Plant Assets Deposal

PLANT ASSETS PLANT ASSETS ACQUISITION & DEPOSALACQUISITION & DEPOSAL

MBA (Finance)

FINANCIAL ACCOUNTING (5533)

INTRODUCTIONINTRODUCTION

Introduced the idea of plant Introduced the idea of plant assets and depreciation and assets and depreciation and stressed the importance of stressed the importance of such assets to the successful such assets to the successful functioning of businesses. functioning of businesses. Greater depth the accounting Greater depth the accounting issues surrounding plant issues surrounding plant assets and discuss intangible assets and discuss intangible assets.assets.

Plant Assets as aPlant Assets as a“Stream of Future Services”“Stream of Future Services”

Plants assets represent a Plants assets represent a bundle of future services bundle of future services and, thus, can be and, thus, can be thought of as long-term thought of as long-term prepaid expenses. prepaid expenses.

EXAMPLEEXAMPLEOwnership of a delivery truck, for example, Ownership of a delivery truck, for example, may provide about 100,000 miles of may provide about 100,000 miles of transportation. The cost of the truck is transportation. The cost of the truck is entered in as asset account, which in entered in as asset account, which in essence represents the advance purchase essence represents the advance purchase of these transportation services similarly; a of these transportation services similarly; a building represents the advance purchase building represents the advance purchase of many years of housing services. As the of many years of housing services. As the years go by, these services are utilized by years go by, these services are utilized by the business, and the cost of the plant the business, and the cost of the plant asset gradually is transferred to asset gradually is transferred to depreciation expense to reflect the cost of depreciation expense to reflect the cost of using the asset to generate revenue.using the asset to generate revenue.

Major Categories ofMajor Categories ofPlant AssetsPlant Assets

Plant and equipment items are often Plant and equipment items are often classified into the following groups:classified into the following groups:

Tangible plant assetsTangible plant assets. The term . The term tangible denotes physical substance, as tangible denotes physical substance, as exemplified by land, a building, or a exemplified by land, a building, or a machine. This category may be further machine. This category may be further separated into two distinct classifications:separated into two distinct classifications:– Property subject to depreciation. Included are Property subject to depreciation. Included are

plants assets of limited useful life such as plants assets of limited useful life such as buildings and office equipment.buildings and office equipment.

– Land. The only plant asset not subject to Land. The only plant asset not subject to depreciation is land, which has an unlimited depreciation is land, which has an unlimited term of existence and whose usefulness does term of existence and whose usefulness does not decline over time.not decline over time.

Intangible assetsIntangible assets.. The term intangible asset is The term intangible asset is used to describe assets that are used in the used to describe assets that are used in the operation of the business but have no physical operation of the business but have no physical characteristics and are non current. Examples characteristics and are non current. Examples include patents, copyright, trademarks, franchises, include patents, copyright, trademarks, franchises, and goodwill. Current assets such a accounts and goodwill. Current assets such a accounts receivable or prepaid rent are not included in the receivable or prepaid rent are not included in the intangible classification, even though they also are intangible classification, even though they also are lacking in physical substance.lacking in physical substance.Natural resourcesNatural resources. A site acquired for the . A site acquired for the purpose of extracting of removing some valuable purpose of extracting of removing some valuable resource such as oil, minerals, or timber is resource such as oil, minerals, or timber is classified as a natural resource, not as land. This classified as a natural resource, not as land. This type of plant asset is gradually converted into type of plant asset is gradually converted into inventory as the natural resource is extracted from inventory as the natural resource is extracted from the site.the site.

Accountable Events in the Lives Accountable Events in the Lives of Plant Assetsof Plant Assets

AcquisitionsAcquisitions

DepreciationDepreciation

Sale or DisposalSale or Disposal

ACQUISITIONS OFACQUISITIONS OFPLANTS ASSETSPLANTS ASSETS

The cost of a plant asset includes all The cost of a plant asset includes all expenditures that are reasonable and expenditures that are reasonable and necessary for getting the asset to the necessary for getting the asset to the desired location and ready for use. desired location and ready for use. Thus many incidental costs may be Thus many incidental costs may be included in the cost assigned to a plan included in the cost assigned to a plan asset. These include, for example, asset. These include, for example, sales taxes on the purchase price, sales taxes on the purchase price, delivery costs, and installation costs.delivery costs, and installation costs.

Determining Cost: An ExampleDetermining Cost: An Example

The concept of including in the cost of a The concept of including in the cost of a plant asset all of the incidental charges plant asset all of the incidental charges necessary to put the asset in use is necessary to put the asset in use is illustrated by the following example. illustrated by the following example.

List price*$10,000List price*$10,000

Sales taxes600Sales taxes600

Transportation charges1,350Cos of Transportation charges1,350Cos of installation andinstallation and

set-up500Totalset-up500Total$12,450$12,450

Some Special ConsiderationsSome Special ConsiderationsLand:Land:

When land is purchased, various incidental When land is purchased, various incidental costs are often incurred in addition to costs are often incurred in addition to purchase price. These additional costs may purchase price. These additional costs may include commissions to real estate broker, include commissions to real estate broker, escrow fees, legal fees for examining and escrow fees, legal fees for examining and insuring the title, delinquent taxes paid by the insuring the title, delinquent taxes paid by the purchaser, and fees for surveying, draining, purchaser, and fees for surveying, draining, clearing, and grading the property. All these clearing, and grading the property. All these expenditures become part of the cost of the expenditures become part of the cost of the land.land.

Land Improvements:Land Improvements:

Improvements to real estate such as Improvements to real estate such as driveways, fences, parking lots, driveways, fences, parking lots, landscaping, and sprinkler systems landscaping, and sprinkler systems have a limited life and are therefore have a limited life and are therefore subject to depreciation. For this subject to depreciation. For this reason, they should be recorded in a reason, they should be recorded in a separate account entitled Land separate account entitled Land Improvements.Improvements.

Buildings:Buildings:

Old buildings are sometimes Old buildings are sometimes purchased with the intention of purchased with the intention of repairing them prior to placing repairing them prior to placing them in use. Repairs made under them in use. Repairs made under these circumstances are charged these circumstances are charged to Buildings account.to Buildings account.

Equipment:Equipment:

When equipment is purchased, all of the When equipment is purchased, all of the sales taxes, delivery cost, and cost of sales taxes, delivery cost, and cost of getting the equipment in good running getting the equipment in good running order are treated as part of the cost of the order are treated as part of the cost of the asset. Once the equipment has been asset. Once the equipment has been placed in operation, maintenance costs placed in operation, maintenance costs (including interest, insurance, and (including interest, insurance, and property taxes) are treated as expenses of property taxes) are treated as expenses of the current period.the current period.

Allocation of a Lump-Sum Purchase:Allocation of a Lump-Sum Purchase:When land and buildings (and perhaps other assets) When land and buildings (and perhaps other assets) are purchased for a lump sum, the purchase price are purchased for a lump sum, the purchase price must be allocated among the types of assets must be allocated among the types of assets acquired. An appraisal may be needed for this acquired. An appraisal may be needed for this purpose. The allocation of this cost on the basis of as purpose. The allocation of this cost on the basis of as appraisal is illustrated as follow:appraisal is illustrated as follow:

Value per Appraisal Percentage of Total Value per Appraisal Percentage of Total Appraised Value Allocation of $800,000 CostAppraised Value Allocation of $800,000 Cost

Land$ Land$ 250,000250,000 200,000200,000Land improvement Land improvement 50,00050,000 540,000540,000BuildingBuilding 300,000300,000 324,000324,000Equipment Equipment 400,000400,000 432,000432,000Total$Total$ 1,000,000 1,000,000 800,000800,000

DEPRECIATIONDEPRECIATIONDepreciationDepreciation, as the term is used in accounting, , as the term is used in accounting, is the allocation the cost of a tangible plant asset is the allocation the cost of a tangible plant asset to expense in the periods in which services are to expense in the periods in which services are received from the asset. The basic purpose of received from the asset. The basic purpose of depreciation is to offset the revenue of an depreciation is to offset the revenue of an accounting period with the costs of the goods and accounting period with the costs of the goods and services being consumed in the effort to generate services being consumed in the effort to generate that revenue.that revenue.

EFFECTSEFFECTSBook value:Book value:The book value of a plant asset is its cost minus The book value of a plant asset is its cost minus the related accumulated depreciation. the related accumulated depreciation. Accumulated depreciation is a contra-asset Accumulated depreciation is a contra-asset account, representing that portion of the asset's account, representing that portion of the asset's cost that has already been allocated to expense.cost that has already been allocated to expense.Causes of DepreciationCauses of DepreciationThe need to systematically allocate plant asset The need to systematically allocate plant asset costs over multiple accounting periods arises costs over multiple accounting periods arises from two major causes: (1) physical deterioration from two major causes: (1) physical deterioration and (2) obsolescence.and (2) obsolescence.Physical Deterioration:Physical Deterioration:Physical deterioration of a plant asset results Physical deterioration of a plant asset results from use , as well as from exposure to sun, wind, from use , as well as from exposure to sun, wind, and other climatic factors. and other climatic factors.

Methods of Computing Methods of Computing DepreciationDepreciation

CostCost $ 17,000$ 17,000

Estimated residual valueEstimated residual value $ 2,000$ 2,000

Estimated useful lifeEstimated useful life 5 years5 years

The Straight-Line MethodThe Straight-Line Method

Cost – Residual ValueCost – Residual Value

Year if Useful LifeYear if Useful Life

17,000 - $ 2,00017,000 - $ 2,0005 years5 years

= $ 3,000 per year

Declining-Balance MethodDeclining-Balance Method

Depreciation Expense =Depreciation Expense =

Remaining Book ValueRemaining Book Value X X Accelerated Accelerated Depreciation RateDepreciation Rate

Double-Declining-BalanceDouble-Declining-BalanceDepreciation Accumulated Book

Year Computation Expense Depreciation Value $17,000

First $ 17,000 X 40% $ 6,800 $ 6,800 10,200 Second 10,200 X 40% 4,080 10,880 6,120 Third 6,120 X 40% 2,448 13,328 3,672

Fourth 3,672 X 40% 1,469 14,797 2,203

Fifth 2,203 - $2,000 203 15,000 2,000

Total $ 15,000

DISPOSAL OF PLANTDISPOSAL OF PLANT

When depreciable assets are When depreciable assets are disposed off at any date other disposed off at any date other than the end of the year, an than the end of the year, an entry should be made to record entry should be made to record depreciation for the fraction of depreciation for the fraction of the year ending with the date of the year ending with the date of disposal.disposal.

GAINS AND LOSSES ONGAINS AND LOSSES ONDISPOSAL OF PLANTDISPOSAL OF PLANT

DISPOSAL AT A PRICE DISPOSAL AT A PRICE ABOVE BOOK VALUE:ABOVE BOOK VALUE:

Assume that a machine costing $10,000 Assume that a machine costing $10,000 and accumulated depreciation of $8,000 and had and accumulated depreciation of $8,000 and had a book value of $2,000 at the time it was sold for a book value of $2,000 at the time it was sold for $3,000 cash. The journal entry to record is as $3,000 cash. The journal entry to record is as follow:follow:

CashCash 3,0003,000Accumulated depreciationAccumulated depreciation 8,0008,000MachineryMachinery 10,00010,000Gain on disposalGain on disposal 1,000 1,000

DISPOSAL AT A PRICE BELOW DISPOSAL AT A PRICE BELOW BOOK VALUE:BOOK VALUE:

Now assume instead that the same machine is Now assume instead that the same machine is sold for $500. The journal entry would be as sold for $500. The journal entry would be as follow:follow:

CashCash 500 500Accumulated depreciationAccumulated depreciation 8,0008,000Loss on disposalLoss on disposal 1,5001,500MachineryMachinery

10,00010,000

The EndThe End