Lecture Notes on Plant Assets and Depreciation

Balance Sheet Overview

  • Assets
    • Current Assets
    • Cash (Chapter 6)
    • Inventory (Chapters 4-5)
    • Accounts Receivable (Chapter 7)
    • Long-term Assets
    • Property, Plant, and Equipment (Chapter 8)
    • Intangible Assets (Chapter 8)
    • Long-term Investments
    • Notes Receivable (Chapter 7)

Chapter 8: Reporting and Analyzing Long-term Assets

  • Focus on the following topics:
    • Plant Assets
    • Life span
    • Acquisition
    • Natural Resources
    • Use (Depreciation)
    • Intangibles
    • Disposal

Plant Assets

  • Also known as Property, Plant and Equipment (PPE) or Fixed Assets
  • Characteristics:
    • Resources with physical substance
    • Utilized in business operations
    • Expected useful life of more than one year
    • Not intended for resale (not classified as Inventory)

Acquisition of Plant Assets

  • To record the purchase of a plant asset, utilize the following journal entry structure:
    • Debit Land/Equipment (increasing Asset) by amount XX
    • Credit Cash (decreasing Asset) or Payable (increasing Liability) by amount XX
  • “Cost” includes all necessary expenditures for:
    1. Acquiring the asset
    2. Readying it for intended use
  • Recorded at historical cost as per GAAP measurement principle.

Land Costs

  • Components of Land Cost:
    • Purchase price
    • Closing costs
    • Unpaid property taxes from previous years
    • Liens assumed or paid
    • Grading and clearing costs
    • Demolition costs of old structures
  • Recording Land Costs:
    • Land recorded at cost and remains on the balance sheet at cost until disposal
    • Indefinite life - Land is not depreciated.

Land Improvements

  • Land Improvements:
    • Recorded at cost and depreciated over useful life
    • Examples include parking lots, fences, and lighting.
    • These improvements are subject to decay.
    • Entry for Land Improvement:
    • Debit Land Improvement
    • Credit Cash

Buildings

  • Recorded at cost:
    • Building Cost when constructed includes:
    • Contract price
    • Architect fees
    • Permits
    • Interest payments incurred during construction
    • Recorded:
    • Debit Building
    • Credit Cash
  • If purchased, cost includes purchase price, closing costs, repairs, and remodel costs.

Machinery / Equipment / Furniture / Fixtures

  • Recorded at Cost:
    • Equipment Cost = Purchase price + Taxes + Freight-in + Insurance during transport + Installation + Assembly + Testing (not including unpacking damages)
  • Contra-asset account for accumulated depreciation.

Assignments

  • Upcoming:
    • Chapter 8 Homework due 10/30 (Connect)
    • Exam #4 scheduled for 10/31 (D2L)

Examples Related to Costs of Plant Assets

Example 1: Cost Calculation

  • Rizio Co. Case:
    • Purchases machine for $12,500, terms 2/10, n/60, FOB shipping point.
    • Total cost including freight: $12,860
    • Additional costs: special steel mounting ($895), assembly ($475), adjustment materials ($40)
    • Damage during moving ($180) not included in cost.

Example 2: Recording Costs for Cala Manufacturing

  • Cala Manufacturing:
    • Purchases land ($280,000) and old building ($110,000)
    • Demolition cost of old building ($33,500)
    • Fill and level lot ($47,000)
    • Total construction costs: $1,540,000
    • Entry for costs: single journal entry reflecting all cash payments.

Additional Accounting Practices for Purchases

  • Lump-sum Purchase: plant assets acquired in a group at a single price; allocation of costs based on market values of purchased assets.

Chapter Covers

  1. Plant Assets
  2. Acquisition
  3. Natural Resources
  4. Use (Depreciation)
  5. Intangibles
  6. Disposal

Depreciation

  • Definition: Process of allocating the cost of a plant asset over its useful life for financial reporting.
  • Financial Statements Impact:
    • Initially recorded as an asset on the balance sheet
    • Allocated expense on the income statement over time.

Depreciation Recording Structure

  • Entry Method:
    • Debit Depreciation Expense (reducing Net Income and Retained Earnings)
    • Credit Accumulated Depreciation (reducing Asset value on Balance Sheet)

Accumulated Depreciation

  • Represents total depreciation charged against an asset over time; includes previous periods’ depreciation.
  • Importance: Provides difference leading to Net Book Value reported on Balance Sheet.
  • Three Critical Factors for Computing Depreciation Expense:
    1. Cost of the asset
    2. Estimated useful life of the asset
    3. Estimated salvage value (value at the end of useful life)

Depreciation Methods

Straight-Line Method

  • Depreciation Expense = rac{Cost - Salvage \, Value}{Useful \, Life \, (in \, years)}
  • Equal depreciation expense each year; if partial year, prorate based on months of service.

Units-of-Production Method

  • Depreciation Expense = rac{Cost - Salvage \, Value}{Useful \, Life \, (in \, units)} imes Units \, produced \, that \, period
  • No partial adjustment needed when calculating based on units used.

Double-Declining-Balance Method

  • Accelerated depreciation method; greater expense in early years;
    • Depreciation Expense = 2 imes rac{Cost}{Useful \, Life \, (in \, years)} imes Beginning \, Book \, Value
  • Claims lower expense in latter years, handles partial year in the same manner as above methods.

Comparison of Depreciation Methods

  1. Straight-Line Method: consistent annual depreciation.
  2. Units of Production Method: variable based on usage.
  3. Double-Declining Balance Method: higher expense earlier, declining in later years.
  • All methods eventually achieve the same total depreciation expense over an asset’s life.

Examples Calculating Depreciation

Example 4: Matthews Band

  • Equipment cost: $65,800, useful life: 4 years, estimated salvage value: $2,000.
  • Determine annual depreciation for each method (Straight-Line, Double-Declining, Units-of-Production).

Example 5: Ramirez Company

  • Machine cost: $43,500, useful life: 10 years, 385,000 units.
  • Compute second-year depreciation under different methods based on production for that year.

Example 6: Luther Company

  • Machine cost: $257,500, useful life: 4 years, with production units for depreciation computation.

Example 7: Partial-Year Depreciation

  • Example for Cyclone's Backhoe Co.: Trencher purchase, compute depreciation based on methods for each specified year.

Revising Periodic Depreciation (SL Method)

  • Changes in salvage value and useful life affect current and future calculations; retroactive adjustments not made to prior periods.
  • Updated Calculation:
    • New \, Depreciation \, Expense = rac{Remaining \, Book \, Value - Updated \, Salvage \, Value}{Updated Remaining \, Useful \, Life}

Example 8: Revising Depreciation

  • Apex Fitness Club adjusts machine estimated life and salvage value; compute book value at year-end and revised depreciation expense.

Expenditures During Useful Life

  • Costs incurred after asset acquisition; determine whether to expense or capitalize.
    • Ordinary Repairs: Expense
      during operation efficiency=
    • Additions/Improvements: Capitalize

Example 10: Oki Company

  • Entries for related equipment costs: distinguish between ordinary repairs and improvements expected to enhance equipment efficiency.

Upcoming Assignments (continued)

  • Upcoming deadlines will be repeated throughout as the material conveys consistent expectations.

Chapter 8: Disposal of Plant Assets

  • Recording Disposal:
    1. Eliminate asset by debiting accumulated depreciation and crediting the asset account.
    2. Record cash or other assets received in disposal transactions.
    3. Record gain or loss through "plug" entry based on received value minus book value of disposed asset.

Example 9: Diaz Company Disposal

  • Various scenarios for milling machine disposal, prepare journal entries for varied outcomes (receiving nothing, selling for cash).

Natural Resources

  • Types include timber, minerals; recorded at cost.
  • Depletion method used to account for resource consumption.

Example 11: Depletion Calculation

  • Montana Mining Co.: Prepare entries for depletion and depreciation of machinery.

Intangible Assets

  • Non-physical assets; recorded at cost when purchased.
  • Types:
    1. Limited Life Intangibles: Amortized over useful life through straight-line method.
    2. Indefinite Life Intangibles: No amortization until impairment.

Example 12: Amortization of Intangible Assets

  • Milano Gallery: Prepare entries for copyright purchase and annual amortization.

Example 13: Asset Classification Exercise

  • Categorization of various assets into relevant accounting categories (Intangible, Natural Resources, Other).