ACCT 100 Chapter 9 Plant Assets, Natural Resources, and Intangible Assets.

ACCT 100

Chapter 9

Plant Assets, Natural Resources, and Intangible

Assets

2

Plant Assets, Natural Resources and Intangible Assets Plant Assets:

- Assets used in operations (not for resale)- Long-term in nature (Eco. Life > one year)- Possess physical substance- $ must be material Natural Resources:Including timber, oil, gas and mineral

deposits.Requiring cutting, pumping or mining to

extract these resources in operations.

Plant Assets, Natural Resources and Intangible Assets (Contd.) Intangible Assets:

long-lived assets with no physical substance but have value based on rights from these assets (i.e., patents, copyrights, trademarks, trade names franchises, leaseholds and goodwill).

3

4

Topics of Plant Assets (i.e., Property, Plant, and Equipment or PPE)

A. 1)Valuation of PPE. 2)Determination of acquisition costs of

land, building and equipment.

B. Payments: Lump-sum purchaseC. Depreciation of PPED. Disposition of PPE: exchange, discard,

and sell for cash.E. Costs occurred subsequent to acquisition

(i.e., replacement, repair, etc.)

5

Topics of Intangible Assets

Valuation

Amortization

6

A.1 PPE Valuation (APB Opinion No. 6)

At acquisition, PPE is recorded at the acquisition cost.

At the end of period, PPE is also reported at cost.

Acquisition cost includes the purchase price and any costs necessary to bring the asset to the location and condition for its intended use (i.e., applicable taxes, purchase commissions, etc.).

7

PPE Valuation (contd.) PPE (except for land) is subject to

depreciation.

Both cost and accumulated depreciation are reported on the balance sheet statement.

Depreciation is a process of cost allocation, not a process of asset valuation.

8

A.2 Determination of Acquisition Cost

Cost of Land Cost of Buildings Cost of Equipment

9

A. Determination of Acquisition Cost Cost of Land (held for operation, not for resale)

Any cost occurred before the land is

ready for its intended use should be

capitalized as cost of land.

10

A. Determination of Acquisition Cost Cost of Land (contd.)

Cost of land includes:1. Purchase price.2. Title fee.3. Closing fee.4. Clearing fee.5. Back property taxes (unpaid by previous

owner).6. Net razing cost of an old building.

11

A. Determination of Acquisition Cost Cost of Land (contd.) Land improvements with limited life

(i.e., parking lot, fences, drive ways, etc.) would be debited to land improvement account and subject to depreciation.

12

A. Determination of Acquisition Cost Cost of BuildingsCost of Buildings includes:1. contract price(including material, labor, etc),2. cost of remodeling,3. architects’ fees,4. building permits,5. survey cost before construction,6. interest cost (for self-constructed building),and7. excavation cost before construction.

* Cost of strike or accidents should be expensed.

13

A. Determination of Acquisition Cost Cost of Equipment Any cost occurred to acquire and to

bring the asset to the location and condition for its intended use.

14

A. Determination of Acquisition Cost Cost of Equipment (contd.) Cost of Equipment includes:

1. purchase price,

2. freight-in,

3. insurance in transit, and

4. foundation cost, installation cost, cost of test runs and assembling cost.

Not including:Cash discount lost, unnecessary storage cost and hauling charges from storage for delivery of machine.

15

Capitalizing the Cost of Interest

Capitalize the interest on funds borrowed for construction. The capitalized interest should not exceed the actual interest cost.

The capitalized interest =

interest rate average accumulated expenditures on the construction project.

16

Example

The Greenway borrowed $2,000,000 on a one-year, 12% note payable to construct a factory on 1/5/98. Assume the average accumulated expenditures on this project during 1998 are $1,200,000. The company should capitalize $1,200,000 x 12% = $144,000. The actual interest cost of 1998 on the borrowing is $2,000,000 x 12% = $240,000.

17

Example (contd.)

The journal entry to record the interest expense and capitalized interest for 1998 is:

Interest Exp. 96,000

Factory 144,000

Cash240,000

Capitalized interest cost

18

B. Lump Sum Purchase

Acquisition costs would be allocated

proportionately to the market value of

the individual asset purchased.

19

B. Lump Sum Purchase (contd.)

A building and land were purchased at $100,000. The market value of building and land was $30,000 and $90,000, respectively.

J.E.

Building 25,0001

Land 75,0002

Cash 100,0001. 30,000/(30,000+90,000)=25%, 25%x100,000 = 25,000

2. 90,000/(30,000+90,000)=75%, 75%x100,000 = 75,000

20

C. Depreciation of P.P.E & Depletion of Nature Resources

The allocation of a plant asset’s cost to expense over the life of the asset is called depreciation.

21

C. Depreciation of P.P.E & Depletion of Nature Resources (contd.)

(For Financial Reporting Purposes)

1. Time-Based Methods: depreciation

based on the passage of time.

22

C. Depreciation of P.P.E & Depletion of Nature Resources (contd.)1. Time-Based Methods:

a. Straight-Line: cost is allocated evenly through out the life of the P.P.E. (assets)

b. Sum-of-the-Years’-Digits (SYD): cost is allocated more heavily in the early years of life of the P.P.E.

c. Declining-Balance:same as S-Y-D.

(b. and c. are called the accelerated depreciation methods.)

23

C. Depreciation of P.P.E & Depletion of Nature Resources (contd.)2. Activity-Based Method : depreciation is

based on the usage of assets. Depreciation bases -- hours of usage or production units.

Method:

Unit-of-Production Method

24

Depreciation (For Financial Reporting Purposes)

1a. Straight-Line Method:

cost is allocated evenly through the life of the P.P.E.

25

Example 1

Machine costing $10,000 was purchased on 1/1/98. The estimated residual value of the machine is $2,000 and the estimated life of the machine is 4 years.

Depreciation Expense per year:

($10,000 - 2,000)/ 4 = $2,000 or 8,000 x 25% = $2,000

12/31/98 Depreciation Expense 2,000

Accumulated Depreciation 2,000

26

Example 2 (partial year depreciation) Using the information in example 1, except that

the machine was purchased on 3/11/98 rather than 1/1/98.

Depreciation Expense of 1998 ==> [($10,000-2,000)/4] x (10/12) = $1,667

Year Depr. Exp Acc. Depr.1998 1667 (10 months) 1,6671999 2000 (12 months) 3,6672000 2000 (12 months) 5,6672001 2000 12 months) 7,6672002 333 (2 months) 8,000

27

Example 2 (contd.) - Presentation(Book Value (Carrying Value) = Cost - Acc. Depr)

B/S (1998)P.P.E. Machine $10,000Acc. Depr. (1,667)Net B/V 8,333

B/S (1999)P.P.EMachine $10,000Acc. Depr. (3,667)Net $6,337

B/S (2000)P.P.EMachine $10,000Acc. Depr. (5,667)Net $ 4,333

B/S (2001)P.P.EMachine $10,000Acc. Depr. (7,667)Net 2,333

28

1b. Sum-of-the-year’s-Digits Method (SYD)

Same example as Example 1 on page 25, except using the SYD method:

Year Depreciation Expense

1998 $8,000 x 4/10 = 3,200

1999 8,000 x 3/10 = 2,400

2000 8,000 x 2/10 = 1,600

2001 8,000 x 1/10 = 800

29

1c. Declining-Balance Method Depreciation Exp.=constant Rate book value* at

the beginning of the period Residual value is not considered in the

computation. Assets cannot be depreciated below the residual

value (i.e., book value cannot be smaller than the residual value).

The constant rate is expressed as a function of a straight-line annual depreciation rate.

* Book value = Cost - Acc. Depreciation.

30

Example

Life of Asset S-L Depr. Rate Double-Declining-

Balance Depr. Rate

4 years 25% 50%

5 years 20% 40%

10 years 10% 20%

31

Double Declining- Balance Method

(the constant rate is twice of the S-L Depr.

Rate) Depr. Exp. = constant rate book value at beginning of the period.

32

Example 1

Example 1:

Machine costing $10,000 purchased on 1/1/98, with residual value $2,000 and life 4 years.

33

Example 1 (contd.)

Straight-Line Depr. Rate=1/4=25%Double Declining-Balance Depr. Rate =225%=50%* Assets cannot be depreciated below the residual value.

Year

Book value ofAsset at Beg.

of the year Rate Depr. ExpBook valueat the end

1998 $10,000 50% $5,000 $5,0001999 5,000 50% 2,500 2,5002000 2,500 50% 500* 2,000*2001 2,000 50% 0 2,000

34

A Comparison of Depreciation Methods

1. Straight-Line Method

2. S-Y-D Method

3. Declining-Balance Method

Year

Depreciation Expense

123

35

Changes in Depreciation Estimate

Accounting treatment: no retroactive effect and make no adjustment for the past misstatement. Spread the remaining undepreciated balance (i.e., the book value) less the revised (new) residual value over the revised (new) estimate of the remaining life of the assets.

36

Example: (S-L Depr. Method)

Machine costing $10,000 acquired on 1/1/98.

EstimatesEstimates

on 1/1/98 1/1/00

Residual value $2,000 $1,000

Life 4 years 5 years

37

Year Depr. Exp Acc. Depr Book Value1998 $2,000 2,000 8,0001999 $2,000 4,000 6,0002000 $1,667 5,666.7 4,333.32001 $1,667 7,333.4 2,666.62002 $1,667 9,000.1 1,000

1. (10,000-2,000)/4 = $2,0002. (6,000-1,000)/(5-2) =1666.7

Example: (contd.)

38

2. Activity-Based Method:

Units-of-Production Method:

depreciation based on the usage of the

asset.

39

Example:

Machine costing $10,000, with estimated residual value $2,000 and estimated service hours, 8,000 hours.

Depreciation expense per hour= ($10,000-2,000)/8,000 hours= $1 per hourDuring 1998, the machine was used for 1,000 hours, the

depreciation expense of 1998: $1 * 1,000 = $1,000

12/31/98 Depreciation Expense 1,000Accumulated Depreciation 1,000

40

Tax Depreciation Methods in different periods:

1. GAAP depreciation methods (i.e., S-L, SYD or DDB): apply to assets acquired before 1981; cannot be depreciated to below the residual value. IRS published tables with estimated lives for depreciable assets .

2. ACRS: Accelerated Cost Recovery System applies to assets purchased between 1981 - 1986.

3. Modified ACRS: MACRS applies to assets purchased in 1987 or later.

41

MACRS

MACRS was enacted by Congress in the Tax Reform Act of 1986. Assets are classified in 8 property classes instead of 5 classes as in ACRS. In addition, a specified GAAP depreciation method is used in computing the depreciation expense for all classes.

42

MACRS (Continued)

Depreciation methods:

MACRS

Property Class Double-Declining Balance 3,5,7 or 10-year property150% declining Balance 15 or 20-year propertystraight-line 27.5 or 31.5-year property

43

D. Disposal of Plant Assets

Example A: Selling for cash

Cost of an equipment = $20,000

Accumulated Depreciation (should be updated) = $12,000

Sold for cash = $9,000

Journal Entry:Cash 9,000Acc. Depr. 12,000

Equipment 20,000Gain on Sale of equipment 1,000

44

D. Disposal of Plant Assets (contd.)

Example B: Disposal of an equipment

Information as above except the equipment is being disposed off.

Journal Entry:

Loss on Disposal of Equip. 8000

Accum. Depr. 12,000

Equipment 20,000

45

Exchanging of Assets

Example C: AMY company trades in an old machine for a new machine. The cost of the old machine is $15,000 with an accumulated depreciation of $9,000. Thus, the book value of the old machine is $6,000. The market value of the old machine is 7,000. The market value of the new machine is $10,000 . How much cash would Amy pay for this exchange ?Cash Paid = $10,000- 7,000 = $3,000

46

Exchanging of Assets (contd.)

J. E.

Machine (new) $10,000

Accum. Depr. 9,000

Machine (old) 15,000

Cash 3,000

gain on disposal of assets 1,000*

* Market value of old asset – book value of old = 7,000-6,000 =1,000

47

E. Capital Expenditures Versus Revenue Expenditures

1. Costs subsequent to Acquisition

2. Types of costs occurred subsequent to acquisition.

48

1. Costs Subsequent to Acquisition

Basic Principle for capitalization of these costs:

Capitalize the cost if it can:

a. extend the life of the existing asset, or

b. increase the service quality of the existing asset, or

c. increase the productivity of the existing asset (including the reduction of unit cost).

Otherwise, expense the cost.

49

2. Types of costs occurred subsequent to acquisition:a. Additions

b. Improvements, Replacements

c. Rearrangement and Reinstallation

d. Repairs

e. Maintenance

50

Accounting for Natural Resources and DepletionExample for natural resources: petroleum,

natural gas, timber, etc.Cost allocation of natural resources is called

depletion.Method of depletion: units-of-production (units-

of-activity)

Journal EntryDepletion Exp. xxx

Accumulated Depletion xxx

51

Accounting for Intangible Assets

Intangible Assets are long-lived assets with no physical substance but have value based on rights from these assets (i.e., patents, copyrights, trademarks, franchises, leaseholds and goodwill).

The cost allocation of these assets is called amotization.

Journal Entry

Amortization Exp. XXXPatents XXX

52

Amortization of Intangibles Intangibles with indefinite lives are not

subject to amortization but impairment tests (i.e., goodwill, trademark, etc.)

Intangibles with definite lives should be amortized over the shorter of their legal or useful lives (i.e., patents, copyrights, etc.).

Franchises and licenses are amortized over the contractual lives.

All research and development costs are expensed.

53

1. Patents:

Granted by the U.S. Patent office for a period of 20 years. The patent will give the holder the exclusive right to produce, use and sell a product or process without interference or infringement by others.

54

2. Copyrights:

A federally granted right to authors, sculptors, painters, and other artists for their creations.

A copyright is granted for the life of the creator plus 70 years.

Copyright gives the creators and heirs an exclusive right to reproduce and sell the artistic work or published work.

55

3. Trademarks & Trade Names:

A word, a phrase, or a symbol that distinguishes a product or an enterprise from another (i.e., company names, XEROX, ...).

Life: register at the US Patent Office for 10 years life. The registration can be renewed every 10 years for unlimited times.

56

4. Leaseholds

By signing a contract, the leasee is acquiring an exclusive right to use the property.

Leasehold Improvements: Improvements made to the leased property.

57

5. Franchises & Licenses:

A franchise is a contractual agreement between a franchisor and a franchisee.

In the agreement, the franchisor (i.e., the holder of patents, formulas, trade names, etc.) grants the franchisee the right to sell certain products or service or to use certain trade names or trademarks.

58

Franchises & Licenses (contd.):

A license is a contractual agreement between a governmental body (i.e., city, state, etc.) and a private enterprise.

The license allows a private enterprise to use public property to provide services.

59

6. Computer Software Costs:

Expense all developing (R&D) costs if for internal use.

Expense most of the costs if the software is to be sold.

60

7. Goodwill (not subject to amortization ):

Cannot be separated from the business.

Can only be recognized if the whole business is purchased.

Goodwill equals the excess of the purchase price over the market value of the net assets acquired (i.e., (market value of assets -- market value of liabilities) of the acquired company).