.

• Straight-Line Depreciation:

  • ($50,000 - 2,000$) * 10% = $4,800$

• Journal Entry (Dec. 31, 2022):

  • Debit Depreciation Expense $4,800$

  • Credit Accumulated Depreciation $4,800$

Units-of-Activity Method

• Estimate total units of activity to calculate depreciation cost per unit.

• Expense varies based on units of activity.

• Depreciable cost is cost less salvage value.

• Depreciable Cost ÷ Total Units of Activity = Cost per Unit.

• 12,000 ÷ 100,000 = $0.12

Units-of-Activity Method Example with Bill's Pizzas

• Journal Entry (Dec. 31, 2022):

  • Debit Depreciation Expense $1,800$

  • Credit Accumulated Depreciation $1,800$

Management’s Choice: Comparison

• Annual depreciation expense varies, but total depreciation expense is the same ($12,000$) for the five-year period.

Disposal of Plant Assets

• Three ways: sale, retirement, or exchange.

• Accounting for disposals:

  • Record depreciation up to the disposal date.

  • Eliminate asset by debiting Accumulated Depreciation and crediting the asset account.

Determining Gain or Loss on Sale

• Compare book value of asset with proceeds from the sale.

• Proceeds > Book Value: Gain on disposal.

• Proceeds < Book Value: Loss on disposal.

Example: Wright Company Sale of Office Furniture

• Sold on July 1, 2022, for $16,000$ cash.

• Original cost: $60,000$.

• Accumulated depreciation (Jan 1, 2022): $41,000$.

• Depreciation for first six months of 2022: $8,000$.

• Journal Entry (July 1):

  • Debit Depreciation Expense $8,000$

  • Credit Accumulated Depreciation $8,000$

• Calculation:

  • Cost: $60,000$

  • Accumulated depreciation: $41,000 + 8,000 = 49,000$

  • Book value: $60,000 - 49,000 = 11,000$

  • Proceeds: $16,000$.

  • Gain: $16,000 - 11,000 = 5,000$

• Journal Entry (July 1):

  • Debit Cash $16,000$

  • Debit Accumulated Depreciation $49,000$

  • Credit Gain on Disposal of Plant Assets $5,000$

  • Credit Equipment $60,000$

Scenario: Sale for $9,000$

• Proceeds from sale: $9,000$.

• Loss on disposal: $11,000 - 9,000 = 2,000$

• Journal Entry (July 1):

  • Debit Cash $9,000$

  • Debit Loss on Disposal of Plant Assets $2,000$

  • Debit Accumulated Depreciation $49,000$

  • Credit Equipment $60,000$

Retirement of Plant Assets

• No cash received.

• Decrease Accumulated Depreciation with a debit.

• Decrease asset account with a credit.
  Loss on Disposal of Plant Asset will be created.

Example: Overland Trucking - Truck Disposal

Old truck cost $30,000$, accumulated depreciation of $16,000$.

Scenario 1: Sell for $17,000$ cash

• Cash $17,000$

• Accumulated Depreciation $16,000$

• Equipment $30,000$

• Gain on Disposal of Plant Assets $3,000$

Scenario 2: Truck is Worthless

• Accumulated Depreciation $16,000$

• Equipment $30,000$

• Loss on Disposal of Plant Asset $14,000$

Intangible Assets

• Rights, privileges, and competitive advantages from ownership of long-lived assets without physical substance.

• Limited or indefinite life.

• Common types: patents, trademarks, copyrights, trade names, franchises, goodwill.

Accounting For Intangibles

• Limited-life intangibles: Amortize to expense.

• Indefinite-life intangibles: No amortization.

Copyrights

• Exclusive right to reproduce and sell artistic/published work.

• Granted for life of creator plus 70 years.

• Capitalize costs of acquiring and defending.

• Amortize to expense over useful life.

Trademarks and Trade Names

• Word, phrase, jingle, or symbol that identifies an enterprise/product.

• Legal protection for indefinite number of 20-year renewal periods.

• Capitalize acquisition costs.

• No amortization.

Franchises

• Contractual arrangement between franchisor and franchisee.

• Limited life: amortized to expense over life of franchise.

• Indefinite life: carried at cost and not amortized.

Goodwill

• Exceptional management, desirable location, good customer relations, skilled employees, etc.

• Recorded when an entire business is purchased.

• Goodwill = FMV of identifiable net assets acquired - Purchase Price.

• Internally created goodwill should not be capitalized.

Classification Concepts

• Amortization: Allocation to expense of an intangible asset's cost over its useful life.

• Intangible assets: Rights, privileges, and competitive advantages from long-lived assets without physical substance.

• Copyright: Exclusive right to reproduce and sell an artistic/published work.

• Franchise: Right to sell products/services or use trademarks within a geographic area.

• Research and development costs: Costs incurred that often lead to patents or new products; expensed as incurred.