Financial Accounting: Chapter 9: Plant Assets, Natural Resources and Intangible Assets

Depletion Expense Formula

(Total Cost - Salvage Value) / Total Estimated Units = *Depletion Cost per Unit*. *Depletion Cost per Unit* x Number of Unit Extracted and Sold = Annual Depletion Expense.

Three Factor in Computing Depreciation

1. Cost - all expenditures necessary to acquire the asset and make it ready for intended use. 2. Useful Life - estimate of the expected life based on need for repair, service life, and vulnerability. 3. Salvage value - estimate of the assets value at the end of its useful life.

Determining Cost of Plant Assets

1. Plant assets are recorded in accordance with the cost principle. 2. Cost consists of all expenditures necessary to acquire the asset and make it ready for its intended use.

Three Methods Recognizing Depreciation

1. Straight-Line 2. Declining-balance 3. Units-of-activity. All methods are accepted under GAAP. If a method is chosen it must be applied consistently.

Cost of Land

1. The cash purchase price. 2. Closing costs such as title and attorney's fees. 3. Real estate brokers commissions. 4. Accrued property taxes and other liens on the land assumed by the purchaser.

Units of Activity Method Formula

1. Total units of activity for entire useful life are estimated. 2. This amount is divided into depreciable cost to determine the depreciation cost per unit. 3. The depreciation cost per unit is then applied to the units of activity during the year to determine the annual depreciation. Example: Depreciable Cost / Total Units of Activity = Depreciable Cost per Unit Depreciable Cost per Unit * Units of Activity during the year = Annual Depreciation Expense

Cost of Equipment

1. cash purchase price 2. sales taxes 3. freight charges 4. insurance during transit, paid by the purchaser. Also, expenditures required in... 1. assembling 2. installing 3. testing Motor Vehicles licenses and accident insurance on company cars and trucks are expensed as incurred because they represent annual recurring costs that do not benefit future periods. *Figure 9.4*

Franchises and Licenses

A franchise is a contractual agreement under which the franchisor grants the franchisee the right to sell certain products, to provide specific services, or the use certain trademarks or trade name, usually within a designated geographic area. Another type of franchise, granted by a government body, permits the enterprise to use public property in performing its service (i.e: radio waves to broadcasted). Such operating rights are referred to as licenses. Annual payments made under a franchise agreement should be recorded as operating expenses.

Trademark *Not Amortized*

A word phrase jingle or symbol that distinguished or identifies a particular enterprise or product. Trade names like Sunkist, Coca-Cola and Big-Mac create immediate product identification and generally enhance the sale of the product. Trademarks are not amortized because they have indefinite lives.

Additions and Improvements

Additions and Improvements are costs incurred to increase the operating efficiency, productive capacity, or useful life of a plant asset. 1. They are usually material in amount and occur infrequently. 2. Additions and Improvements increase the company's investment in productive facilities. They are debited to the plant asset affected, and are referred to as capital expenditures.

Patent

An exclusive right issued by the United States Patent Office that enables the recipient to manufacture, sell, or otherwise control an invention for a period of 20 years from the date of the grant. The initial cost of a patent is cash or cash equivalent price paid to acquire the patent. Legal costs of protecting a patent in an infringement suit are added to the Patent account and amortized over the remaining life of a patent. Cost is amortized over its 20-year life, or useful life, whichever is shorter.

The Disposal of Plant Assets

Book value is the difference between the cost of the plant asset and the accumulated deprecation to date. If disposal occurs mid-year, the depreciation for the fraction of the year to the date of disposal must be recorded. Book value is eliminated by reducing Accumulated Depreciation for the total depreciation associated with that asset and reducing the asset account for the cost of the asset.

Buildings

Buildings are facilities used in operations such as stores, offices, and factories. The cost of buildings included all necessary expenditures relating to the purchase or constructions of a building. When a building is purchased, such costs include the purchase price, closing costs, and broker's commission. When a new building is constructed, cost consists of the contract price plus payments for architects' fees, building permits, interest payments during construction, and excavation cost.

Loss on Disposal

Cost of Office Furniture 60000 Accumulated Dep. (49000) Book Value at Date of Disposal 11000 Proceeds From Sale 9000 Loss on Disposal 2000. Journal Entry Cash 9000 Accumulated Dep. 49000 Loss on Disposal 2000 Office Furniture 60000 *Proceeds from cash are less than book value at the date of disposal.*

Record Purchase of Truck (Equipment)

Delivery Truck 23820 License Expense 80 Prepaid Insurance 1600 Cash 25k

Depletion Expense Journal Entry

Depletion Expense 400k Accumulated Depletion 400k Accumulated Depletion is a contra asset account.

Straight-Line Method Formula

Depreciable Cost / Useful Life (in years) = Depreciable Expense.

Depreciable Cost

Depreciable cost represents the total amount subject to depreciation and is computed as follows... Cost of Asset - Salvage Value = Depreciable Cost

Depreciation

Depreciation - is the allocation of the cost of a plant asset to expense over its useful or service life in a rational and systematic manner. Cost allocation provides for the proper matching of expenses with revenues in accordance with the matching principle. During an assets life, its usefulness may decline because of wear and tear of obsolescence. It is important to understand that recognizing deprecation does not result in an accumulation of cash for replacement of the asset. *Land is the only plant asset that is not depreciated.*

Plant Asset Disposals

Disposal for retirement: the plant asset is scrapped or discarded. Eliminate the book value of the plant at the of sale by debiting *Accumulated Depreciation* and crediting the asset account for its cost. Debit *Cash* to record the cash proceeds from the sale. Compute gain or loss. If the cash proceeds are greater than the book value, recognize a gain by crediting *Gain or Disposal* for the difference. If the cash proceeds are less than the book value, recognize a loss by debiting *Loss or Disposal* for the difference.

Record Purchase of Machinery

Factory Machinery 54500 Cash 54500

Computation of Cost of Land

For example, All demolition and removal costs, less any proceeds from salvaged materials are debited to the Land Account. Illustration 9.2

Gain On Disposal After Accumulated Depreciation is Updated

Gain on disposal of 5000 is computed: Cost of Office Furniture 60000 Accumulated Depreciation (49000) Book Value at Date of Disposal 11000 Proceeds From Sale 16000 Gain on Disposal 5000 Journal Entry Cash 16000 Accumulated Dep. 49000 Office Furniture 60000 Gain on Disposal 5000 *Proceeds from cash are greater than book value at the date of disposal.*

Goodwill *Not Amortized*

Goodwill represents the value of all favorable attributes that relate to a business enterprise, including exceptional management, desirable location, good customer relations, skilled employees, etc. Goodwill is recorded only when there is an exchange transaction that involves the purchase of an entire business. When an entire business is purchased, goodwill is the excess of cost over the fair market value of the net assets (assets less liabilities acquired). Goodwill is not amortized because it is considered to an indefinite life. Must be written down if its value is determined to have been permanently impaired

Copyrights

Granted by the federal government, copyrights give the owner the exclusive right to reproduce and sell artistic or published work. Copyrights extend for the life of the creator plus 50 year. Generally, the useful life is significantly shorter than legal life.

Revising Periodic Depreciation

If wear and tear or obsolescence indicate that annual depreciations are inadequate or excessive, a change should be made. When a change is made, there is no correction of previously recorded depreciation expense. Instead, depreciation expense for current and future year is revised. To determine the new annual depreciation expense, the depreciable cost at the time of the revision is divided by the remaining useful life.

Land Improvements

Land improvements are structured additions made to land such as... 1. parking lots 2. fencing 3. lighting 4. landscaping

Revised Depreciation Computation

New Depreciation Expense = Depreciable Cost at Time of Revision / Remaining useful life. For example: Book Value as of 1/1/14 = 5800 Less: Salvage Value = (1000) Depreciable Cost = 4800 Remaining Useful Life = 3 years Revised Annual Depreciation = 1600 or (4800 / 3).

Land

Often used as building site for a manufacturing plant or office site. - All necessary costs incurred to make land ready for it intended use are debited to the land account.

Expenditures During Useful Life

Ordinary repairs are expenditures to maintain the operating efficient and productive life of the unit. Such repairs are debited to Repairs Expense as incurred and are often referred to as revenue expenditures.

Natural Resources

Timber, Oil, Gas, and Minerals. Long-Lived productive assets that have two distinguishing characteristics: 1. They are physically extracted in operations. 2. They are replaceable only by an act of nature.

Declining Balance Method

Produces a decreasing annual deprecation expense over the asset's useful life. The asset's periodic depreciation is based on a declining book value or cost less accumulated depreciation of the asset. Annual depreciation expense is computed by multiplying the book value at the beginning of the year by the declining-balance depreciation rate. The deprecation rate remains constant from year to year, but the book value to which the rate is applied declines each year. Book value for the first year is the cost of the asset because the balance in accumulated depreciation at the beginning of the assets useful life is zero. In subsequent years, book value is the difference between cost and accumulated depreciation at the beginning of the year. This method is compatible with the matching principle because the higher the depreciation in early years is matched with the higher benefits received in these years.

Intangible Assets

Rights, privileges, and competitive advantages that result from ownership of long-lived assets that do not possess physical substance. Well known intangibles are the patents of Microsoft or McDonalds, the trade name iPod and Nike's trademarked swoosh. They are recorded at cost. For intangibles with limited lives, this cost is expensed over the useful life of the intangible asset in a rational and systematic manner. When costs can identified with the acquisition of the franchise or license., an intangible asset should be recognized.

Declining Balance Method Formula

Salvage value is ignored in determining the amount to which the declining balance rate is applied. Book Value at Beginning of Year * Declining Balance Rate = Annual Depreciation Expense.

Depletion

The allocation of the cost of natural resources to expense in a rational and systematic manner over the resource's useful life. The units-of-activity method is generally used to compute depletion. The reason it is used is that depletion generally is a function of the units extracted during the year.

Equipment

The cost of equipment consists of the cash purchase price and certain related costs. These cost include sales tax, freight charges, and insurance paid by the purchaser during transit. Cost includes all expenditures required in assembling, installing, and testing the unit. Recurring costs such as licenses and insurance are expensed as incurred.

Gain On Disposal Entry

The entry to record depreciation expense and update accumulated depreciation. Depreciation Expense 8000 Accumulated Depreciation 8000

Amortization

The term used to describe the allocation of the cost of an intangible asset to expense is amortization. Amortization expense is classified as an operating expense in the income statement. Intangible assets with indefinite lives should not be amortized.

Research and Development Costs *Not Intangible Assets*

These are not intangible assets, but because these expenditures may lead to patents and copyrights, they are covered in this section. There are uncertainties in identifying the extent and timing of future benefit of these expenditures. As a result, research and development costs are usually recorded as an expense when incurred.

Straight-Line Method and Rate

Under the straight line method, depreciation is the same for each year of the assets useful life. It is measured solely by the passage of time. In order to compute depreciation expense, it is necessary to determine depreciable cost. The straight line rate which is also used in the double declining balance rate is 100% divided by the assets useful life.

Units of Activity Method

Useful life expressed in terms of the total units of production or expected use from the asset, rather than as time period. Using this method is often difficult when trying to make a reasonable estimate of total activity. When the productivity of an asset varies significantly from one period to another, this method results in the best matching of expenses with revenues.

Declining Balance Rate

Using the double-declining-balance method.. The Declining Balance Rate is determined by doubling the straight-line rate.