CHAPTER 6

PLANT AND
INTANGIBLE ASSETS

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 Plant Assets
 Plant assets are tangible assets that are used actively in
the operations of an entity.
 It’s fully expected that these assets, will benefit future
periods.
 Plant assets represent a bundle of future services and
thus can be thought of as long-term prepaid expenses.
Plant assets as similar to long-term prepaid
expenses
As years pass, and the
The cost of plant assets services are used, the
is the advance purchase cost is transferred to
of services. depreciation expense.
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 Major Categories of Long-term Assets

Tangible Plant Intangible Natural

Assets Assets Resources

Long-term Noncurrent assets Sites acquired for

assets having with no physical extracting valuable
physical substance. substance. resources.

Land, buildings, Patents, copyrights, Oil reserves,

equipment, trademarks, timber, other
furniture, fixtures. franchises, goodwill. minerals.
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Accountable events in the life of plant assets

 For all categories of plant assts there are

three basic accountable events. These are
1. Acquisition cost
2. Allocation of the acquisition cost to expense
over the asset’s useful life (Depreciation) and
3. Sale or disposal of plant asset

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Acquisition of Plant asset

 Determining the cost of plant asset

 The cost of a plant asset included all expenditure
that are reasonable and necessary for getting the
asset to the desired location and ready for use.
 Thus, many incidental costs may be included in
the cost assigned to a plant asset.
 For example, sales tax on the purchase price,
delivery cost, and installation costs

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 Asset
price
Cost = +
Reasonable and
necessary costs . . .

. . . for getting . . . for getting

the asset to the the asset ready
desired location. for use.

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Determining Cost
 On May 4, Heat Co., a stove maker, buys a new
machine from Supply Co. The new machine has a
price of $52,000. Sales tax is 8%.
 Heat Co. pays $500 shipping cost to get the
machine to its plant. After the machine arrives, set-
up costs of $1,300 are incurred, along with $4,000
in testing costs.

 Compute the cost of Heat Co.’s new machine.

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Determining Cost
List price $ 52,000
Sales tax ($52,000 × 8%) 4,160
Transportation cost 500
Set-up 1,300
Testing 4,000
Total cost to Heat Co. $ 61,960

Date Description Debit Credit

May 4 Machine 61,960
Cash 61,960

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 Special Considerations
When purchasing land, the cost includes the purchase price and other
costs generally incurred in connection with land acquisitions. Many of
these costs are related to obtaining legal title to the land.

Land improvements include parking lots, driveways, fences, sidewalks,

landscaping, and any outdoor lighting systems. Land improvements are
depreciated over their useful life.

Land Cost includes real estate commissions,

escrow fees, legal fees, clearing and
grading the property.

Land Improvements to land such as

Improvements driveways, fences, and landscaping
are recorded separately. 9
 Special Considerations
Repairs made prior to the building being put in
Buildings
use are considered part of the building’s cost.

Equipment Related interest, insurance, and property

taxes are treated as expenses of the current
period.

Whether we purchase or construct a building, the cost should include the purchase
price plus any attorney fees, title fees, and repairs made prior to using the building.
If the building is built, the cost will include all the necessary construction costs as
well as the costs just mentioned.

Machinery and equipment are recorded at their purchase price less any available
cash discount. If the company pays delivery charges on a truck, these costs are
included in the cost of the truck. If any special parts need to be installed to make the
machinery or equipment ready for its intended use, these costs will be included in
the price of these assets. Insurance and property taxes are expenses in the current
period; they are not part of the acquisition cost of an asset.

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 Special Considerations

Allocation of a Lump-Sum Purchase

If the company buy The total cost The allocation

the whole thing;
must be is based on
building, land, and
equipments with allocated to the relative
lump sum amount. separate Fair Market
accounts for Value of each
each asset. asset
purchased.

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 Depreciation
 Tangible plant assets with the exception of land are of
use to a company for only a limited number of years
 The allocation of the cost of a plant asset to expense in the
periods in which services are received from the asset
 The basic purpose of depreciation is to offset the revenue of
an accounting period with the cost of the goods and services
being consumed in the effort to generate that revenue

 Depreciation is a process of cost allocation, not a

process of asset valuation.

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When dealing with depreciation, there are several
terms and concepts to understand.
 Depreciation distributes the asset’s cost over the
time (life) the asset is used.
 Depreciation is recapturing the cost invested in the
asset.
Book Value
• Cost – Accumulated Depreciation
Depreciation
• Contra-asset

• Represents the portion of an asset’s cost that has

already been allocated to expense.
Causes of Depreciation
• Physical deterioration

• Obsolescence

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Measuring Depreciation

 Depreciation of a plant asset is calculated

based on three main factors:
1. Original cost
2. Estimated useful life
3. Estimated residual value

Depreciable cost =
Cost – Estimated residual value

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 Depreciation Methods
 There are four basic methods of depreciation for plant assets. These
are:

Straight-line method

Units-of-production method

Declining-balance method

Sum of years digit method

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Straight-Line Depreciation
Regardless of the method used to calculate depreciation expense, three
variables must be known:
(1) the asset’s cost;
(2) the estimated residual value expected to be received at the end of its useful
life, and
(3) the estimated useful life of the asset.

When using the straight-line method, depreciation expense is calculated by

taking cost minus residual value and dividing by the years of useful life.

The straight-line (SL) method allocates an equal

amount of depreciation to each year

Depreciation Cost - Residual Value

=
Expense per Year Years of Useful Life

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Straight-Line Depreciation
On January 1, 2007, Bass Co. buys new equipment.
Bass pays a total of $24,000 for the equipment. The
equipment has an estimated residual value of $3,000 and
an estimated useful life of 5 years.

Compute depreciation for 2007 using the straight-line

method.

Cost – Residual Value $ 24,000 – $ 3,000

=
Years of Useful Life 5
= $ 4,200 per year
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 Straight-Line Depreciation

Bass Co. will record $4,200 depreciation each year for five
years. Total depreciation over the estimated useful life of
the equipment is:

Depreciation Accumulated Accumulated Undepreciated

Expense Depreciation Depreciation Balance
Year (debit) (credit) Balance (book value)
$ 24,000
2007 $ 4,200 $ 4,200 $ 4,200 19,800
2008 4,200 4,200 8,400 15,600
2009 4,200 4,200 12,600 11,400
2010 4,200 4,200 16,800 7,200
2011 4,200 4,200 21,000 3,000
$ 21,000 $ 21,000
Salvage Value
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Depreciation for Fractional Periods

When an asset is acquired during the year, depreciation

in the year of acquisition must be distributed

Half-Year Convention
In the year of
acquisition, record six
months of depreciation. ½
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Half-Year Convention

Using the half-year convention, calculate the

straight-line depreciation on December 31, 2007, for
equipment purchased in 2007. The equipment cost
$75,000, has a useful life of 10 years and an
estimated residual value of $5,000.

Depreciation = ($75,000 - $5,000) ÷ 10

= $7,000 for a full year
1
Depreciation = $7,000 × /2 = $3,500
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Declining-Balance Method
An accelerated depreciation method writes off more
depreciation near the start of an asset’s life than straight-
line does.
Depreciation in the early years of an asset’s
estimated useful life is higher than in later years.

Accelerated
Depreciation Remaining
= × Depreciation
Expense Book Value
Rate

The double-declining balance depreciation

rate is 200% of the straight-line
depreciation rate of (1÷Useful Life). 21
 The DDB method multiplies decreasing book
value by a constant percentage that is twice the
straight-line rate.
 DDB amounts can be computed using the
following formula:

2
Depreciation Expense  cos t  accum. depreciation  *
life

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Declining-Balance Method
On January 1, 2007, Bass Co. buys a new delivery truck.
Bass Co. pays $24,000 for the truck. The truck has an
estimated residual value of $3,000 and an estimated useful
life of 5 years.
Compute depreciation for 2007 using the double-
declining balance method.

2007 Depr. Remaining Accelerated

= ×
Expense Book Value Depreciation Rate
= $ 24,000 × 2 × 1/5
= $ 24,000 × 40%
= $ 9,600
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 Declining-Balance Method

Total depreciation over the estimated useful life of an

Compute depreciation for the rest of the
asset is the same using either the straight-line method or
truck’s estimated
the declining-balance method. useful life.

Depr. Accumulated Book

Year Computation Expense Depreciation Value
2007 $ 24,000 × 40% $ 9,600 $ 9,600 $ 14,400
2008 $ 14,400 × 40% $ 5,760 $ 15,360 $ 8,640
2009 $ 8,640 × 40% $ 3,456 $ 18,816 $ 5,184
2010 $ 5,184 × 40% $ 2,074 $ 20,890 $ 3,110
2011 Plug year # 5 $ 110 $ 21,000 $ 3,000
Total Depreciation $ 21,000
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Units-of-Production (UOP) Method
 The units-of-production (UOP) method
allocates a fixed amount of depreciation to each
unit of output.
 UOP depreciates by units rather than by years.
 a unit of output can be miles, units, hours, or
output, depending on which unit type best
defines the asset’s use.

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 To calculate depreciation per unit the
following formula is applied
Cost – Residual Value Depreciation cost
=
Estimated Units of Output per unit of output

Example the Truck has a cost of 41,000, estimated residual value

1,000 and it is estimated to be driven for the total miles of 100,000. It
is driven 20,000 miles the first year, 30,000 the second, 25,000 the third,
15,000 the fourth, and 10,000 during the fifth.

How much is the UOP depreciation for each period?

UOP per unit = (41,000 -1,000)

100, 000 miles
= 0.40 per mile
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The UOP depreciation for each period
Year Cost Depreciation for the year Acc. Book
Dep. Per Dep. Exp.
Dep. value
No.
unit units
Big. Bal 1 41,000 - - - - 41,000
End 1 41,000 0.40 20,000 8,000 8,000 33,000
End 2 0.40 30,000 12,000 20,000 21,000
End 3 0.40 25,000 10,000 30,000 11,000
End 4 0.40 15,000 6,000 36,000 5,000
End 5 0.40 10,000 4,000 40,000 1,000

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 Sum of the Years' Digits Method
 Sum of the Years' Digits Method: is an accelerated
method of depreciation which also based on the
assumption that the loss in the value of the fixed asset
will be greater during the earlier years and will go on
decreasing gradually with the decrease in the life of such
asset.
 The SYD is found by estimating an asset's useful life in
years, then assessing consecutive numbers to each year,
and totalling these numbers. For n years:
 SYD = 1 + 2 + 3 + 4 + ...... + n
 SYD = n (n + 1) / 2
 where n = the number of periods in the asset's useful life can be
applied to derive the SYD

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 Thus, the formula for depreciation for this
method is:
 Depreciation expense =
Depreciation cost × (Remaining useful life/SYD)

Example: On January 1, 2007, Bass Co. buys a new

delivery truck. Bass Co. pays $24,000 for the truck. The
truck has an estimated residual value of $3,000 and an
estimated useful life of 5 years.
Compute depreciation for 2007 and the remaining
years using the sum of years digit method.

SYD = n(n+1)/2
=5(5+1)/2
= 15
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Depreciable value = cost – salvage value
= 24,000 – 3,000
= 21,000
Depreciation expense for year 2007(1st year)
= 21,000 x 5/15
= 7,000
Depreciation expense of the preceding years
are indicated in the next page

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First year depreciation =5/15×21,000=7,000

Second year depreciation =4/15×21,000=5,600

Third year depreciation =3/15×21,000=4,200

Fourth year depreciation =2/15×21,000=2,800

Fifth year depreciation =1/15×21,000=1,400

Total = 21,000

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Revising Depreciation Rates

Predicted Predicted
salvage value useful life

So depreciation
is an estimate.

Over the life of an asset, new information

may come to light that indicates the
original estimates need to be revised.
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Revising Depreciation Rates

On January 1, 2004, equipment was

purchased that cost $30,000, has a useful life
of 10 years and no salvage value. During
2007, the useful life was revised to 8 years
total (5 years remaining).

Calculate depreciation expense for the year

ended December 31, 2007, using the
straight-line method.

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Revising Depreciation Rates

When our estimates change, depreciation is:

Book value at Salvage value at

date of change – date of change

Remaining useful life at date of change

Asset cost $ 30,000

Accumulated depreciation, 12/31/2006
($3,000 per year × 3 years) 9,000
Remaining book value $ 21,000
Divide by remaining life ÷5
Revised annual depreciation $ 4,200
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Disposal of Plant Assets

If the cost of an asset cannot be

recovered through future use or sale,
the asset should be written down to its
net realizable value.

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Disposal of Plant and Equipment
Update depreciation
to the date of disposal.

Journalize disposal by:

Recording cash Recording a

received (debit). gain (credit)
or loss (debit).

Removing accumulated Removing the

depreciation (debit). asset cost (credit).

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Disposal of Plant and Equipment

If Cash > BV, record a gain (credit).

If Cash < BV, record a loss (debit).
If Cash = BV, no gain or loss.

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Disposal of Plant and Equipment

On September 30, 2007, Evans Company

sells a machine that originally cost $100,000
for $60,000 cash. The machine was placed
in service on January 1, 2002. It has been
depreciated using the straight-line method
with an estimated salvage value of $20,000
and an estimated useful life of 10 years.

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Let’s answer the following questions.

Q1. How much is the amount of depreciation

recorded on September 30, 2007, to
bring depreciation up to date?

a. $8,000. Annual Depreciation:

($100,000 - $20,000) ÷ 10 Yrs. = $8,000
b. $6,000.
c. $4,000. Depreciation to Sept. 30:
d. $2,000. 9/12 × $8,000 = $6,000

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Q2. How much is the book value of
the machine’s after updating the
depreciation, on September
30, 2007:

a. $54,000.
Cost $ 100,000
b. $46,000. Accumulated Depreciation:
c. $40,000. (5 yrs. × $8,000) + $6,000 = 46,000
Book Value $ 54,000
d. $60,000.

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Q3. The machine’s sale resulted in:

a. a gain of $6,000.
b. a gain of $4,000. Cost $ 100,000
Accum. Depr. 46,000
c. a loss of $6,000. Book value $ 54,000
Cash received 60,000
d. a loss of $4,000. Gain $ 6,000

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 Q4. The journal entry to record the
sale.

Date Description Debit Credit

Sept. 30 Cash 60,000
Accumulated Depreciation 46,000
Gain on Sale 6,000
Machinery 100,000

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Trading in Used Assets for New Ones
 There are two types of exchanges: similar exchanges and
dissimilar exchanges.
 A similar exchange involves the exchange of one asset for another
asset that performs the same type of function.
 A dissimilar exchange, which is less common than a similar exchange,
involves the exchange of one asset for another asset that performs a
different function.
Example 1:
Suppose a $90,000 delivery truck with a net book value of $10,000 is
exchanged for a new delivery truck on May 31, 2004. The company
receives a $6,000 trade-in allowance on the old truck and pays an
additional $95,000 for the new truck.

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How much is the cost of the new truck?
Cost of Truck Traded In $90,000
Less: Accumulated Depreciation (80,000)
Net Book Value 10,000
Trade-in Value (6,000)
Loss on Exchange $4,000
The cost of the new truck is
$101,000 = $95,000 cash + $6,000 trade-in allowance

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If the company receives a $12,000 trade-in allowance and
pays an additional cash $89,000 for the new truck.

Cost of Truck Traded In $90,000

Less: Accumulated Depreciation (80,000)
Net Book Value 10,000
Trade-in Value (12,000)
Gain on Exchange ($ 2,000)

Gains on similar exchanges are handled differently from gains on

dissimilar exchanges.

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On a similar exchange, gains are deferred and reduce the
cost of the new asset.

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 Gains on dissimilar exchanges are recognized

Example:
A company exchange the truck for forklift with the
trade in allowance of $12,000 and pays an additional
$14,000 cash for the forklift.

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Intangible assets

 Intangible assets include patents, copyrights,

trademarks, trade names, franchise licenses,
government licenses, goodwill, and other items that
lack physical substance but provide long-term
benefits to the company.
 Companies account for intangible assets much as
they account for depreciable assets and natural
resources.
 The cost of intangible assets is systematically
allocated to expense during the asset's useful life or
legal life, whichever is shorter.

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Characteristics of intangible assets
Intangible assets lack physical substance, and that makes it difficult to
determine the asset’s useful life or any residual value.
Many intangible assets involve exclusive rights or privileges.

Noncurrent assets Often provide

without physical exclusive rights
substance. or privileges.

Characteristics

Useful life is Usually acquired

often difficult for operational
to determine. use.
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Amortization

 The process of allocating the cost of intangible

assets to expense is called amortization, and
companies almost always use the straight-line
method to amortize intangible assets.
 Amortization is the systematic write-off to expense
of the cost of intangible assets over their useful life
or legal life, whichever is shorter.

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How to record the journal entry of amortization

Date Description Debit Credit

Amortization Expense $$$$$
Accum. Intangible Asset $$$$$

Instead of using a contra-asset account to record

accumulated amortization, most companies decrease
the balance of the intangible asset directly.

Date Description Debit Credit

Amortization Expense $$$$$
Intangible Asset $$$$$

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Goodwill
Goodwill is an accounting concept meaning the
value of an entity over and above the value of its
assets. It is the difference between the sales price
of a company and the value of its tangible assets.

Goodwill is based on the company’s reputation

and customer loyalty.

It occurs when one company buys another company.

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 Patents
 It has an exclusive right granted by federal government
to sell or manufacture an invention.
 Cost is purchase price plus legal cost to defend.
 Amortize cost over the shorter of useful life or 20 years.

 Trademarks and Trade Names

 A symbol, design, or logo associated with a
business.
 Internally developed trademarks have no recorded
asset cost.
 Purchased trademarks are recorded at cost, and
amortized over shorter of legal or economic life
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 Franchises
 Legally protected right to sell products or
provide services purchased by franchisee
from franchisor.
 Purchase price is intangible asset which is
amortized over the shorter of the protected right or
useful life.

 Copyrights
 Exclusive right granted by the federal government
to protect artistic or intellectual properties.

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NATURAL RESOURCES
 Extracted from the natural environment
and reported at cost less accumulated depletion.

 Total cost, including exploration and development,

is charged to depletion expense over periods
benefited.

 Examples: oil, coal, gold

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Depletion of Natural Resources
Depletion is calculated using the units-of-
production method.

Unit depletion rate is calculated as follows:

Cost – Residual Value

Total Units of Natural Resource

Total depletion cost for a period is:

Unit Depletion Number of Units
Rate × Extracted in Period

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Depletion of Natural Resources
 Specialized plant assets may be required to
extract the natural resource.

 These assets should be depreciated over

their normal useful lives or over the life of the
natural resource, whichever is shorter.

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Plant Transactions and the
Statement of Cash Flows
Cash payments for plant assets represent a cash
outflow for investing activities on the statement of
cash flows. A disposal of a plant asset for cash
results in a cash inflow to the company.

Depreciation is a non-cash charge to income

and has no effect on cash flows.

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 Financial Statement Disclosures
 Disclosure principle requires a company to provide the
necessary information
 The required disclosures can be found as
 footnote in a company's financial statements
 disclose significant accounting policies such as how and when
revenues are recognized, how property is depreciated, how
inventory and income taxes are accounted for, and more.
Principle of Consistency
• Companies should avoid switching depreciation
methods from period to period.

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