Ch. 7 Plant Assets, Natural Resources and Intangibles
How does the DDB method differ from the other two depreciation methods?
1. At first, the residual value is ignored -depreciation cost is computed on the asset's full cost 2. Final year depreciation expense is the "plug" amount -the final year depreciation expense is the exact amount needed to reduce the asset's book value too residual amount
Steps for Double Declining Balance Method (DDB)
1. Find the DDB rate -Multiply the Straight-line depreciation rate (1/useful life) x 2 2. Find Depreciation Expense Beginning Book Value x DDB rate
As an asset is used in operations, what happens to Accumulated Depreciation and the Book Value of the Asset?
Accumulated Depreciation increases Book Value of Asset decreases
What should the final book value of the plant asset equal after all depreciation has been accumulated?
Asset's final book value = residual value
How are the estimated amounts of the Estimated Useful Life and Estimated Residual Value determined?
Based on company's experiences and trade publications
When can an asset become obsolete?
Becomes obsolete when another asset can do the job more efficiently than that particular asset
Example of Estimated Useful Life
Buildings useful life is expressed in Years Airplanes or trucks useful life is expressed in miles the vehicle is expected to travel
What Plant Assets have a related Depreciation Expense on the Income Statement?
Buildings, Machinery and Equipment Furniture and Fixtures Land Improvement
When accounting for purchases of plant assets, what account will be credited for an owner buying assets?
Cash or Accounts Payable (if paying on account and owes to another company)
How do you determine Depreciable Cost (amount you will depreciate)?
Cost of the Asset - Estimated Residual Value (amount seller expects to get from selling asset after its useful life)
Example of a Fully Depreciated asset: FedEx has fully depreciated equipment with no residual value (cost of $60,000) what would the T-accounts look like to calculate the book value? what is the book value of asset?
Equipment: debit 60,000 Accumulated Depreciation credit 60,000 Book Value: 60,000-60,000 = 0
Estimated Residual Value (AKA "scrap value" or "salvage value")
Estimated cash value of an asset at the end of its useful life (estimated amount)
Units of Production Method (depreciation)
Fixed amount of depreciation is assigned to each unit of output produced by the asset -Depreciable Cost is divided by useful life (units of production) in order to determine fixed amount per unit -Once you determine the fixed amount per unit, then you can multiply it by the number of units produced per period in order to find Depreciation Expense
What is the depreciation pattern for Units of Production Method?
Follows no particular pattern since Accumulated Depreciation depends on the use of the product
Why is the DDB method most popularly used for income tax purposes?
It provides the fastest tax deductions, reduces income taxes (which then increases tax savings and conserves cash). -it decreases the company's immediate tax payments and allows them to reinvest their tax savings back into the business
Is Depreciation a process of valuation? -does it measure market market value? -what does it measure?
NO -does not measure/record the market value changes of the plant asset It measures usefulness of an asset
Is Estimated Residual Value depreciated?
NO, because they expect to receive the full amount of the Residual Value from selling the asset (you subtract the estimated residual value from the plant asset prior to depreciating it)
What is the depreciation pattern for the Straight Line Method?
Stays the same in all periods
Which Depreciation method is most popular for financial reporting?
Straight-line method
Why are losses incurred when an asset has been disposed of when it has been partially depreciated (for no proceeds)?
They incur a loss because the business will never receive the benefit of the remainder of the value of the asset since they are disposing it
What do many companies do rather than purchasing fixed assets? -what will appear on the balance sheet?
They lease the fixed assets - the asset and the liability will appear on the balance sheet
When will a plant asset no longer serve a company's needs?
When it has been worn out or becomes obsolete
What are the causes of Depreciation of Plant Assets?
- Physical wear and tear *deterioration takes a toll on usefulness of airplanes, equipment and trucks, buildings - Obsolescence (asset becomes obsolete when another asset can do the job more efficiently)
Steps for Units of Production Method (Depreciation)
1. Calculate Depreciable Cost 2. Calculate the average unit depreciation cost depreciable cost / total units 3. Multiply the number of units produced in the year x the average unit depreciation cost to compute the depreciation expense and accumulated depreciation
Steps of Straight-Line Method (depreciation)
1. Determine total depreciable cost (cost of asset - estimated residual value) 2. Calculate the average yearly depreciation expense depreciable cost/useful life
FedEx sells equipment on September 30, 2021, for $7,300 cash. The equipment cost $10,000 when purchased on January 1, 2018, and it has been depreciated using the straight-line method. It had an estimated life of 10 years with no residual value 1. Update the depreciation expense 2. Calculate Net Book Value 3. Determine whether there was a Gain or Loss in Sale
10,000/10 = 1,000 per year Accumulated Depreciation: 3 years+9/12 = 3,000+750 = $3,750 Book Value: 10,000 - 3,750 = $6,250 Gain: 7,300 - 6,250 = $1,050
FedEx signs a $300,000 note payable to purchase 20 acres of land. FedEx also pays $10,000 for real estate commission, $8,000 of back property tax, $5,000 for removal of an old building, a $1,000 survey fee, and $260,000 to pave the parking lot—all in cash. What is Fedex's cost of this land? How would you record the journal entry for the purchase of land?
300,000 + 10,000 + 8,000 + 5,000 + 1,000 = $324,000 Journal entry: Land debit 324,000 Notes Payable credit 300,000 Cash credit 24,000
Suppose FedEx purchases a warehouse building on September 1 for $500,000. The building's estimated life is 20 years, and its estimated residual value is $80,000. FedEx's accounting year ends on May 31.
500,000 - 80,000 = $420,000 420,000/20 = $21,000 Depreciation for the 1st Partial Year: 9 months/12 months x 21,000 = $15,750 book value on June 1: 420,000-15,750 = $404,250
Which depreciation method is most commonly used for income tax purposes?
Accelerated Depreciation (DDB method)
What is the contra asset to a Plant Asset on the Balance Sheet?
Accumulated Depreciation -specific to each plant asset (except land)
Disposing of a Partially Depreciated Asset for No Proceeds Suppose FedEx disposes of equipment that cost $60,000. This asset only has $50,000 of accumulated depreciation and a book value of $10,000. -what is the journal entry? -what is the effect of the entry? -is there a Gain/Loss?
Accumulated Depreciation -debit 50,000 Loss on Disposal of Equipment -debit 10,000 Equipment -credit 60,000 Total Assets and Equity decrease; Decreases net income (like an expense) Result: incurs a loss on the disposal that is equal to the net book value of asset
What is the related expense account for intangible assets?
Amortization Expense
Can an asset's useful life be shorter than its physical life?
Assets useful life can be shorter than its physical life -EX: Companies depreciate their computers over a short period of time (even though the computers will remain in good condition for a much longer period)
Why is Land not depreciated?
Assumed to be used forever - unlimited life
Costs of constructing a building include:
Costs include: - Architectural fees - building permits - contractor's charges - payment for material, labor and overhead - interest on money borrowed to finance construction (interest on an account/notes payable)
Costs of purchasing a building includes:
Costs include: - purchase price - brokerage commission - sales and other taxes - expenditures to repair and renovate a building for its intended purpose
Example of Double Declining Balance Method: If the cost of a truck is $41,000 and its Estimated Residual Value is $1,000. It has a useful life of 5 years and its total units of production is 100,000 units (miles).
DDB rate: (1/5) = .2 x 2 = .4 - decreases asset by 40% in depreciation per year based on its book balance Depreciation Expenses: 1st year: 41,000 x .4 = $16,400 2nd year: 24,600 x .4 = $9,840 3rd year: 14,760 x .4 = $5,904 4th year: 8,856 x .4 = $3,542 5th year: 5314 - 1,000 (RV) = $4,314 Accumulated Depreciation: 1. 16,400 2. 16,400 + 9,840 = 26,240 3. 26,240 +5,904 = 32,144 4. 32,144 + 3,542 = 35,686 5. 35,686 + 4,314 = $40,000 (= depreciable cost)
Example of Straight Line Method: If the cost of a truck is $41,000 and its Estimated Residual Value is $1,000, what is its Depreciable Cost? It has a useful life of 5 years and its total units of production is 100,000 units (miles). What is the annual depreciation expense? What is the annual rate? what is the journal entry to record depreciation of this plant asset?
Depreciable Cost: 41,000 - 1,000 = $40,000 Annual yearly depreciation expense: 40,000/5 = $8,000 per year Annual Rate: 1/5 years = .2 Depreciation Expense-Truck debit 8,000 Accumulated Depreciation-Truck credit 8,000
How do you account for costs that are related to assets after the assets have been put into use?
Distinguishing Capital Expenditures from Immediate Expenses of Asset
How do you estimate the "age" or "used up" amount of a plant asset?
Divide the Accumulated Depreciation by the cost of the basis will be based on the straight-line method
Accounting depreciation does not measure _____ ______, it measures ______.
Does not measure: market value measures: use of asset
Which is the best depreciation method for assets that generate more revenue earlier in their useful life?
Double Declining Balance (DDB) Method
What is the most frequently used accelerated depreciation method?
Double Declining Balance Method (DDB)
What are the costs of Land/Leasehold Improvements
Driveways Signs Fences Sprinkler Systems Security Systems Lighting
Straight-Line Method (Depreciation)
Equal amount of depreciation are assigned to each period under this method -depreciable cost is divided by the useful life = annual depreciation expense
Example of Estimated Residual Value
Fedex says their package machine will be useful for 7 years -their Estimated Residual Value (Scrap/Salvage Value): amount Fedex says it can get for the machine from selling it
When accounting for purchases, when will you debit the asset?
If the asset will receive the benefit of the cost in the future (prolong the life of the asset or extend its value/usefulness)
What are leasehold improvements? -how are its expenses accounted for the plant asset?
Improvements made to leased property Either depreciated or amortized over the term of the lease
What do Land costs include:
Includes: Purchase price of asset+brokerage commission+survey fees+ legal fees +back property taxes + expenditures for grading and clearing land + removing any unwanted buildings
At the end of the asset's useful life, what should happen to the asset?
It should be fully depreciated
What is the depreciation pattern of Accelerated Depreciation (DDB)?
Its greatest expense is within the 1st year and the expense slowly starts to decrease in the later years
What assets are considered Plant Assets?
Land Buildings, Machinery and Equipment Furniture and Fixtures Land Improvements
Record the Lump Sum Purchases Above
Land -Debit 280,000 Building -Debit 2,520,000 Cash -Credit 2,800,000
What do land costs not include: -what are these assets considered (hint: separate type of plant assets)?
Land costs do not include: - Fencing, Paving, Security Systems and Lighting (these costs are considered land Improvements)
Estimated Useful Life of Plant Asset -how is it expressed as?
Length of service expected from using the asset (estimated amount) -Expressed in years, unit of output, miles or etc..
Prior to accounting for the disposal of the asset, what must a company do?
Must bring the depreciation of the asset up-to-date - must measure the final book value of asset - must record the expense up until the date of the disposal
If a company bought an asset past the 15th of a month, will they record the monthly depreciation for the asset?
NO - will most likely record the asset if it was purchased on or before the 15th of a month
Why is it necessary to account for Accumulated Depreciation and Depreciation Expense of a Plant Asset?
Necessary as plant assets wear out, grow obsolete and lose value over time -Depreciation Expense: reported on the income statement
Does land have a depreciation expense?
No, because Land never loses its usefulness and never becomes obsolete. It will always hold the same usefulness
Does Depreciation mean to set aside cash to replace assets as they wear out?
No, they are not used as cash funds from depreciation -cash funds are separate from depreciation
Cost of equipment includes:
Purchase price (minus any discounts) Transportation from the seller Insurance while in transit sales and other taxes purchase commission installation costs expenditures needed to test the asset before its placed in service cost of any special platforms used
Cost
Purchase price and all costs to get plant asset ready for use -this is a known amount
What is a Lump-Sum (or Basket) purchases of an asset? -how is the cost found for her each asset
Purchase several types of fixed assets as a group or "basket" for a single lump-sum amount The total cost is divided among the assets based on their individual relative market values
What does "Life" refer to in Estimated Useful Life? example
Refers to the use of the asset before you have to start investing significant amounts to keep up with the asset's intended use Although you can use a computer past its typical estimated useful life (3 to 4 years), you would need to purchase a memory or processing capacity in order to use the asset past its original useful life. -this is why you would assign a useful life of 3 to 4 Years for computers
What is the technique used in calculating the individual values of the fixed assets in a Lump-Sum Purchase?
Relative Sales Value Method A/(A+B) B/(A+B) = % weighted average
Once the asset is disposed of (sold), what must you do?
Remove the cost of the asset and its accumulated depreciation
What is Asset Disposal?
Removing the asset and its related accumulated depreciation from the books
Examples of Immediate Expenses
Repair and Maintenance Expense (not considered an asset) - these are costs incurred to maintain an asset at its intended use For example, oil changes for a vehicle to keep the vehicle fulfilling its intended life/use. If the oil changes were not performed, then the vehicle will break and will not fulfill its intended life.
How is Plant Asset reported on a Balance Sheet? What must be considered when calculating its value (every plant asset, except land)?
Reported at Book Value Book Value must include the Historical Cost - Accumulated Depreciation
What are the common accounting errors that occur when recording the costs for plant assets?
Sometimes they capitalize expenses that should be expensed immediately (results in an overstatement of assets, understatement of expenses) Sometimes they expense costs immediately that should be capitalized (results in an understatement of assets and an overstatement of expenses)
Which is the best depreciation method of plant assets that generate revenue evenly over time?
Straight Line Method
What are the three depreciation methods?
Straight Line Method Unit-of-Production Method Double-declining balance method
When you dispose of an asset that has been fully depreciated and are not expecting any proceeds for the disposal, what is the assert assumed to be?
The asset is assumed to be junked when it has been fully depreciated and the company is not expecting any proceeds (no residual value)
In DDB method, what is the beginning book value equaled to? - what does it consider?
The beginning book value = ending book value in the last year -considers the cost minus the accumulated depreciation
What does it mean to "capitalize? (capital expenditures)
The cost is added to an asset account rather than being expensed immediately
Rule to Measure the Cost of an Asset Formula?
The cost of any asset is the sum of all costs intended to bring the asset to its intended use Purchase Price of Asset + Taxes + Commissions + Other costs to make the asset ready for use (like installation of asset)
What is Depreciation? -what accounting principle does it follow?
The process of allocating a plant assets cost to expense over its life - follows the Matching Principle -apportions the cost of a fixed asset over time by allocating a portion of the cost against the revenue the asset helps earn per period (matches expense to revenue earned)
What does it mean if an expenditures does not increase the useful life of an asset or the capacity of the asset?
Then the expenditure should be expensed immediately (AKA Immediate Expense)
What do companies do to all small, immaterial costs?
They expense them as Immediate Expenses
Why are Plant Assets complex in Accounting for them?
They have long lives Their depreciation affects income taxes Companies may either have a gain or loss once they sell their plant assets (after its useful life)
Property, Plant and Equipment assets and Intangible assets will do what in the future?
They will be used to generate revenues in the future
What can you see is the similarity and difference between the Depreciation Methods?
Total Depreciation Costs are the same Yearly depreciation expense is different
FedEx purchases land and a building in Denver. The building sits on two acres of land, and the combined purchase price of land and building is $2,800,000. An appraisal indicates that the land's market value is $300,000 and that the building's market value is $2,700,000.
Total Value of Assets (altogether): 2,700,000+300,000 = $3,000,000 300,000/3,000,000 = 10% .1 X 2,800,000 = 280,000 2,700,000/3,000,000 = 90% .9 X 2,800,000 = 2,520,000
Which is the best depreciation method for assets that wear out because of use?
Units of Production Method
Why do you classify plant assets in categories like, land, building, equipment, etc..?
We need to convert the cost of plant assets to expenses as we use them (except for land) - Since we use different types of assets during different time periods, we need to track the costs for assets with different "useful lives" - we need to use the different individual plant asset accounts in order to calculate the expense later on
When is an asset fully depreciated?
When the asset has reached the end of its estimated useful life
When accounting for purchases of plant assets, when will you debit the expense account of a plant asset?
When the business has already received the benefit of the cost (based on the past)
Double Declining Balance Method (Depreciation)
Writes off a larger amount of the cost near the start of the asset's useful life - Multiplies the asset's declining book value at the beginning of the year by a constant % (which is 2x the rate of Straight-Line Depreciation)
Will the three depreciation methods result in the same total of Depreciation accumulated?
YES
Does the GAAP allow companies to use different depreciation methods for their tax purposes VS financial reporting?
YES (and it is expected to) - there are different methods used for tax purposes and financial reporting because the objectives of the GAAP and IRC (Internal Revenue Code) are different - GAAP: to provide useful info to help shareholders and creditors make economic decisions - IRC: to raise sufficient amount of revenue to pay for the expenses of the federal government
Will the three depreciation methods result in different amounts of depreciation per period?
Yes they will result in different amounts of period PER PERIOD
Are companies allowed to use assets once they have reached the end of its useful life and have been fully depreciated? - what is the book value of asset?
Yes, they can still use the asset ( but will not need to record anymore depreciation ) -Book Value: 0 (asset is worthless)
What do you initially do when calculating with the DDB Method?
You ignore the residual value of the asset when computing the annual depreciation First, start with the total coast of the asset On the last year of the useful life of asset, subtract the estimated residual value from the beginning book value of the asset at the last year of its depreciation
Disposing of a Fully Depreciated Asset (for NO Proceeds) Suppose the final year's depreciation expense has just been recorded for a machine that cost $60,000 and has a residual value of zero. The entry to record its disposal is: -what is the effect of this entry? - is there a gain or loss?
Zero out the AD account and the Plant Asset Account Accumulated Depreciation-Machinery -debit 60,000 Machinery -credit 60,000 -No effect on Total Assets, Total Liabilities and Stockholder's Equity -Neither a Gain nor Loss
Example of Units of Production Method: If the cost of a truck is $41,000 and its Estimated Residual Value is $1,000, what is its Depreciable Cost? It has a useful life of 5 years and its total units of production is 100,000 units (miles). Assume that FedEx expects to drive the truck 20,000 miles during the first year, 30,000 during the second, 25,000 during the third, 15,000 during the fourth, and 10,000 during the fifth.
depreciable cost: $40,000 Average Unit Cost of Output: 40,000/100,000 = $0.40 per mile Depreciable Expense 1st year: .40 x 20,000 = $8,000 Depreciable Expense 2nd year: .40 x 30,000 = $12,000 Depreciable Expense 3rd year: .40 x 25,000 = $10,000 Depreciable Expense 4th year: .40 x 15,000 = $6,000 Depreciable Expense 5th year: .40 x 10,000 = $4,000
Capital Expenditures
expenditures that increase the company's investment in plant assets - increases the asset's capacity or extends its useful life
Under DDM: The faster the tax deductions ---> _____ tax savings
more tax savings
