Chapter 9 - Plant Assets, Natural Resources, and Intangible Assets
Companies report a loss on disposal of plant assets in the...?
"Other expenses and losses" section of the income statement.
Companies report a gain on disposal of plant assets in the...?
"Other revenues and gains" section of the income statement.
plant assets
- Resources that have physical substance - are used in the operations of the business - are not intended for sale to customers.
Franchises and licenses may be granted for...?
- a definite period of time - an indefinite period - perpetually
Salvage Value
- an estimate of the asset's value at the end of its useful life. - This value may be based on the asset's worth as scrap or on its expected trade-in value
Useful Life
- an estimate of the expected productive life, also called service life, of the asset for its owner - may be expressed in terms of time, units of activity (such as machine hours), or units of output
Depreciation affects the _________________ through accumulated depreciation and the ______________________ through depreciation expense.
- balance sheet - income statement
The depreciation rate is ______________ from year to year, but the book value to which the rate is applied _______________ each year.
- constant - declines
Three factors that affect the computation of depreciation:
- cost - useful life - Salvage value
depreciation is a process of ______________ and not a process of ______________
- cost allocation - asset valuation
additions and improvements
- costs incurred to increase the operating efficiency, productive capacity, or useful life of a plant asset - usually material in amount and occur infrequently
Examples of Goodwill
- exceptional management - desirable location - good customer relations - skilled employees - high-quality products - harmonious relations with labor unions
Ordinary repairs
- expenditures to maintain the operating efficiency and productive life of the unit - usually are small amounts that occur frequently
Depreciation applies to three classes of plant assets:
- land improvements - buildings - equipment
Intangibles are categorized as having either...?
- limited life - indefinite life
Companies may disclose in the balance sheet or the notes to the financial statements the...?
- major classes of assets - they should describe the depreciation and amortization methods that were used - the amount of depreciation and amortization expense for the period
Amortization is to intangibles what depreciation is to_________________ and depletion is to ____________________.
- plant assets - natural resources
declining balance method
- produces a decreasing annual depreciation expense over the asset's useful life - the periodic depreciation is based on a declining book value (cost less accumulated depreciation) of the asset
The cost of Equipment consists of...?
- the cash purchase price - sales taxes - freight charges - insurance during transit paid by the purchaser - expenditures required in assembling installing, and testing the unit
Units-of-activity method
- useful life is expressed in terms of the total units of production or use expected from the asset, rather than as a time period - units-of-activity method is ideally suited to factory machinery.
Sources of Intangible assets:
1. Government grants, such as patents, copyrights, licenses, trademarks, and trade names. 2. Acquisition of another business, in which the purchase price includes a payment for goodwill. 3. Private monopolistic arrangements arising from contractual agreements, such as franchises and leases.
Depreciation computation methods...?
1. Straight-line 2. Units-of-activity 3. Declining-balance
The cost of land includes:
1. 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
In recording an exchange at a gain, the following three steps are involved:
1. eliminate the book value of the asset given up 2. record the cost of the asset acquired 3. recognize the gain on disposal of plant assets
In recording an exchange at a loss, three steps are required:
1. eliminate the book value of the asset given up 2. record the cost of the asset acquired 3. recognize the loss on disposal of plant assets.
When a new building is constructed, its cost consists of...?
1. the contract price plus payments for architects' fees 2. building permits 3. excavation costs.
When a building is purchased, costs include...?
1. the purchase price, closing costs (attorney's fee 2. title insurance, etc.) 3. the real estate broker's commission.
Two distinguishing characteristics of natural resources...?
1. they are physically extracted in operations (such as mining, cutting, or pumping) 2. they are replaceable only by an act of nature.
Annual rate of depreciation =
100%/Useful life (years)
legal life of a patent
20 years
The patent holder amortizes the cost of a patent over its...?
20-year legal life or its useful life, whichever is shorter
Companies amortize the cost of a patent over its...?
20-year life or its useful life, whichever is shorter.
accelerated depreciation method
A depreciation method that produces higher depreciation expense in the early years than in the later years
Companies charge certain interest costs to the _____________ Account
Buildings
copyrights
Exclusive grant from the federal government that allows the owner to reproduce and sell an artistic or published work.
The declining-balance method is compatible with the expense recognition principle because...?
It matches the higher depreciation expense in early years with the higher benefits received in these years. It also recognizes lower depreciation expense in later years, when the asset's contribution to revenue is less.
Depletion
The allocation of the cost of natural resources in a rational and systematic manner over the resource's useful life
Amortization
The process of allocating the cost of intangibles
Companies use land as...?
a building site for a manufacturing plant or office building.
A license granted by a governmental body permits...?
a company to use public property in performing its services
Franchise
a contractual arrangement between a franchisor and a franchisee. The franchisor grants the franchisee the right to sell certain products, perform specific services, or use certain trademarks or trade names, usually within a designated geographic area
If the proceeds of the sale exceed the book value of the plant asset...?
a gain on disposal occurs
If the proceeds of the sale are less than the book value of the plant asset sold...?
a loss on disposal occurs.
plant assets are expected to be of use to the company for...?
a number of years
impairment
a permanent decline in the fair value of an asset
Taxpayers must use on their tax returns either the straight-line method or...?
a special accelerated-depreciation method called the Modified Accelerated Cost Recovery System (MACRS).
trademark or trade name
a word, phrase, jingle, or symbol that identifies a particular enterprise or product.
Any legal costs an owner incurs in successfully defending a patent in an infringement suit are...?
added to the Patents account and amortized over the remaining life of the patent.
When disposing of a plant asset, the company removes...?
all amounts related to the asset. This includes the original cost and the total depreciation to date in the accumulated depreciation account.
The cost of intangible assets consists of...?
all expenditures necessary for the company to acquire the right, privilege, or competitive advantage
Cost consists of...?
all expenditures necessary to acquire an asset and make it ready for its intended use
The cost of land improvements includes...?
all expenditures necessary to make the improvements ready for their intended use
Because trademarks and trade names have indefinite lives, they are not __________________
amortized
The cost of intangible assets with indefinite lives should not be __________________
amortized
Recognizing depreciation on an asset does not result in...?
an accumulation of cash for replacement of the asset.
depreciable asset
an asset thats usefulness to the company and revenue-producing ability will decline over the asset's useful life.
companies record goodwill only when...?
an entire business is purchased, where goodwill is the excess of cost over the fair value of the net assets (assets less liabilities) acquired.
patent
an exclusive right issued by the U.S. 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.
companies usually record R&D costs as...?
an expense when incurred, whether the research and development is successful or not.
Asset Turnover
analyzes the productivity of a company's assets
When a company uses an annual straight-line rate, it...?
applies the percentage rate to the depreciable cost of the asset
Once a company chooses a method, it should...?
apply it consistently over the useful life of the asset
Management's intended use is important in...?
applying the historical cost principle.
Intangible assets
are rights, privileges, and competitive advantages that result from the ownership of long-lived assets that do not possess physical substance.
Land Improvements
are structural additions with limited lives that are made to land.
To determine the new annual depreciation expense, the company first computes the...?
asset's depreciable cost at the time of the revision. It then allocates the revised depreciable cost to the remaining useful life.
This ratio varies greatly among different industries—from those that are...?
asset-intensive (utilities) to those that are not (services).
Accumulated depreciation is reported on the...?
balance sheet as a deduction from plant assets.
if a fully depreciated plant asset is still useful to the company, the asset and its accumulated depreciation continue to...?
be reported on the balance sheet, without further depreciation adjustment, until the company retires the asset
Companies consider obsolescence and inadequacy in determining useful life. These factors may cause a patent to...?
become economically ineffective before the end of its legal life.
The objective is to select the method that...?
best measures an asset's contribution to revenue over its useful life
In a disposal by sale, the company compares the...?
book value of the asset with the proceeds received from the sale
Companies must describe in the financial statements significant ____________________
changes in estimates
A patent is nonrenewable. But...?
companies can extend the legal life of a patent by obtaining new patents for improvements or other changes in the basic design
Land improvements have limited useful lives, as a result...?
companies expense (depreciate) the cost of land improvements over their useful lives.
straight-line method of depreciation
companies expense the same amount of depreciation for each year of the asset's useful life. It is measured solely by the passage of time.
Cost
companies record plant assets at cost, in accordance with the historical cost principle.
If wear and tear or obsolescence indicate that annual depreciation estimates are inadequate or excessive, the...?
company should change the amount of depreciation expense.
Companies generally use the units-of-activity method to...?
compute depletion because that depletion generally is a function of the units extracted during the year.
The Internal Revenue Service (IRS) allows taxpayers to deduct depreciation expense when they...?
compute taxable income
For assets purchased mid year under the units of activity method, companies...?
compute the depreciation using the productivity of the asset for the partial year.
Natural Resources
consist of standing timber and underground deposits of oil, gas, and minerals
Accumulated Depletion is a...?
contra asset
Evidence of intangibles may exist in the form of...?
contracts or licenses
Companies record intangible assets at ___________
cost
The historical cost principle requires that companies record plant assets at...?
cost
In subsequent years, book value is the difference between...?
cost and accumulated depreciation to date
Interest costs incurred to finance the project are included in the...?
cost of the building when a significant period of time is required to get the building ready for use
In recording the purchase of a business, the company...?
debits (increases) the identifiable acquired assets, credits liabilities at their fair values, credits cash for the purchase price, and records the difference as goodwill
When construction has been completed, the company records subsequent interest payments on funds borrowed to finance the construction as...?
debits (increases) to Interest Expense.
Companies record Ordinary repairs as...?
debits to Maintenance and Repairs Expense as they are incurred, often referred to as revenue expenditures.
When land has an existing building on it that must be removed before the construction of a new building, the company...?
debits to the Land account all demolition and removal costs, less any proceeds from salvaged materials.
Except for land, plant assets ...?
decline in service potential over their useful lives
Some assets lose usefulness rapidly because of obsolescence. In these cases, the ____________________ method provides the most appropriate depreciation amount.
declining-balance method
The units-of-activity method can be used for assets such as...?
delivery equipment (miles driven) and airplanes (hours in use)
The units-of-activity method is generally not suitable for buildings or furniture because...?
depreciation for these assets is more a function of time than of use.
To compute the depletion cost per unit under the units of activity method, companies...?
divide the total cost of the natural resource minus salvage value by the number of units estimated to be in the resource
Asset Turnover tells us how many...?
dollars of sales a company generates for each dollar invested in assets
A common declining-balance rate is...?
double the straight-line rate. The method is often called the double-declining-balance method.
Examples of land improvements
driveways, parking lots, fences, landscaping, and underground sprinklers
Depreciable cost
equal to the cost of the asset less its salvage value.
Retirement of plant assets
equipment is scrapped or discarded
Sale of plant assets
equipment is sold to another party
Exchange of plant assets
existing equipment is traded for new equipment
When companies acquire vacant land, these costs include...?
expenditures for clearing, draining, filling, and grading.
Costs to make the building ready for its intended use include...?
expenditures for remodeling and replacing or repairing the roof, floors, electrical wiring, and plumbing
Revenue expenditures
expenditures that are immediately charged against revenues as an expense
capital expenditures
expenditures that increase the company's investment in productive facilities
research and development costs
expenditures that may lead to patents, copyrights, new processes, and new products
If a company develops and maintains the trademark or trade name, any costs related to these activities are...?
expensed as incurred
Annual recurring expenditure that do not benefit future periods are treated as...?
expenses as they are incurred
Buildings
facilities used in operations, such as stores, offices, factories, warehouses, and airplane hangars
the book value of plant assets is rarely the same as the...?
fair value
In instances where the value of a plant asset declines substantially, its fair value might...?
fall materially below book value.
Ordinarily, companies record a _________________ on the exchange of plant assets.
gain or loss
the largest intangible asset that appears on a company's balance sheet is _______________
goodwill
salvage value is an estimate. In making the estimate, management considers...?
how it plans to dispose of the asset and its experience with similar assets.
Trade names create...?
immediate product identification; enhance the sale of the product
Equipment
includes assets used in operations, such as store check-out counters, office furniture, factory machinery, delivery trucks, and airplanes
Depreciation expense is reported on the...?
income statement
To record amortization of an intangible asset, a company...?
increases (debits) Amortization Expense and decreases (credits) the specific intangible asset
Reporting the asset and related accumulated depreciation on the balance sheet...?
informs the financial statement reader that the asset is still in use
Companies report goodwill in the balance sheet under...?
intangible assets
the inclusion of interest costs in the cost of a constructed building is limited to...?
interest costs incurred during the construction period
additions and improvements increase the company's...?
investment in productive facilities
Goodwill is not amortized because...?
it is considered to have an indefinite life
The useful life of a copyright generally is significantly shorter than...?
its legal life
Depreciation does not apply to land because...?
its usefulness and revenue-producing ability generally remain intact over time
When a change in an estimate is required, the company...?
makes the change in current and future years. It does not change depreciation in prior periods
Cost allocation enables companies to properly...?
match expenses with revenues in accordance with the expense recognition principle
Many corporations use straight-line in their financial statements to...?
maximize net income
Companies use a special accelerated-depreciation method on their tax returns to...?
minimize income taxes
Under the declining-balance method, companies compute annual depreciation expense by...?
multiplying the book value at the beginning of the year by the declining-balance depreciation rate.
Companies record as debits (increases) to the Land account all...?
necessary costs incurred to make land ready for its intended use.
Companies debit to the Buildings account all...?
necessary expenditures related to the purchase or construction of a building
Asset Turnover = ?
net sales/average total assets
Once fully depreciated...?
no additional depreciation should be taken, even if an asset is still being used. In no situation can the accumulated depreciation on a plant asset exceed its cost.
Companies dispose of plant assets that are...?
no longer useful to them
Companies classify Amortization Expense as an...?
operating expense in the income statement
Annual payments made under a franchise agreement are recorded as...?
operating expenses in the period in which they are incurred.
During the useful life of a plant asset, a company may incur costs for...?
ordinary repairs, additions, or improvements.
plant assets are also called...?
property, plant, and equipment; plant and equipment; and fixed assets.
When an asset is purchased during the year, it is necessary to...?
prorate the annual depreciation on a time basis.
the book value (cost less accumulated depreciation) of a plant asset may be...?
quite different from its fair value
When a company incurs costs in connection with the purchase of a franchise or license, it should...?
recognize an intangible asset
When an impairment occurs, the company...?
records a write-down, whereby the asset's cost is reduced to its new fair value during the year in which the decline in value occurs
When disposing a plant asset the company eliminates the book value by...?
reducing (debiting) Accumulated Depreciation for the total depreciation associated with that asset to the date of disposal and reducing (crediting) the asset account for the cost of the asset
Materiality
refers to the impact of an item's size on a company's financial operations
Goodwill
represents the value of all favorable attributes that relate to a company that are not attributable to any other specific asset
Methods of plant asset disposal
sale, retirement, exchange
Unlike the other depreciation methods, the declining-balance method ignores...?
salvage value in determining the amount to which the declining-balance rate is applied
Companies ____________ amortize the cost of an indefinite-life franchise (or license)
should not
If a company does not use a going concern assumption, then plant assets should be...?
stated at their fair value. In that case, depreciation of these assets is not needed.
Materiality Concept
states that if an item would not make a difference in decision-making, the company does not have to follow GAAP in reporting that item.
Going concern assumption
states that the company will continue in operation for the foreseeable future.
if an asset is fully depreciated, it can have a zero book value but...?
still have a fair value.
Intangible assets are typically amortized on a...?
straight-line basis
Under any method, depreciation stops when...?
the asset's book value equals expected salvage value.`
When the productivity of an asset varies significantly from one period to another, the units-of-activity method results in...?
the best matching of expenses with revenues.
During an asset exchange, A Loss occurs when...?
the book value of the old asset is greater than the fair value of the asset exchanged
goodwill can be identified only with...?
the business as a whole.
The initial cost of a patent is...?
the cash or cash equivalent price paid to acquire the patent.
If an intangible has a limited life...?
the company allocates its cost over the asset's useful life using a process similar to depreciation
The cost of a copyright is...?
the cost of acquiring and defending it.
At the beginning of the first year, book value is...?
the cost of the asset because the balance in accumulated depreciation at the beginning of the asset's useful life is zero
To compute depletion...?
the cost per unit is then multiplied by the number of units extracted.
The method recommended for an asset that is expected to be significantly more productive in the first half of its useful life is...?
the declining-balance method.
During an asset exchange, a gain occurs when...?
the fair value of the old asset is greater than its book value.
When an exchange has commercial substance, the debit to the new asset is equal to...?
the fair value of the old asset plus the cash paid
An exchange has commercial substance if...?
the future cash flows change as a result of the exchange
Useful life is an estimate. In making the estimate, management considers such factors as...?
the intended use of the asset, its expected repair and maintenance, and its vulnerability to obsolescence
Copyrights extend for...?
the life of the creator plus 70 years
Companies generally debit additions and improvements amounts to...?
the plant asset affected, often referred to as capital expenditures.
The acquisition cost of a natural resource is...?
the price needed to acquire the resource and prepare it for its intended use
For an already-discovered resource, such as an existing coal mine, cost is...?
the price paid for the property.
Depreciation
the process of allocating to expense the cost of a plant asset over its useful (service) life in a rational and systematic manner
obsolescence
the process of becoming out of date before the asset physically wears out.
If a company purchases the trademark or trade name the cost is...?
the purchase price
For plant assets, cost includes both...?
the purchase price of the asset and the costs incurred in designing and constructing the asset
the initial cost for an intangible asset includes only...?
the purchase price, companies expense any costs incurred in developing an intangible asset
The balance in Accumulated Depreciation represents...?
the total amount of the asset's cost that the company has charged to expense
On a balance sheet, natural resources may be described more specifically as...?
timberlands, mineral deposits, oil reserves, and so on.
Annual depreciation varies considerably among the methods, but...?
total depreciation expense is the same ($12,000) for the five-year period under all three methods
Manufacturing companies can measure production in...?
units of output or in machine hours.
Companies should amortize the cost of a limited-life franchise (or license) over its _________________
useful life
Once cost is established, the company...?
uses that amount as the basis of accounting for the plant asset over its useful life.
During a depreciable asset's useful life, its revenue-producing ability declines because of...?
wear and tear
