08 Chapter - Accounting for Long-Term Assets
Chapter 08
Accounting for Long-Term Assets
Chapter Outline
Notes
Section 1Plant Assets
I. Cost Determination
Plant assets are tangible assets used in a company's operations
that have a useful life of more than one accounting period.
Consistent with cost principle, plant assets are recorded at cost
when acquired. Cost includes all normal and reasonable
expenditures necessary to get the asset in place and ready for its
intended use.
A. Landhas an unlimited life and is not usually used up over time.
Cost includes:
1. The total amount paid for the land.
2. Real estate commissions, title insurance fees, legal fees, and
any accrued property taxes paid by the purchaser.
3. Payments for surveying, clearing, grading, and draining, and
government assessments for public roadways, sewers, and
sidewalks are included in the cost of land.
4. Removal of any existing structures (less proceeds from sale of
salvaged material). These costs are charged to the land
account. Land is not depreciated.
B. Land Improvementscosts that increase the usefulness of the
land. Land improvements have limited useful lives and are used
up.
1. Examples include parking lot surfaces, driveways, fences, and
lighting systems.
2. Costs are charged to a separate Land Improvement account so
that their costs can be allocated to the periods they benefit.
C. Buildings
1. When purchased, costs usually includes its purchase price,
brokerage fees, taxes, title fees, attorney costs, and all
expenditures to make it ready for its intended use including
any necessary repairs or renovations such as wiring, lighting,
flooring and wall coverings.
2. If constructed for own use, cost includes materials and labor
plus a reasonable amount of indirect overhead costs, such as
heat, lighting, power, and depreciation on machinery used to
construct the asset. Cost also includes design fees, building
permits, and insurance during construction (but not after it is
placed in use; insurance then becomes an operating expense).
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Chapter 08 - Accounting for Long-Term Assets
D. Machinery and Equipment
Costs include all normal and necessary expenditures to purchase
and prepare them for intended use, including purchase price, taxes,
transportation charges, insurance while in transit, and the
installing, assembling and testing of the machinery and equipment.
Notes
E. Lump-Sum Purchase
1. A lump-sum purchase is the purchase of plant assets as a
group in a single transaction for a lump-sum price.
2. Individual asset cost is determined by allocating the cost of the
purchase among the different types of assets acquired based on
their relative market values.
II.
DepreciationThe process of allocating the cost of a plant asset to
expense in the accounting periods benefiting from its use.
A. Factors in Computing Depreciation
1. Costconsists of all necessary and reasonable expenditures to
acquire the plant asset and to prepare it for its intended use.
2. Salvage valuean estimate of the asset's value at the end of
its benefit period (also called residual value or scrap value).
3. Useful lifelength of time the asset is expected to be
productively used in a company's operations (also called
service life). Factors affecting useful life include:
a. Wear and tear from use in operations.
b. Inadequacythe insufficient capacity of plant assets to
meet the company's growing productive demands.
c. Obsolescencerefers to a plant asset that is no longer
useful in producing goods or services with a competitive
advantage because of new inventions and improvements.
B. Depreciation Methods
Depreciation methods are used to allocate a plant assets cost
over the accounting periods in its useful life.
1. Straight-line methodcharges the same amount to expense
for each period of the assets useful life; most frequently used
method. Computation:
a. Cost minus salvage value (equals the depreciable cost)
divided by the useful life equals annual depreciation
expense.
b. Can be expressed as a rate by dividing 100% by the
number of periods in the assets useful life.
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2. Units-of-production methodcharges a varying amount to
expense for each period of an assets useful life depending on
its usage. Computation:
a. Cost minus salvage value divided by the total number of
units expected to be produced during its useful life equals
the depreciation per unit.
b. Depreciation cost per unit times number of units produced
in the period equals the periods depreciation expense.
3. Declining-balance methodan accelerated depreciation
method that yields larger depreciation expense during the
early years of an asset's life and less depreciation in the later
years. Computation:
a. Multiply the assets beginning-of-period book value by a
multiple of the straight-line rate. (Do not consider salvage
value.) Book value is computed as the assets cost less its
accumulated depreciation.
b. A common depreciation rate for the declining-balance
method is double the straight-line rate; called the doubledeclining-balance method.
4. Comparing depreciation methodswhile the amount of
depreciation expense per period differs for different methods,
total depreciation expense is the same over a given assets
useful life.
5. Depreciation for tax reportingdifferences between financial
and tax accounting systems are normal and expected.
a. Many companies use accelerated depreciation in
computing taxable income because it postpones tax
payments by charging higher depreciation expense in the
early years and lower amounts in the later years.
b. Federal income tax law rules for depreciating assets are
called the Modified Accelerated Cost Recovery System
(MACRS).
c. MACRS is not acceptable for financial reporting because
it often allocates costs over an arbitrary period that is less
than the asset's useful life and it fails to estimate salvage
value.
C. Partial-Year Depreciation
When an asset is purchased (or disposed of) at a time other
than the beginning or end of an accounting period,
depreciation is recorded for the part of the year the asset was in
use.
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D. Changes in Estimates for Depreciation
Depreciation is based on estimates of salvage value and useful life;
later, new information may indicate these estimates are inaccurate.
1. Use the new estimate to compute depreciation for current and
future periods by revising the deprecation expense
computation by spreading the cost yet to be depreciated over
the remaining useful life.
2. The revision is referred to as a change in an accounting
estimate and is reflected in future financial statements; not in
prior statements.
E. Reporting Depreciation
1. Both the cost and accumulated depreciation of plant assets are
reported on the balance sheet or in its notes.
2. To satisfy the full-disclosure principle, the depreciation
method(s) used must be disclosed in notes.
3. Plant assets are reported on the balance sheet at book
value; not at fair market value; emphasis on cost rather
than fair market value is based on the going concern
assumption unless there is a permanent decline in the fair
market value of an asset relative to its book value. Called an
impairment, in this case, the company writes the asset down to
fair market value.
4. Accumulated Depreciation is a contra asset account with a
normal credit balance. It does not represent funds
accumulated to buy new assets when the currently owned
assets are replaced.
III.
Additional Expenditures
In recording additional expenditures for an assets operation,
maintenance, repair, and improvement, the company must decide
whether to capitalize (that is, debit an asset account) or expense them.
A. Types of Additional Expenditures
1. Revenue expenditures (also called income statement
expenditures) are additional costs of plant assets that do not
materially increase the asset's life or productive capabilities;
they are recorded as expenses and reported on the income
statement.
2. Capital expenditures (also called balance sheet expenditures)
are additional costs of plant assets that provide benefits
extending beyond the current period; they are debited to asset
accounts and reported on the balance sheet.
B. Ordinary Repairs
1. Ordinary repairs are expenditures to keep an asset in normal,
good operating condition.
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2. Ordinary repairs are treated as revenue expenditures; their
costs are reported as expenses on the income statement.
C. Betterments and Extraordinary Repairsaccounting for
betterments and extraordinary repairs is similar. Both are treated
as capital expenditures.
1. Betterments (Improvements)are expenditures make that a
plant asset more efficient or productive.
2. Extraordinary Repairs (Replacements)are expenditures
extending the assets useful life beyond its original estimate.
These are capital expenditures because they benefit future
periods and their costs are debited to the asset account.
IV.
Disposals of Plant AssetsAssets may be discarded, sold, or
exchanged.
A. Discarding Plant Assets
1. Entry to record disposal of plant assets when fully
depreciated (when accumulated depreciation is less than the
assets cost): debit Accumulated Depreciation, credit the
plant asset account.
2. Entry to record disposal of plant assets when not fully
depreciated (when accumulated depreciation is less than the
assets cost): first, record depreciation expense through date
discarded, then debit Accumulated Depreciation, debit Loss
on Disposal (for the remaining book value), credit the plant
asset account.
B. Selling Plant Assets
First, record depreciation expense through date sold, then:
1. Entry to record sale at book value: debit cash, debit
Accumulated Depreciation, credit the plant asset account.
2. Entry to record sale above book value: debit cash, debit
Accumulated Depreciation, credit Gain on Disposal, credit
the plant asset account.
3. Entry to record sale below book value: debit cash, debit Loss
on Disposal, debit Accumulated Depreciation, credit the plant
asset account.
V.
Section 2Natural Resourcesassets that are physically consumed
when used. Examples include timber, mineral deposits, and oil and
gas fields. Since they are consumed when used, they are also called
wasting assets.
A. Cost Determination and Depletion
1. Natural resources are recorded at cost, which includes all
expenditures necessary to acquire the resource and prepare it
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for its intended use.
2. Depletion is the process of allocating the cost of a natural
resource to the period when it is consumed.
3. Natural resources are reported on the balance sheet at cost
less accumulated depletion.
4. The depletion expense per period is based on the units
extracted; entry to record depletion: debit Depletion Expense,
credit Accumulated Depletion.
B. Plant Assets Used in Extracting
When the usefulness of plant assets used in extracting resources is
directly related to the depletion of the natural resource, their costs
are depreciated using the units-of-production method in
proportion to the depletion of the natural resource.
VI.
Section 3 -- Intangible Assetsnonphysical assets (used in
operations) that confer on their owners long-term rights, privileges, or
competitive advantages.
A. Cost Determination and Amortization
1. An intangible asset is recorded at cost when purchased.
Intangibles are then separated into those with limited lives or
indefinite lives. For those with a limited life, its cost is
systematically allocated to expense over its estimated useful
life through a process called amortization. If an intangible
asset has an indefinite life, it should not be amortized.
2. Amortization is similar to depreciation and depletion, except
that only the straight-line method is generally used for
amortization.
3. The effects of amortization are recorded in a contra account
called Accumulated Amortization. The gross acquisition cost
and accumulated amortization are disclosed in the balance
sheet.
B. Types of Intangibles
1. Patentan exclusive right granted to its owner to
manufacture and sell a patented machine or device, or to use
a process, for 20 years.
2. Copyrightthe exclusive right given to its owner to publish
and sell a musical, literary, or artistic work during the life of
the creator plus 70 years.
3. Leaseholdlessee is granted the right to use property by the
lessor, the propertys owner.
4. Leasehold improvementsalterations or improvements to
leased property, such as partitions, painting, and storefronts.
5. Franchises and Licensesrights that a company or
government grants an entity to deliver a product or service
under specified conditions. If for an indefinite period, costs
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are not amortized.
6. Trademarks and Trade Namessymbols, names, phrases,
or jingles identified with a company, product, or service. If
the company plans to renew indefinitely its right to the
trademark, the cost is not amortized.
7. Goodwillmeaning in accounting: the amount by which the
value of a company exceeds the value of its individual assets
and liabilities; implies the company as a whole has certain
value attributes not measured among its individual assets and
liabilities.
8. Other Intangibles-include assets such as software,
noncompete convenants, customer lists, etc. Record the
intangible assets costs, then determine whether the asset has
a limited or indefinite life. If limited, allocate its costs over
that period. If indefinite, its costs are not amortized.
VII.
VIII.
1.
Decision AnalysisTotal Asset Turnover
A. Total asset turnover is a measure of a companys ability to use
its assets most efficiently and effectively.
B. Calculated by dividing net sales by average total assets.
C. It is safe to say that all companies desire a high total asset
turnover. However, interpreting a companys total asset
turnover requires an understanding of the companys
operations.
1. Some operations are capital intensive, meaning that a
relatively large amount is invested in assets to generate sales,
which would suggest a lower total asset turnover.
2. Other operations are labor intensive, meaning that they
generate sales more by the efforts of people than the use of
assets; a higher total asset turnover would be expected.
Exchanging Plant Assets (Appendix 8A) Many plant assets are
disposed of by exchanging them for newer assets. In a typical
exchange, a trade-in allowance is received on the old asset and the
balance is paid in cash. Accounting for the exchange depends on
whether the transaction has commercial substance. An exchange has
commercial substance if the companys future cash flows change as a
result of the transaction. If an asset exchange has commercial
substance, a gain or loss is recorded based on the difference between
the book value of the asset given up and the market value of the asset
received. If an asset exchange lacks commercial substance, no gain or
loss is recorded, and the asset received is recorded based on book
value of the asset given up.
A. Exchange with Commercial Substance: A Loss
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Chapter 08 - Accounting for Long-Term Assets
When the book value of the assets given up (cash paid plus book
value of the old equipment) is more than the market value of the
equipment received, a loss is recorded. Entry: debit the new
equipment for market value, debit Loss on Exchange of Assets
(difference between the book value of the assets given up and the
market value of the new asset), debit Accumulated Depreciation
for the old equipment, credit Equipment (old) for cost of the old
equipment, credit cash for the cash paid.
B. Exchange with Commercial Substance: A Gain
When the market value of the equipment received is more than
the book value of the assets given up (cash paid plus book value
of the old equipment), a gain is recorded. Entry: debit the new
equipment for market value, debit Accumulated Depreciation for
the old equipment, credit Equipment (old) for cost of the old
equipment, credit cash for the cash paid, and credit Gain on
Exchange of Assets for the gain (difference between market value
of the new asset and the book value of the assets given up).
C. Exchange without Commercial Substance
If the transaction lacks commercial substance, any gain or loss
which would have been recorded when the transaction had
commercial substance is not recorded. The unrecognized gain is
subtracted from the new assets market value to determine its cost
basis. The cost basis of the new asset also can be computed by
summing the book values of the assets given up.
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Chapter 08 - Accounting for Long-Term Assets
VISUAL #8-1
FORMULAS FOR DEPRECIATION METHODS
1. STRAIGHT LINE
Cost - Estimated salvage =
Estimated useful life
Annual
Depreciation
2. UNITS OF PRODUCTION
a)
b)
(Depreciable)
Cost - Estimated salvage =
Cost per
Predicted units of production
Unit
CPU x units produced
in period
=
Depreciation
for PERIOD
(In last year, depreciate to estimated salvage value; never
depreciate below this amount.)
3. DOUBLE-DECLINING BALANCE
Book Value (beginning of year) x RATE* = Depreciation (for that year)
*RATE The rate used is constant and it is twice what the
straight line rate would have been for this asset.
(In the last year, depreciate to estimated salvage value; never
depreciate below this amount.)
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