18-1. Property, Plant, and Equipment Section 1: Acquisition and Depreciation Chapter 18 Section Objectives 1.Determine the amount to record as an asset’s.

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Property, Plant, and EquipmentProperty, Plant, and Equipment

Section 1: Acquisition and

Depreciation

Chapter

18

Section Objectives

1. Determine the amount to record as an asset’s cost.

2. Compute and record depreciation of property, plant, and equipment by commonly used methods.

3. Apply the Modified Accelerated Cost Recovery System (MACRS) classes for federal income tax purposes.

McGraw-Hill © 2009 The McGraw-Hill Companies, Inc. All rights reserved.

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Determine the amount to record as an asset’s cost.

Objective 1

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Cost of Tangible Personal Property Gross purchase price less discounts.

Transportation costs.

Installation costs.

Costs of adjustments or modifications needed to prepare the asset for use.

Cost of Real Property Purchase price.

Legal costs.

Other costs related to the acquisition.

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Compute and record depreciation of property, plant, and equipment by commonly used methods.

Objective 2

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Long term assets, like buildings, machinery, equipment, furniture, and fixtures are depreciated because they have a limited life and get used up over time.

Depreciation refers to the loss of usefulness, and not necessarily to a decrease in the market value.

The account Depreciation Expense is debited, and the account accumulated depreciation is credited to record the depreciation for a period.

Depreciation

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Depreciation Methods

Straight-Line

Declining-Balance

Sum-of-the-Years’-Digits

Units-of-Output

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Straight-Line Method

Formula: Depreciation = Cost – Salvage Value Estimated Useful Life The same dollar amount of depreciation is taken

each year as an expense.

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Declining-Balance Method

The book value of an asset at the beginning of the year is multiplied by a percentage to determine depreciation for the year.

This is an accelerated method of depreciation.

This method ignores salvage value.

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Double-Declining-Balance Method

Step 1 Calculate the straight-line rate.

100% 100% Useful Life 5 years

= 20% (straight-line rate)=

Step 2 Calculate the double-declining rate.

Straight-line rate x 2 =

20% x 2 = 40%

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Beginning Depreciation Accumulated Year Book Value Percentage for the Year Depreciation

1 $2,400.00 40% $960.00 $960.00

(–960.00)

Double-Declining-Balance Method Step 3 Compute depreciation for the period by

multiplying the book value by the double- declining rate. Repeat over asset’s useful life.

3 864.00 40%

2 1,440.00 40% 576.00 1,536.00

(- 576.00)

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Sum-of-the-Years’-Digits Method

This is an accelerated depreciation method.

The denominator is sum of the useful life years added together.

(If the useful life is 5 years, then denominator is 15 (1+2+3+4+5).

The numerator is the number of years remaining in the useful life of the asset.

Year 1: The fraction is 5/15.

Year 2: The fraction is 4/15.

Year 5: The fraction is 1/15.

The fraction is multiplied by the acquisition cost less the net salvage value.

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Units-of-Output Method

Calculates depreciation at the same rate for each unit produced.

Unit of production can be measured by:

Physical quantities of production.

Number of hours the asset is used.

Other measures.

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Depreciation for Federal Income Tax Purposes

A different set of rules is used for depreciation for income tax purposes.

MACRS = Modified Accelerated Cost Recovery System

“Cost Recovery” refers to the amount of depreciation expense used in computing taxable income.

Apply the Modified Accelerated Cost Recovery System (MACRS) for federal income tax purposes

Objective 3

Adjustments and the Worksheet

Adjustments and the Worksheet

Section 2: Disposition

of Assets

Chapter

18

Section Objectives

4. Record sales of plant and equipment.

5. Record asset trade-ins using financial accounting rules and income tax requirements.

McGraw-Hill © 2009 The McGraw-Hill Companies, Inc. All rights reserved.

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Businesses routinely sell or dispose of plant assets that are no longer useful to the business.

When assets are disposed of, the business often incurs a gain or loss.

Proceeds – Book Value = Gain or loss

Methods of Disposition

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Methods of Disposition

Scrapping or discarding

Sale

Trade-in for a similar asset

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Disposal by Scrapping or Discarding

When an asset is worn out, often it is simply discarded.

If the discarded asset is not fully depreciated, depreciation is recorded up to the date of disposal.

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Disposal by Sale

Step 1. Record depreciation to the date of disposition.

Step 2. Remove the cost of the asset.

Step 3. Remove the accumulated depreciation.

Step 4. Record the proceeds.

Step 5. Determine and record the gain or loss, if any.

Record sales of plant and equipment

Objective 4

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If the asset is sold for the same amount as the book value, there is no gain or loss.

Sale at Book Value

Income Statement

Balance Sheet

No change in net income

No change in equity

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If the asset is sold for more than book value, there is a gain.

Sale Above Book Value

Income Statement

Balance Sheet

Assets

Equity

Gain on Sale

Net Income

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If the asset is sold for less than book value, there is a loss.

Sale Below Book Value

Income Statement

Balance Sheet

Loss on Sale

Net Income

Assets

Equity

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Record asset trade-ins using financial accounting rules and income tax requirements.

Objective 5

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Disposal by Trade-in

Step 1. Record the depreciation up to the date of trade-in.

Step 2. Record the trade-in of the old asset and the purchase of the new asset. Use either: the financial accounting rules, or

the income tax rules.

Disposing of Fixed Assets by Exchange

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The financial accounting rules allow a loss to be recognized on the trade-in of a similar asset.

ANSWER:

QUESTION:

What are the financial accounting rules for trade-ins of similar assets?

A gain is not recognized!!

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Applying the Financial Accounting Rules if there is a loss on the trade-in:

Step 1. Remove the cost of the old asset.

Step 2. Remove the accumulated depreciation for the old asset.

Step 3. Record the payment.

Step 4. Record the new asset at its fair market value.

Step 5. Determine and record the loss.

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Financial Accounting Rules

Formula for determining loss or gain:

Trade-in allowance

– (Book value)

= (Loss) or gain

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Gain: (Trade in > Book Value of old.)Gain not recognized!! New asset’s recorded cost: Book value of old asset + Cash Payment = Recorded cost of new asset

Loss: (Trade in < Book Value of old)Recognize loss in Loss on Trade-in of Plant Asset.

Financial Accounting Rules

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The income tax method records the trade-in of an asset according to income tax rules.

ANSWER:

QUESTION:

What is the income tax method?

Income tax rules do not recognize gain or loss on a trade-in.

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Income Tax Method

Step 1.Remove the cost of the old asset.

Step 2.Remove the accumulated depreciation for the old asset.

Step 3.Record the payment.

Step 4.Determine and record the cost of the new asset.

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Formula for the new asset:

Book Value of the old asset

+ Payment for the new asset

= Cost of the new asset

Income Tax Method

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Gain: Not recognized.A gain simply reduces the new asset’s cost.

Loss: Not recognized.A loss simply increases the tax basis (historical cost for tax purposes).

Income Tax Method

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Recall that conservatism requires that the method that is least likely to overstate income should be used.

Income Tax Method

Therefore, under GAAP, a loss must be recorded.

However, some argue that the income tax method is acceptable (no loss recorded) if the loss is not material.

Property, Plant, and EquipmentProperty, Plant, and Equipment

Section 3: Special Topics in

Long-Term Assets

Chapter

18

Section Objectives

6. Compute and record depletion of natural resources.7. Recognize asset impairment and understand the

general concepts of accounting for impairment.8. Compute and record amortization of intangible

assets.

McGraw-Hill © 2009 The McGraw-Hill Companies, Inc. All rights reserved.

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Depletion matches an asset’s costs with the benefits derived from its use.

Natural Resources: Iron ore

Oil

Gold

Coal

Compute and record depletion of natural resources.

Types of Depletion

Depletion for Financial Statement Purposes.

Depletion for Federal Income Tax Purposes.

Objective 6

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Depletion for Financial Statement Purposes

Depletion of natural resources for financial statement preparation is called cost depletion.

Formula for cost depletion:

Depletion per unit=Cost of natural resource

Estimated units of the resource

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Depletion for Federal Income Tax Purposes

Depletion for federal income tax purposes is the larger of cost depletion or percentage depletion.

Formula for percentage depletion:

Gross income from sale of resource X a percentage

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Impairment of Property, Plant, and Equipment

Three steps are used to determine whether an asset is impaired.

Step 1. Review circumstances that suggest impairment may have occurred.

Step 2. Apply the recoverability test.

Step 3. Compute the amount of the impairment.

Recognize asset impairment and understand the general concepts of accounting for impairment.

Objective 7

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Types of Intangible Assets

Patent

Copyright

Franchises

Trademarks, trade names, brand names

Computer software

Goodwill

Compute and record amortization of intangible assets.

Objective 8

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Internal Control of Property, Plant, and Equipment

Authorize and justify the purchase of assets.

Assign identification number to each asset.

Maintain an asset register listing.

Assign responsibility for safekeeping, maintaining, and operating each asset to a specific person.

Take a physical inventory count periodically.

Establish procedures to authorize asset retirement, sale, or other disposition.

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College Accounting, 12th Edition

Price • Haddock • Farina