Describe how the cost principle applies to plant assets.
2.
Explain the concept of depreciation.
3.
Compute periodic depreciation using different methods.
4.
Describe the procedure for revising periodic depreciation.
5.
Distinguish between revenue and capital expenditures, and
explain the entries for each.
6.
Explain how to account for the disposal of a plant asset.
7.
Compute periodic depletion of extractable natural resources.
8.
Explain the basic issues related to accounting for intangible
assets.
9.
Indicate how plant assets, natural resources, and intangible
assets are reported.
Plant Assets, Natural Resources, and Intangible
Assets
Plant Assets
Determining the
cost of plant
assets
Accounting for
extractable
natural resources
Depreciation
Financial
statement
presentation
Revaluation of
plant assets
Expenditures
during useful life
Plant asset
disposals
Slide
9-4
Natural
Resources
Intangible
Assets
Accounting for
intangibles
Types of
intangibles
Research and
development
costs
Statement
Presentation and
Analysis
Presentation
Analysis
Section 1 – Plant Assets
Plant assets include land, land improvements, buildings,
and equipment (machinery, furniture, tools).
Major characteristics include:
“Used in operations” and not for resale.
Long-term in nature and usually depreciated.
Possess physical substance.
Referred to as property, plant, and equipment; plant and
equipment; and fixed assets.
Slide
9-5
Section 1 – Plant Assets
Illustration 9-1
Percentages of plant assets
in relation to total assets
Slide
9-6
Determining the Cost of Plant Assets
Land
Includes all costs to acquire land and ready it for use.
Costs typically include:
(1) purchase price;
(2) closing costs, such as title and attorney’s fees;
(3) real estate brokers’ commissions;
(4) costs of grading, filling, draining, and clearing;
(5) assumption of any liens, mortgages, or encumbrances
on the property.
Slide
9-7
SO 1 Describe how the cost principle applies to plant assets.
Determining the Cost of Plant Assets
Illustration: Assume that Hayes Manufacturing Company
acquires real estate at a cash cost of $100,000. The property
contains an old warehouse that is razed at a net cost of $6,000
($7,500 in costs less $1,500 proceeds from salvaged materials).
Additional expenditures are the attorney’s fee, $1,000, and the
real estate broker’s commission, $8,000. The cost of the land is
$115,000, computed as follows.
Required: Determine amount to be reported as the cost of the
land.
Slide
9-8
SO 1 Describe how the cost principle applies to plant assets.
Determining the Cost of Plant Assets
Required: Determine amount to be reported as the cost of the
land.
Land
Cash price of property of $100,000
$100,000
Net removal cost of warehouse of $6,000
6,000
Attorney's fees of $1,000
1,000
Real estate broker’s commission of $8,000
8,000
Cost of Land
$115,000
Journal Entry
Land
Cash
Slide
9-9
115,000
115,000
SO 1 Describe how the cost principle applies to plant assets.
Determining the Cost of Plant Assets
Land Improvements
All expenditures necessary to make the improvements
ready for their intended use.
Driveways, parking lots, fences, landscaping, and
underground sprinklers.
Limited useful lives.
Expense (depreciate) the cost of land improvements
over their useful lives.
Slide
9-10
SO 1 Describe how the cost principle applies to plant assets.
Determining the Cost of Plant Assets
Buildings
All costs related directly to purchase or construction.
Purchase costs:
Purchase price, closing costs and real estate broker’s
commission.
Remodeling and replacing or repairing the roof, floors,
electrical wiring, and plumbing.
Construction costs:
Contract price plus payments for architects’ fees, building
permits, and excavation costs.
Slide
9-11
SO 1 Describe how the cost principle applies to plant assets.
Determining the Cost of Plant Assets
Equipment
All costs incurred in acquiring the equipment and
preparing it for use.
Costs typically include:
purchase price,
sales taxes,
freight and handling charges,
insurance on the equipment while in transit,
assembling and installation costs, and
costs of conducting trial runs.
Slide
9-12
SO 1 Describe how the cost principle applies to plant assets.
Determining the Cost of Plant Assets
Illustration: Assume Merten Company purchases factory
machinery at a cash price of $50,000. Related expenditures are
for sales taxes $3,000, insurance during shipping $500, and
installation and testing $1,000. Determine amount to be
reported as the cost of the machinery.
Machinery
$50,000
Cash price
3,000
Sales taxes
Insurance during shipping
Installation and testing
Cost of Machinery
Slide
9-13
500
1,000
$54,500
SO 1 Describe how the cost principle applies to plant assets.
Slide
9-14
Answer on notes page
Depreciation
Depreciation is the process of allocating the cost of
tangible assets to expense in a systematic and rational
manner to those periods expected to benefit from the use
of the asset.
Process of cost allocation, not asset valuation.
Applies to land improvements, buildings, and
equipment, not land.
Depreciable, because the revenue-producing ability of
asset will decline over the asset’s useful life.
Slide
9-15
SO 2 Explain the concept of depreciation.
Depreciation
Factors in Computing Depreciation
Illustration 9-6
Cost
Slide
9-16
Useful Life
Residual Value
SO 2 Explain the concept of depreciation.
Depreciation
Depreciation Methods
Objective is to select the method that best measures an
asset’s contribution to revenue over its useful life.
Examples include:
SO 3 Compute periodic depreciation using different methods.
Depreciation
Units-of-Activity
Companies estimate total units of activity to calculate
depreciation cost per unit.
Expense varies based on units of activity.
Depreciable cost is
cost less residual
value.
Slide
9-21
Illustration 9-10
SO 3 Compute periodic depreciation using different methods.
Depreciation
Illustration: (Units-of-Activity Method)
Units
of
Cost /
Year
Activity
2011
15,000
2012
x
Unit
Depreciation Accumulated
=
Book
Expense
Depreciation
Value
$ 0.12
$ 1,800
$ 1,800
$ 11,200
30,000
0.12
3,600
5,400
7,600
2013
20,000
0.12
2,400
7,800
5,200
2014
25,000
0.12
3,000
10,800
2,200
2015
10,000
0.12
1,200
12,000
1,000
2011
Journal
Entry
Slide
9-22
Illustration 9-11
Annual
Depreciation expense
Accumulated depreciation
1,800
1,800
SO 3 Compute periodic depreciation using different methods.
Depreciation
Declining-Balance
Decreasing annual depreciation expense over the asset’s
useful life.
Declining-balance rate is double the straight-line rate.
Rate applied to book value.
Illustration 9-12
Slide
9-23
SO 3 Compute periodic depreciation using different methods.
SO 3 Compute periodic depreciation using different methods.
Depreciation
Depreciation and Income Taxes
Tax laws often do not require the taxpayer to use the
same depreciation method on the tax return that is used
in preparing financial statements.
Many corporations use straight-line in their financial
statements to maximize net income. At the same time,
they use an accelerated-depreciation method on their
tax returns to minimize their income taxes.
Slide
9-32
SO 3 Compute periodic depreciation using different methods.
Depreciation
Revising Periodic Depreciation
Accounted for in the period of change and future
periods (Change in Estimate).
Not handled retrospectively.
Not considered error.
Slide
9-33
SO 4 Describe the procedure for revising periodic depreciation.
Depreciation
Illustration: Assume that Barb’s Florists decides on January 1,
2014, to extend the useful life of the truck one year because of
its excellent condition. The company has used the straight-line
method to depreciate the asset to date, and book value is
$5,800 ($13,000 - $7,200).
Questions:
1. What is the journal entry to correct
the prior years’ depreciation?
No Entry
Required
2. Calculate the depreciation expense
for 2014.
Slide
9-34
SO 4 Describe the procedure for revising periodic depreciation.
Depreciation
Book value, 1/1/14
Residual value
Depreciable cost
Useful life (revised)
Annual depreciation
First,
establish
Book Value at
the date of
change in
estimate.
$5,800
- 1,000
/
4,800
3 years
$ 1,600
Illustration 9-17
Journal entry for 2014
Depreciation expense
Accumulated depreciation
Slide
9-35
1,600
1,600
SO 4 Describe the procedure for revising periodic depreciation.
Depreciation
Review Question
When there is a change in estimated depreciation:
a. previous depreciation should be corrected.
b. current and future years’ depreciation should be
revised.
c. only future years’ depreciation should be revised.
d. None of the above.
Slide
9-36
SO 4 Describe the procedure for revising periodic depreciation.
Revaluation of Plant Assets
IFRS allows revaluation of plant assets to fair value
If revaluation is used, it must be applied to all assets in
a class of assets.
Assets that are experiencing rapid price changes must
be revalued on an annual basis, otherwise less
frequent revaluation is acceptable.
Slide
9-37
SO 4 Describe the procedure for revising periodic depreciation.
Revaluation of Plant Assets
Illustration: Pernice Company applies revaluation to plant
assets with a carrying value of $1,000,000, a useful life of 5
years, and no residual value. Pernice makes the following
journal entries in year 1, assuming straight-line depreciation.
Depreciation expense
Accumulated depreciation
200,000
200,000
After this entry, Pernice’s plant assets have a carrying amount
of $800,000 ($1,000,000 - $200,000).
Slide
9-38
SO 4 Describe the procedure for revising periodic depreciation.
Revaluation of Plant Assets
Illustration: At the end of year 1, independent appraisers
determine that the asset has a fair value of $850,000. To report
the plant assets at fair value, Pernice makes the following entry.
Accumulated depreciation
Plant assets
Revaluation surplus
200,000
150,000
50,000
Revaluation surplus is an example of an item reported as other
comprehensive income, as discussed in Chapter 5.
Slide
9-39
SO 4 Describe the procedure for revising periodic depreciation.
Revaluation of Plant Assets
Pernice now reports the following information in its statement of
financial position at the end of year 1.
Illustration 9-18
$850,000 is the new basis of the asset. Pernice reports depreciation
expense of $200,000 in the income statement and $50,000 in other
comprehensive income. Depreciation in year 2 will be $212,500
($850,000 / 4).
Slide
9-40
SO 4 Describe the procedure for revising periodic depreciation.
Expenditures During Useful Life
Ordinary Repairs - expenditures to maintain the operating
efficiency and productive life of the unit.
Debit - Repair (or Maintenance) Expense.
Referred to as revenue expenditures.
Additions and Improvements - costs incurred to increase
the operating efficiency, productive capacity, or useful life of a
plant asset.
Debit - the plant asset affected.
Referred to as capital expenditures.
Slide
9-41
SO 5 Distinguish between revenue and capital expenditures,
and explain the entries for each.
Plant Asset Disposals
Companies dispose of plant assets in three ways —
Retirement, Sale, or Exchange (appendix).
Illustration 9-19
Record depreciation up to the date of disposal.
Eliminate asset by (1) debiting Accumulated Depreciation, and
(2) crediting the asset account.
Slide
9-42
SO 6 Explain how to account for the disposal of a plant asset.
Plant Asset Disposals - Retirement
Retirement of Plant Assets
Illustration: Assume that Hobart Enterprises retires
its computer printers, which cost $32,000. The accumulated
depreciation on these printers is $32,000. The journal entry to
record this retirement is:
Accumulated depreciation
Printing equipment
32,000
32,000
Question: What happens if a fully depreciated plant asset is still useful
to the company?
Slide
9-43
SO 6 Explain how to account for the disposal of a plant asset.
Plant Asset Disposals - Retirement
Illustration: Assume that Sunset Company discards delivery
equipment that cost $18,000 and has accumulated
depreciation of $14,000. The journal entry is:
Accumulated depreciation
Loss on disposal
Delivery equipment
14,000
4,000
18,000
Companies report a loss on disposal in the “Other income and
expense” section of the income statement.
Slide
9-44
SO 6 Explain how to account for the disposal of a plant asset.
Plant Asset Disposals
Sale of Plant Assets
Compare the book value of the asset with the proceeds
received from the sale.
If proceeds exceed the book value, a gain on disposal
occurs.
If proceeds are less than the book value, a loss on
disposal occurs.
Slide
9-45
SO 6 Explain how to account for the disposal of a plant asset.
Plant Asset Disposals - Sale
Gain on Disposal
Illustration: Assume that on July 1, 2011, Wright Company sells
office furniture for $16,000 cash. The office furniture originally
cost $60,000. As of January 1, 2011, it had accumulated
depreciation of $41,000. Depreciation for the first six months of
2011 is $8,000. Prepare the journal entry to record depreciation
expense up to the date of sale.
Depreciation expense
Accumulated depreciation
Slide
9-46
8,000
8,000
SO 6 Explain how to account for the disposal of a plant asset.
Plant Asset Disposals - Sale
Illustration 9-20
Computation of gain on
disposal
Illustration: Wright records the sale as follows.
July 1
Slide
9-47
Cash
16,000
Accumulated depreciation
49,000
Office equipment
60,000
Gain on disposal
5,000
SO 6 Explain how to account for the disposal of a plant asset.
Plant Asset Disposals - Sale
Loss on Disposal
Illustration 9-21
Computation of loss on disposal
Illustration: Assume
that instead of selling
the office furniture for
$16,000, Wright sells it
for $9,000.
July 1
Cash
9,000
Accumulated depreciation
49,000
Office equipment
Loss on disposal
Slide
9-48
60,000
5,000
SO 6 Explain how to account for the disposal of a plant asset.
Section 2 – Natural Resources
Natural resources consist of standing timber and
resources extracted from the ground, such as oil, gas,
and minerals.
Standing timber is considered a biological asset under
IFRS.
In the years before they are harvested, the recorded
value of biological assets is adjusted to fair value each
period.
Slide
9-49
SO 7 Compute periodic depletion of extractable natural resources.
Section 2 – Natural Resources
IFRS defines extractive industries as those businesses
involved in finding and removing natural resources located in
or near the earth’s crust.
Cost - price needed to acquire the resource and prepare it for
its intended use.
Depletion - allocation of the cost to expense in a rational and
systematic manner over the resource’s useful life.
Depletion is to natural resources as depreciation is to plant
assets.
Companies generally use units-of-activity method.
Depletion generally is a function of the units extracted.
Slide
9-50
SO 7 Compute periodic depletion of extractable natural resources.
Section 2 – Natural Resources
Illustration: Assume that Lane Coal Company invests $5
million in a mine estimated to have 10 million tons of coal and no
salvage value. In the first year, Lane extracts and sells 800,000
tons of coal. Lane computes the depletion expense as follows:
$5,000,000 ÷ 10,000,000 = $.50 depletion cost per ton
SO 7 Compute periodic depletion of extractable natural resources.
Financial Statement Presentation
Illustration 9-23
Statement presentation of accumulated depletion
Extracted resources that have not been sold are reported as
inventory in the current assets section.
Slide
9-52
SO 7 Compute periodic depletion of extractable natural resources.
Section 3 – Intangible Assets
Intangible assets are rights, privileges, and competitive
advantages that do not possess physical substance.
Intangible assets are categorized as having either a
limited life or an indefinite life.
Common types of intangibles:
Patents
Copyrights
Trademarks and trade
names
Franchises or licenses
Goodwill
IFRS permits revaluation of intangible assets to fair value, except for goodwill.
Slide
9-53
SO 8 Explain the basic issues related to accounting for intangible assets.
Types of Intangible Assets
Patents
Exclusive right to manufacture, sell, or otherwise control
an invention for a specified number of years from the
date of the grant.
Legal life in many countries is 20 years.
Capitalize costs of purchasing a patent and amortize
over its legal life or its useful life, whichever is shorter.
Legal fees incurred successfully defending a patent are
capitalized to Patent account.
Slide
9-54
SO 8 Explain the basic issues related to accounting for intangible assets.
Accounting for Intangible Assets
Intangible assets are typically amortized on a straight-line
basis.
Illustration: Assume that National Labs purchases a patent at
a cost of $60,000. National estimates the useful life of the
patent to be eight years. National records the annual
amortization as follows.
Amortization expense
Patent
Slide
9-55
7,500
7,500
SO 8 Explain the basic issues related to accounting for intangible assets.
Accounting for Intangible Assets
Copyrights
Give the owner the exclusive right to reproduce and sell
an artistic or published work.
plays, literary works, musical works, pictures,
photographs, and video and audiovisual material.
Granted for the life of the creator plus a specified number
of years, which can vary by country but is commonly 70
years.
Capitalize costs of acquiring and defending it.
Amortized to expense over useful life.
Slide
9-56
SO 8 Explain the basic issues related to accounting for intangible assets.
Accounting for Intangible Assets
Trademarks and Trade Names
Word, phrase, jingle, or symbol that identifies a particular
enterprise or product.
Wheaties, Game Boy, Frappuccino, Kleenex, Windows,
Coca-Cola, and Jetta.
Registration provides a specified number of years of
protection, which can vary by country, but is commonly 20
years.
Capitalize acquisition costs.
Renewed indefinitely, no amortization.
Slide
9-57
SO 8 Explain the basic issues related to accounting for intangible assets.
Accounting for Intangible Assets
Franchises and Licenses
Contractual arrangement between a franchisor and a
franchisee.
BP (GBR), Taco Bell (USA), or Rent-A-Wreck (USA)
are franchises.
Franchise (or license) with a limited life should be
amortized to expense over the life of the franchise.
Franchise with an indefinite life should be carried at cost
and not amortized.
Slide
9-58
SO 8 Explain the basic issues related to accounting for intangible assets.
Accounting for Intangible Assets
Goodwill
Includes exceptional management, desirable location, good
customer relations, skilled employees, high-quality products,
etc.
Only recorded when an entire business is purchased.
Goodwill is recorded as the excess of ...
purchase price over the fair value of the identifiable net
assets acquired.
Internally created goodwill should not be capitalized.
Slide
9-59
SO 8 Explain the basic issues related to accounting for intangible assets.
Slide
9-60
Answer on notes page
Research and Development Costs
Frequently results in something that a company patents
or copyrights such as:
new product,
process,
idea,
formula,
composition, or
literary work.
Costs in the research phase are always expensed as
incurred.
Costs in the development phase are expensed until
specific criteria are met, primarily that technological
feasibility is achieved.
Slide
9-61
SO 8 Explain the basic issues related to accounting for intangible assets.
Statement Presentation and Analysis
Presentation
Slide
9-62
Illustration 9-24
SO 9 Indicate how plant assets, natural resources,
and intangible assets are reported.
Statement Presentation and Analysis
Analysis
Illustration 9-25
Each dollar invested in assets produced
in sales. If a
company is using its assets efficiently, each investment in
assets will create a high amount of sales.
Slide
9-63
SO 9 Indicate how plant assets, natural resources,
and intangible assets are reported.
Understanding U.S. GAAP
Key Differences
Plant Assets, Natural Resources,
and Intangible Assets
As in IFRS, under GAAP, the costs associated with research
and development are segregated into the two components.
Costs in the research phase are always expensed under
both IFRS and GAAP. Under GAAP, however, costs in the
development phase are also always expensed. As shown in
this chapter, under IFRS, development costs can be
capitalized once technological feasibility is achieved.
IFRS permits revaluation of intangible assets (except for
goodwill). GAAP prohibits revaluations of intangible assets.
GAAP does not require component depreciation.
Slide
9-64
Understanding U.S. GAAP
Key Differences
Plant Assets, Natural Resources,
and Intangible Assets
GAAP does not permit the use of revaluation accounting for
property, plant, and equipment, which is allowed under IFRS.
Under both GAAP and IFRS, changes in the depreciation
method used and changes in useful life are handled in
current and future periods. Prior periods are not affected.
GAAP recently conformed to IFRS in the accounting for
changes in depreciation methods.
Slide
9-65
Understanding U.S. GAAP
Key Differences
Plant Assets, Natural Resources,
and Intangible Assets
IFRS allows reversal of impairment losses when there has
been a change in economic conditions or in the expected
use of the asset. Under GAAP, impairment losses cannot be
reversed for assets to be held and used; the impairment loss
results in a new cost basis for the asset. IFRS and GAAP are
similar in the accounting for impairments of assets held for
disposal.
The accounting for exchanges of non-monetary assets has
recently converged between IFRS and GAAP.
Slide
9-66
Understanding U.S. GAAP
Looking to the Future
Plant Assets, Natural Resources,
and Intangible Assets
It is too early to say whether a converged conceptual framework
will recommend fair value measurement (and revaluation
accounting) for plant assets and intangibles. However, this is likely
to be one of the more contentious issues, given the long-standing
use of historical cost as a measurement basis in GAAP. The IASB
and FASB have identified a project that would consider expanded
recognition of internally generated intangible assets. IFRS permits
more recognition of intangibles compared to GAAP. Thus, it will be
challenging to develop converged standards for intangible assets,
given the long-standing prohibition on capitalizing internally
generated intangible assets and research and development in
GAAP.
Slide
9-67
Exchange of Plant Assets
Appendix
Ordinarily, companies record a gain or loss on the
exchange of plant assets.
The rationale for recognizing a gain or loss is that
most exchanges have commercial substance.
An exchange has commercial substance if the
future cash flows change as a result of the
exchange.
Slide
9-68
SO 10 Explain how to account for the exchange of plant assets.
Exchange of Plant Assets
Illustration: Roland Co. exchanged old trucks (cost $64,000
less $22,000 accumulated depreciation) plus cash of $17,000
for a new semi-truck. The old trucks had a fair value of
$26,000.
Loss
Treatment
Slide
9-69
Cost of old trucks
Less: Accumulated depreciation
Book value
Fair value of old trucks
Loss on disposal
$64,000
22,000
42,000
26,000
$16,000
Fair value of old trucks
Cash paid
Cost of new semi-truck
$26,000
17,000
$43,000
SO 10 Explain how to account for the exchange of plant assets.
Exchange of Plant Assets
Illustration: Roland Co. exchanged old trucks (cost $64,000
less $22,000 accumulated depreciation) plus cash of $17,000
for a new semi-truck. The old trucks had a fair market value of
$26,000.
Prepare the entry to record the exchange of assets by Roland
Co.
Slide
9-70
Semi-truck
43,000
Accumulated depreciation
22,000
Loss on disposal
16,000
Used trucks
64,000
Cash
17,000
SO 10 Explain how to account for the exchange of plant assets.
Exchange of Plant Assets
Illustration: Mark Express Delivery trades its old delivery
equipment (cost $40,000 less $28,000 accumulated
depreciation) for new delivery equipment. The old equipment
had a fair value of $19,000. Mark also paid $3,000.
Gain
Treatment
Slide
9-71
Cost of old equipment
Less: Accumulated depreciation
Book value
Fair value of old equipment
Gain on disposal
$40,000
28,000
12,000
19,000
$ 7,000
Fair value of old equipment
Cash paid
Cost of new equipment
$19,000
3,000
$22,000
SO 10 Explain how to account for the exchange of plant assets.
Exchange of Plant Assets
Illustration: Mark Express Delivery trades its old delivery
equipment (cost $40,000 less $28,000 accumulated
depreciation) for new delivery equipment. The old equipment
had a fair value of $19,000. Mark also paid $3,000.
Prepare the entry to record the exchange of assets by Mark
Express.
Delivery equipment (new)
22,000
Accumulated depreciation
28,000
Delivery equipment (used)
Slide
9-72
40,000
Gain on disposal
7,000
Cash
3,000
SO 10 Explain how to account for the exchange of plant assets.
Exchange of Plant Assets
Review Question
In exchanges of assets in which the exchange has
commercial substance:
a. neither gains nor losses are recognized immediately.
b. gains, but not losses, are recognized immediately.
c. losses, but not gains, are recognized immediately.
d. both gains and losses are recognized immediately.
Slide
9-73
SO 10 Explain how to account for the exchange of plant assets.