Chapter 1

2

Plant

Assets

Natural

Resources

Intangible

Assets

Depreciation Depletion Amortization

Held for use in business

Full cost includes several expenditures

Last several years

Can be sold or traded in

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4

LO1 - Measure the cost of a plant asset -

The Cost Principle

LandLand

improvementsBuildings

Machinery & equipment

Furniture & fixtures

5

NOT depreciated

Costs included in Land◦ Purchase price

◦ Brokerage fees

◦ Survey and legal fees

◦ Property taxes in arrears

◦ Title transfer

◦ Costs of clearing and removing unwanted buildings

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Subject to depreciation

Examples:◦ Fencing

◦ Paving

◦ Sprinkler systems

◦ Lighting

◦ Signs

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Cost includes:◦ Purchase price

◦ Architectural fees

◦ Contractor charges

◦ Materials, labor, and overhead

If self-constructed, interest on loans may be

included

If existing structure is purchased, repairs and

renovations are included

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Cost includes:◦ Purchase price (less any discounts)

◦ Transportation charges

◦ Insurance while in transit

◦ Sales tax

◦ Installation costs

◦ Cost of testing before asset is used

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Purchase price (less any discounts)

Shipping charges

Costs to assemble

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Company purchases a group of plant assets for a

single price◦ Also called basket purchase

Assign cost to individual assets based on relative

sales values

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Fair value Percent Allocated

cost

Land $75,000 50% $70,000

Building $60,000 40% $56,000

Equipment $15,000 10% $14,000

Total $150,000 100% $140,000

Divide fair value of

each asset by the total

fair value of $150,000

Multiply

percent by

total cost

of

$140,000

Capital expenditures Expenses

Debited to an asset

account

Increase asset’s capacity

of efficiency OR

Extend useful life

Debited to an expense

account

Maintain asset in working

order

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If a capital expenditure is incorrectly recorded as

an expense:

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Overstates expenses

Understates net income

Understates Capital

Understates assets (equipment)

Allocation of a plant asset’s cost to expense over

its useful life

Matches expense against revenue generated

using the asset

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$40,000 cost

10-year life

Wear and tear from use

Physical factors

Obsolescence◦ Computers and other technology

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Cost

Estimated useful life◦ Expressed in years, units, miles, or output

Estimated residual value◦ Also called salvage value

◦ Expected cash value at end of useful life

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Cost Useful LifeResidual

Value

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Straight-line

Units-of production

Declining-balance

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(Cost – residual value)1

Life

Depreciation expense

#

12

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CostAccumulated

depreciation

Book value

Increases over

time

Decreases over

time

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Depreciation expense =

Depreciation per unit x activity during the period

Depreciation per unit =

(Cost – Residual value) x1

Life in units

Accelerated method◦ Writes off more depreciation near the start of an asset’s

life

Residual value is not in formula◦ Ignored until last year

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(Cost – Accumulated

depreciation)

#

12

Depreciation expense

Book

value

Twice the straight-

line rate

Decreases over the

asset’s life

2

Life

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The cost of an equipment is $41,000. ABC Company

expects the equipment to remain useful for 5 years

(10,000 units) and to have a residual value of $1,000.

The company expects the equipment to be used 3,000

units the first year; 2,500 units the second year; 2,000

units the third year; 1,500 units the fourth year and

1,000 units the fifth year.

To compute depreciation for all 5 years using the

straight-line method, Units-of- production method and

Double-declining-balance method.

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Year

Value at the

beginning

of the year

Depreciation for the year

Book

valueDepreciation expenseAccumulated

depreciation

1 $41,000 $8,000 $8,000 $33,000

2 $33,000 $8,000 $16,000 $25,000

3 $25,000 $8,000 $24,000 $17,000

4 $17,000 $8,000 $32,000 $9,000

5 $9,000 $8,000 $40,000 $1,000

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Year

Value at the

beginning

of the year

Depreciation for the year

Book

valueDepreciation expenseAccumulated

depreciation

1 $41,000 $12,000 $12,000 $29,000

2 $29,000 $10,000 $22,000 $19,000

3 $19,000 $8,000 $30,000 $11,000

4 $11,000 $6,000 $36,000 $5,000

5 $5,000 $4,000 $40,000 $1,000

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Year

Value at the

beginning

of the year

Depreciation for the year

Book

valueDepreciation expenseAccumulated

depreciation

1 $41,000 $16,400 $8,000 $33,000

2 $33,000 $9,840 $16,000 $25,000

3 $25,000 $5,904 $24,000 $17,000

4 $17,000 $3,542 $32,000 $9,000

5 $9,000 $4,314* $40,000 $1,000

*Last-year depreciation is the “plug figure”

needed to reduce book value to the residual

value amount ($5,314 - $1,000 = $4,314).

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Cost = $50,000 Life = 5 years or

100,000 units

Residual value

= $5,000

Straight-line

• For assets that generate revenue over time

Units-of-production

• For assets that depreciate due to wear and tear

Double-declining-balance

• For assets that produce more revenue in their early years

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(65,000,000 – 5,000,000)

Straight-line – 1st year

1

4

$15,000,000 depreciation, 1st year

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12

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(65,000,000 – 5,000,000) x1

Units-of-Production

6,000,000 miles= $10

per mile

x $10 per mile

1.3 million miles

= $13,000,000

depreciation expense, 1st year

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($65,000,000 - 0)12

12

$32,500,000 depreciation

expense, 1st year

Double-declining-balance – 1st year

2

4

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Cost $65,000,000

Less: Accumulated depreciation 15,000,000

Book value, using straight-line $50,000,000

Considered a change in estimate

Businesses must report on the reason and effect

of the change

Remaining asset book value is depreciated over

the remaining life

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Asset has reached the end of its estimated life

If still useful, a company will continue to use it

Report book value on balance sheet

Record no more depreciation

Asset never reported below residual value

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Asset wears out or becomes obsolete.

Company can:◦ Sell the asset for cash

◦ Scrap the asset for no cash

◦ Trade the asset for another asset

Non-like property exchange

Like-kind exchange

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Result in a

gain or loss

No gain or

loss

Bring depreciation up to date

Remove old asset from books◦ Zero out asset by crediting for original cost

◦ Zero out accumulated depreciation of asset by debiting

for all depreciation taken

Record the value of any cash paid or received◦ If money is borrowed, credit Notes payable

Determine difference between total debits and

total credits

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If asset was traded for a like-kind asset◦ Difference will be recorded as a debit to the new asset

account

If the asset was sold or exchanged for a dissimilar

asset◦ Gain or loss will be recorded

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If debits > credits If debits < credits If debits = credits

GAIN LOSS NO GAIN

OR LOSS

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On January 2, 2011, Ditto Clothing Consignments purchased

showroom fixtures for $16,000 cash, expecting the fixtures to

remain in service 5 years.

Ditto has depreciated the fixtures on a double-declining-balance

basis, with zero residual value.

On August 31, 2012, Ditto sold the fixtures for $7,600 cash.

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When a plant asset is sold during the year, depreciation must be

updated.

First-year double-declining-balance depreciation was computed

by multiplying the book value (same as cost in year one) by 2 over

the life of the asset.

$16,000 x 2/5 = $6,400.

End of year book value equaled $9,600 ($16,000 - $6,400).

For 2012, the book value is multiplied by 2/5, resulting is $3,840

for a full year of depreciation. Since the sale took place on August

31, this amount is multiplied by 8/12.

Depreciation expense is $2,560.

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GENERAL JOURNAL

DATE DESCRIPTION REF DEBIT CREDIT

8 31 Depreciation expense 2,560

Accumulated depreciation 2,560

Year Depreciation

expense

Accumulated

depreciation

Book value

$16,000

2011 $6,400 6,400 9,600

2012 2,560 8,960 7,040

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GENERAL JOURNAL

DATE DESCRIPTION REF DEBIT CREDIT

8 31 Cash 7,600

Accumulated depreciation 8,960

Fixtures 16,000

Gain on sale of plant assets 560

Year Depreciation

expense

Accumulated

depreciation

Book value

$16,000

2011 $6,400 6,400 9,600

2012 2,560 8,960 7,040

Plant assets extracted from the natural

environment◦ Iron, oil, coal

Expensed through depletion using the units-of-

production method

Accumulated depletion is a contra-asset account

to the natural resource

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Depletion expense =

Depletion per unit x number of units removed

Depletion per unit =

(Cost – Residual value) x

1Estimated total units of natural

resource

Non-current assets with no physical form

Provide exclusive rights or privileges

Expensed through amortization using the straight-

line method◦ Credit to the asset directly

◦ If intangible has indefinite life, it is not amortized

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Patent

• Exclusive 20-year right to produce & sell an invention

Copyright

• Exclusive right to sell a book, musical work, film, art, software, or intellectual property

Trademarks and brand names

• Represent distinctive products or services

Issued by the federal government

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Franchises & licenses

• Allows purchaser to sell goods or services under specific conditions

Goodwill

• Excess of the cost to purchase another company over the market value of its net assets

Only recorded when a company purchases another business

Not amortized◦ Current value measured each year

If value increases, no entry

If value decreases, a loss is recorded

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Important to several industries, such as

pharmaceutical companies

Not an intangible◦ Expensed as incurred

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Capitalize

Results in higher

asset value and

larger net income◦ Looks better to

investors

If cost provides a

future benefit, then

capitalize

Expense

Results in lower net

income◦ Less taxes

If cost does not

provide a future

benefit, then expense

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