91

Topic 4: Plant and Intangible

Assets

Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

Learning resources
 Williams, Bettner, Carcello, Financial and
managerial accounting – The basis for
business decision (19th edition), McGraw-
Hill, 2021, Chapter 9
 End of chapter self-test questions, exercies,
discussion questions, problems...
 Other resources:
◦ Other accounting textbooks
◦ Online English dictionaries

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Learning Objectives
 Determine the cost of plant assets.
 Distinguish between capital expenditures and revenue
expenditures.
 Compute depreciation by the straight-line and
declining-balance methods.
 Account for depreciation using methods other than
straight-line or declining-balance.
 Account for the disposal of plant assets.
 Explain the nature of intangible assets, including
goodwill.
 Account for the depletion of natural resources.

9-3

Plant Assets as a “Stream of

Future Services”
Plant assets represent a bundle of future
services, and can be thought of as long-
term prepaid expenses.

Da te De scrip tion De b it Cre d it

As years pass, and the

The cost of plant assets is the services are used, the cost is
advance purchase of services. transferred to depreciation
expense.

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Major Categories of Plant 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.

9-5

Accountable Events in the

Lives of Plant Assets
1. Acquisition.
2. Allocation of the acquisition
cost to expense over the
asset’s useful life
(depreciation).
3. Sale or disposal.

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Acquisition of Plant Assets

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

. . . for getting . . . for getting

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

9-7

Determining Cost: An Example

 A factory in Mississippi orders a machine from a
Colorado tool manufacturer at a list price of $10,000.
Payment will be made in 48 monthly installments of
$250, which include $2,000 in interest charges. Sales
taxes of $600 must be paid, as well as freight charges of
$1,350. Installation and other set-up costs amount to
$500. The cost of this machine to be established in the
Machinery account of the purchasing company is
computed as follows:

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Special Considerations

Cost includes real estate

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

Improvements to land
such as driveways,
Land
Improvements
fences, parking lots, and
landscaping are recorded
separately.
9-9

Special Considerations
Costs incurred for
remodeling prior to the
Buildings building being put in use
are considered part of the
building’s cost.

Related interest,
insurance, and property
Equipment taxes are treated as
expenses of the current
period.
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Special Considerations

Allocation of a Lump-Sum Purchase

The allocation
The total cost is based on
must be the relative
allocated to Fair Market
separate Value of each
accounts for asset
each asset. purchased.

9-11

Lump-Sum Purchase: Example

Assume, for example, that Exercise-for-Health, Inc.,
purchases a complete fitness center from Golden Health
Spas. Exercise-for-Health purchases the entire facility at a
reduced price of $800,000. The allocation of this cost on
the basis of an appraisal is illustrated as follows:

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Lump-Sum Purchase: Example (cont.)

Assuming that Exercise-for-Health purchased this facility
for cash, the journal entry to record this acquisition
would be as follows:

9-13

Capital Expenditures and Revenue

Expenditures
Capital Revenue
Expenditure Expenditure

Any material expenditure Expenditure for

that will benefit several ordinary repairs
accounting periods. and maintenance.

To capitalize an expenditure To expense an expenditure

means to charge it to an means to charge it to an
asset account. expense account.

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Depreciation
The allocation of the cost of a plant asset
to expense in the periods in which
services are received from the asset.

Balance Sheet
Purchase
Assets:
cost as
Plant and
assets equipment
purchased

as the services are

Income Statement
received
Revenues:
Expenses:
Depreciation

9-15

Depreciation
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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Straight-Line Vs. Accelerated

Over the entire life of the asset, however, both the
straight-line method and accelerated methods recognize
the same total amount of depreciation.

9-17

Straight-Line Depreciation

Depreciation Cost - Residual Value

=
Expense per Year Years of Useful Life

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Straight-Line Depreciation
On January 2, S&G Wholesale Grocery buys a
new delivery truck. The truck cost $17,000, has
an estimated residual value of $2,000, and an
estimated useful life of 5 years.
Compute annual depreciation using the
straight-line method.

Cost – Residual Value $ 17,000 – $ 2,000

=
Years of Useful Life 5
= $ 3,000 per year
9-19

Straight-Line Depreciation
S&G will record $3,000 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)
$ 17,000
First $ 3,000 $ 3,000 $ 3,000 14,000
Second 3,000 3,000 6,000 11,000
Third 3,000 3,000 9,000 8,000
Fourth 3,000 3,000 12,000 5,000
Fifth 3,000 3,000 15,000 2,000
$ 15,000 $ 15,000

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 prorated.
- Rounding the depreciation computation
to the nearest whole month
- Recording one-half year’s depreciation
on all assets acquired during the year
(half-year convention)

9-21

Half-Year Convention
Using the half-year convention, assume that an
insurance company purchases hundreds of desktop
computers throughout the current year at a total
cost of $600,000. The company depreciates these
computers by the straight-line method, assuming a
three-year life and no residual value.

Depreciation = ($600,000 − $0) ÷ 3

= $200,000 for a full year
Depreciation = $200,000 × 1/2 = $100,000

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Declining-Balance Method
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).

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Declining-Balance Method
On January 2nd , S&G buys a new delivery
truck paying $17,000 cash. The truck has an
estimated residual value of $2,000 and an
estimated useful life of 5 years.
Compute depreciation for the first year using
the double-declining balance method.

First Year Remaining Accelerated

= ×
Expense Book Value Depreciation Rate
1
= $ 17,000 × 2 × /5
= $ 17,000 × 40%
= $ 6,800
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Declining-Balance Method
Total depreciation over the estimated
useful life of an asset is the same using
either the straight-line method or the
declining-balance method.

Depr. Accumulated Book

Year Computation Expense Depreciation Value
First $ 17,000 × 40% $ 6,800 $ 6,800 $ 10,200
Second 10,200 × 40% 4,080 10,880 6,120
Third 6,120 × 40% 2,448 13,328 3,672
Fourth 3,672 × 40% 1,469 14,797 2,203
Fifth Plug year # 5 203 15,000 2,000
Total Depreciation $ 15,000
9-25

Financial Statement Disclosures

Estimates of Useful Life and Residual Value
• May differ from company to
company.
• The reasonableness of
management’s estimates is
evaluated by external auditors.
Principle of Consistency
• Companies should avoid switching
depreciation methods from period
to period.

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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

 Assume that a company acquires a $10,000

asset estimated to have a five-year useful life and
no residual value. At the beginning of the fourth
year, management decides that the asset will last
for five more years. The revised estimate of
useful life is, therefore, a total of eight years.
Calculate depreciation expense for the
fourth year and for each of the remaining
years.

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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 $ 10,000

Accumulated depreciation
($2,000 per year × 3 years) 6,000
Remaining book value $ 4,000
Divide by remaining life ÷5
Revised annual depreciation $ 800
9-29

Impairment 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
fair value and an
impairment loss
recognized.

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Units-of-Output Depreciation Method

 Under the units-of-output method, depreciation is based
on some measure of output rather than on the passage
of time.
 When depreciation is based on units of output, more
depreciation is recognized in the periods in which the
assets are most heavily used.

9-31

Units-of-Output: Example
Consider Marpole Company’s delivery truck, which cost $35,000
and has an estimated salvage value of $5,000. Assume that Marpole’s
management plans to retire this truck after it has been driven
60,000 miles. The depreciation rate per mile of operation is 50 cents,
computed as follows.

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Units-of-Output: Example (cont.)

At the end of each year, the amount of depreciation to be recorded
is determined by multiplying the 50-cent rate by the number of
miles the truck was actually driven during the year. After the truck
has gone 60,000 miles, it is fully depreciated, and the depreciation
process is stopped. For example if the truck is driven 17,000 miles in
a year, $8,500 depreciation expense is recognized (17,000 miles ×
$0.50 = $8,500).

KEY POINT
This method provides an excellent matching of expense with revenue
when the total units of output can be determined with reasonable
accuracy. This method is used only for assets such as vehicles and
certain types of machinery whose use can be measured in miles,
machine hours, or some other measure of use.

9-33

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.

Recording cash Recording a

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

Removing accumulated Removing the

depreciation (debit). asset cost (credit).

9-35

Disposal of Plant and Equipment –

Price above Book Value
Assume that a machine costing $10,000,
had accumulated depreciation of $8,000
and book value of $2,000 (10,000 - $8,000)
at the time it was sold for $3,000 cash.
Determine the gain or loss on sale of this
machine.
Cost of machine $ 10,000
Accumulated depreciation (8,000)
Book value at time of sale 2,000
Cash received 3,000
Gain on sale of machine $ 1,000

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Disposal of Plant and Equipment:

Price above Book Value
Assume that a machine costing $10,000,
had accumulated depreciation of $8,000
and book value of $2,000 (10,000 - $8,000)
at the time it was sold for $3,000 cash.
Determine the gain or loss on sale of this
machine.
Description Debit Credit
Cash 3,000
Accumulated Depreciation: Machinery 8,000
Machinery 10,000
Gain on Disposal of Plant Asset 1,000

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Disposal of Plant and Equipment: Price

below Book Value
Assume that a machine costing $10,000 had accumulated
depreciation of $8,000 and a book value of $2,000 at the time
it was sold for $500 cash. The journal entry to record this
disposal is as follows:

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Trading in Used Assets

for New Ones
Assume that Rancho Landscape
exchanges an old truck for a new truck
costing $25,000. They received $3,500
trade-in allowance on the old truck, which
had a book value of $2,000. Rancho pays
the remaining $21,500 cost of the new
truck in cash.

9-39

Trading in Used Assets

for New Ones
Cost of old truck $ 10,000
Accumulated derpreciation: Vehicles 8,000
Book value of old truck $ 2,000
Fair market value of old truck 3,500
Gain on disposal of old truck $ 1,500

Description Debit Credit

Vehicles (New truck) 25,000
Accumulated depreciation: Vehicles (old truck) 8,000
Vehicles (Old truck) 10,000
Cash 21,500
Gain on Disposal of Asset 1,500

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International Financial Reporting

Standards
Under international accounting standards,
companies have an option to follow a revaluation
process rather than continuing to use historical
cost throughout the asset’s useful life.

This revaluation alternative requires that an

asset’s fair value can be reliably measured and it
must be applied to an entire class of plant assets.

If an asset’s carrying amount is increased as a

result of a revaluation, the increase is recorded in
other comprehensive income and accumulated
equity.
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Intangible Assets
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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Intangible Assets
Record at
current cash  Patents
equivalent cost,  Copyrights
including  Leaseholds
purchase price,  Leasehold
legal fees, and Improvements
filing fees.  Goodwill
 Trademarks and
Trade Names

9-43

Amortization
• Amortization is the systematic write-off to
expense of the cost of intangible assets over their
useful life or legal life, whichever is shorter.
• Amortization of an intangible asset is essentially
the same as depreciation for a tangible asset.
• Use the straight-line method to amortize most
intangible assets.

Date Description Debit Credit

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

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Goodwill
Occurs when one Only purchased
company buys goodwill is an
another company. intangible asset.

The amount by which the

purchase price exceeds the fair
market value of net assets acquired.

Goodwill is NOT amortized. It is tested

annually to determine if there has been
an impairment loss.

9-45

Patents
Exclusive right granted
by federal government to sell or
manufacture an invention.

Cost is purchase Amortize cost

price plus legal over the shorter of
cost to defend. useful life or 20 years.

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Trademarks and Trade Names

A symbol, design, or logo
associated with a business.

Purchased
Internally trademarks
developed are recorded
trademarks at cost, and
have no amortized over
recorded shorter of legal
asset cost. or economic life.

9-47

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

Legal life is Amortize cost

life of creator over period
plus 70 years. benefited.

9-49

Research and Development Costs

All expenditures classified as research
and development should be charged to
expense when incurred.
All of these R&D costs
will really reduce our
net income this year!

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Natural Resources

Total cost,
Extracted from
including
the natural
exploration and
environment
development,
and reported
is charged to
at cost less
depletion expense
accumulated
over periods
depletion.
benefited.

Examples: oil, coal, gold

9-51

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

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Depletion: Example
Rainbow Minerals pays $48 million to acquire the Red Valley Mine,
which is believed to contain 5 million tons of coal. The residual value
of the mine after all of the coal is removed is estimated to be $8
million. The depletion that will occur over the life of the mine is the
original cost minus the residual value, or $40 million. This depletion
will occur at the rate of $8 per ton ($40 million ÷ 5 million tons) as
the coal is removed from the mine. If we assume that 2 million tons
are mined during the first year of operations, the entry to record the
depletion of the mine would be as follows.

9-53

Depletion: Example (cont.)

 As the coal is sold, this cost is transferred from the
Inventory account to the Cost of Goods Sold account.
 Accumulated Depletion is a contra-asset account similar
to the Accumulated Depreciation account; it represents
the portion of the mine that has been used up
(depleted) to date.
 In Rainbow Minerals’s balance sheet, the Red Valley
Mine now appears as follows.

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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.

9-55