Plant Assets and Depreciation

Special Category of Prepaids

• Definition of Plant Assets

  • Plant assets refer to long term tangible assets that are used to produce and sell products and services.
  • They are expected to provide benefits over more than one accounting period.

• Examples of Plant Assets

  • Buildings
  • Machines
  • Vehicles
  • Equipment
  • Notably, all plant assets, except for land, will eventually wear out or become less useful.

Cost Reporting and Depreciation

• Cost Deferral and Expense Reporting

  • The costs of plant assets are initially deferred.
  • These costs must gradually be reported as expenses in the income statement over the asset's useful life, as specified by the matching principle.

• Adjusting Entry for Plant Assets

  • The related expense for the allocation of costs is recorded through an adjusting entry, analogous to other prepaids, with two significant distinctions:
  • Depreciation: The process of allocating the costs of plant assets over their expected useful lives is termed depreciation.
    • Depreciation Expense: The expense arising from the use of plant assets is universally referred to as depreciation expense, distinguishing it from terms like building expense or equipment expense.
  • The original cost of the plant assets must be readily identifiable within the company’s accounting records.

Ledger and Recording Practices

• Equipment Ledger Issues
  • Consider a scenario where the equipment page in the ledger is torn in two.
  • Purchases of equipment are recorded as debits in the equipment account.
  • Related credits, representing the usage of these assets over time, are recorded in a separate account.
• Contra Account
  • The secondary account associated with the equipment account is called a contra account, which always corresponds to another account with an opposite normal balance.
  • In this case, the contra account is identified as Accumulated Depreciation - Equipment.

Example of Equipment Purchase and Depreciation

• Assumption of Equipment Purchase

  • Assume the company acquires equipment for $26,000 in early December.
  • The cost of this equipment is subject to depreciation.
  • The equipment is expected to have a useful life of five years, with an anticipated salvage value of $8,000 at the end of this period.

• Calculating Net Cost

  • The net cost over the useful life is calculated as:
  • $ext{Net Cost} = ext{Initial Cost} - ext{Salvage Value}$
  • For this equipment:
  • $ext{Net Cost} = 26000 - 8000 = 18000$

Depreciation Methods

• Allocation of Net Cost
  • Various methods exist to allocate the $18,000 net cost to expense.
  • The Straight-Line Depreciation Method will be used for this example:
  • This method divides the asset's net cost equally over its useful life.
  • $ext{Monthly Depreciation Cost} = \frac{ ext{Net Cost}}{ ext{Useful Life in Months}}$
  • Thus,
  • $ext{Monthly Depreciation Cost} = \frac{18000}{60} = 300$

Adjusting Journal Entry

• Related Adjusting Entry

  • The necessary adjusting entry consists of:
  • Debit to Depreciation Expense for $300
  • Credit to Accumulated Depreciation - Equipment for $300

• Effect of Adjusting Entry

  • Posting this entry increases both the Depreciation Expense and Accumulated Depreciation accounts by $300 each.

Understanding Contra Accounts

• Normal Balance of Contra Accounts

  • Even though the accumulated depreciation account is classified as an asset account, it possesses a normal credit balance.
  • This is contrary to typical asset accounts, which usually carry a debit balance.

• Financial Statement Representation

  • A contra account is displayed as a reduction from the associated account's balance on financial statements.
  • The resultant difference in value is referred to as Book Value.
  • $ext{Book Value} = ext{Cost of Asset} - ext{Accumulated Depreciation}$
  • Thus, the book value reflects the real-time value of a plant asset after accounting for depreciation.