Plant Assets, Natural Resources, and Intangibles
Chapter 9: Plant Assets, Natural Resources, and Intangibles
Learning Objectives
9.1 Measure the cost of property, plant, and equipment
9.2 Account for depreciation using the straight-line, units-of-production, and double-declining-balance methods
9.3 Journalize entries for the disposal of plant assets
9.4 Account for natural resources
9.5 Account for intangible assets
9.6 Use the asset turnover ratio to evaluate business performance
9.7 Journalize entries for the exchange of plant assets (Appendix 9 A)
Learning Objective 9.1: Measure the Cost of Property, Plant, and Equipment
Definition of Property, Plant, and Equipment
Property, plant, and equipment (PP&E) are long-lived, tangible assets used in the operations of a business.
Examples of PP&E include:
Land
Buildings
Equipment
Furniture
Fixtures
Automobiles
Characteristics of Plant Assets
Plant assets are characterized as long-term assets that last several years.
The cost of a plant asset is allocated to an expense over the years that the asset is expected to be utilized.
The allocation process is called depreciation, adhering to the matching principle in accounting.
Historical Cost Principle
A plant asset is recorded at its historical cost—defined as the amount paid for the asset.
This follows the cost principle, which states that acquired assets and services should be recorded at their actual costs.
Actual costs include:
Purchase price
Taxes
Commissions
Other amounts necessary to prepare the asset for its intended use
Land and Land Improvements
Cost of Land
Costs included in the acquisition of land are:
Purchase price
Brokerage commission
Survey and legal fees
Delinquent property taxes
Title transfer fees
Cost of clearing the land
Exclusions from Land Costs
Costs not included in land pricing are:
Fencing
Paving
Sprinkler systems
Lighting
Signs
These costs are categorized as land improvements and are subject to depreciation unlike land.
Example
A company purchases land for $50,000 and incurs additional costs totaling $12,000 (delinquent taxes, transfer taxes, old building removal, survey fee).
Capitalized cost:
Buildings
Costs of a Building
Costs associated with constructing a building include:
Architectural fees
Building permits
Contractor charges
Payments for materials, labor, and miscellaneous costs
For purchasing an existing building, costs comprise:
Purchase price
Renovation costs (same as building costs)
Machinery and Equipment
Cost Components
The costs of machinery and equipment include:
Purchase price (net of discounts)
Transportation charges
Insurance during transit
Sales tax and other taxes
Purchase commissions
Installation and testing costs prior to use
Furniture and Fixtures
Examples
Furniture and fixtures examples include desks and chairs.
Cost Components
Costs include:
Purchase price (net of discounts)
Other costs to ready the asset for its intended use
Lump-Sum Purchase
A lump-sum purchase occurs when a company procures several assets at one price (often referred to as a basket purchase).
The total cost must be allocated among the assets based on their relative fair market values, known as the relative-market-value method.
Capital and Revenue Expenditures
Categories of Expenditures
Expenditures on plant assets after acquisition are categorized as:
Capital Expenditures:
Enhance the asset’s capacity, efficiency, or extend useful life (e.g., extraordinary repairs).
Revenue Expenditures:
Maintenance costs incurred to keep the asset operational.
Examples of Expenditures
Example of capital expenditure:
Spending $3,000 on rebuilding a truck's engine is an extraordinary repair, extending its life.
Example of revenue expenditure:
Paying $500 for tire replacements does not extend useful life.
Data Analytics in Accounting
Data analytics can assist companies in managing large property portfolios:
Geographical data can optimize future property acquisitions.
Weather data aids in maintenance scheduling and order planning, as well as tracking resource consumption.
Learning Objective 9.2: Account for Depreciation using Various Methods
Definition of Depreciation
Depreciation is the allocation of an asset's cost over its useful life; differentiating between obsolescence and wear during usage.
Assets, except land, wear out and can become obsolete, signifying decreased efficiency compared to newer assets.
Factors Influencing Depreciation Calculation
Five key components determine depreciation:
Capitalized cost
Estimated Useful Life: Duration the company expects the asset to remain useful
Estimated Residual Value: The value at the end of its useful life, where
Depreciation Methods
Commonly used depreciation methods include:
Straight-Line Method: Equal amount yearly depreciation.
Units-of-Production Method: Varying amounts based on asset usage.
Double-Declining-Balance Method: Accelerated depreciation favoring earlier asset life stages.
Straight-Line Depreciation Method
Equally distributes depreciation expense every period calculated as follows:
The depreciation expense appears on the income statement, while the asset's book value (calculated as cost - accumulated depreciation) is listed on the balance sheet.
Units-of-Production Method
Allocates depreciation corresponding to the asset's actual usage.
An example with a truck might initially drive 20,000 miles the first year, progressing through increased usage leading to different depreciation per year.
Double-Declining-Balance Method
Employs an accelerated approach, allocating greater depreciation in early years than later.
Formula for calculation:
Tax Depreciation
The IRS mandates the Modified Accelerated Cost Recovery System (MACRS) for tax depreciations.
Assets categorized as 3-year, 5-year, 7-year, and 39-year properties with no specified residual value under MACRS.
Partial-Year Depreciation
When assets are acquired within the year, depreciation is recorded proportionally based on usage.
Changing Estimates of a Depreciable Asset
Companies may revise their asset's useful life and residual value over time, necessitating a recalculation of future depreciation without re-evaluating past figures.
Learning Objective 9.3: Journalize Entries for the Disposal of Plant Assets
Disposal of Plant Assets
Disposals might involve discarding, selling, or exchanging assets; following specific steps:
Update depreciation
Remove the asset along with accumulated depreciation
Record cash transactions related to disposal
Determine any gains or losses from the disposal.
Examples of Disposal Scenarios
Example 1: Fully depreciated equipment discarded will simply involve removing its cost and accumulated depreciation.
Example 2: Fully depreciated equipment sold will involve recording any cash received and noting if it contributes to a gain or loss based on the book value.
Summary of Journal Entries for Plant Assets Disposal
Comprehensive entries must be maintained regarding selling assets above, below, or at book value to accurately reflect gains or losses.
Learning Objective 9.4: Account for Natural Resources
Definition of Natural Resources
Natural resources are earth-derived assets consumed in the operations of production, often accounted through depletion, similar to depreciation.
Depletion utilizes the units-of-production method for expense calculation.
Example of Natural Resource Accounting
An oil well totaling $700,000 with an expected 70,000 barrels has no residual value is tracked for depletion.
Learning Objective 9.5: Account for Intangible Assets
Definition of Intangible Assets
Intangible assets lack physical form, including patents, copyrights, trademarks, and similar intellectual properties.
Expenditure Treatments
Purchased intangibles recorded at cost, generally expensed via amortization, applying only to those with a defined useful life.
Intangibles without a definite life require annual impairment testing.
Specific Intangible Assets
Examples include patents providing an exclusive right to their use for a predefined period of two decades, and trademarks for distinct product identification.
Learning Objective 9.6: Use the Asset Turnover Ratio to Evaluate Business Performance
Asset Turnover Ratio
This ratio quantifies net sales generated per average dollar of total assets, calculated as:
A high ratio indicates effective asset utilization in generating sales.
Learning Objective 9.7: Journalize Entries for the Exchange of Plant Assets
Plant Asset Exchanges
Exchanges may take place if there's a commercial substance; gains and losses must be recognized accordingly.
Gain or Loss Situations
Exchanges resulting in gains or losses are recorded meticulously to reflect the accurate financial position of the businesses involved.
Summary of Journalization Techniques
It is critical to master the entry processes when dealing with exchanges to maintain clear and correct asset records.
This document serves as a comprehensive guide for Chapter 9, focusing on critical accounting principles regarding property, plant, equipment, and related financial implications. Each section is crafted to ensure clarity and depth in these complex topics.