Plant Assets, Natural Resources, and Intangible Assets

LO 1: Explain the accounting for Plant Asset Expenditures.

• Plant Assets (Also known as Property, Plant, and Equipment/ Fixed Assets): resources that have
• physical substance (a definite size and shape).
• are used in the operations of a business.
• are not intended for sale to customers.
• are expected to provide service to the company for a number of years.

• Cost of Plant Assets: Historical cost principle requires that companies record plant assets at COST.
• Consists of all expenditures necessary to acquire an asset and make it ready for its
intended use.
• Cost is measured by the cash paid in a cash transaction or the cash equivalent price paid.
• Cash equivalent price is the
• fair value of the asset given up or fair value of the asset received, whichever is
more clearly determinable.

1. Revenue Expenditure: costs incurred to acquire a plant asset that are EXPENSED
IMMEDIATELY.
• Include the cost of ordinary repairs, which are expenditures to maintain operating
efficiency and expected productive life of the unit.
• “Expenditures that produce benefits ONLY IN THE CURRENT PERIOD.” They are
EXPENSED in the current period.
• Ex: Engine tune-up for delivery truck. It allows the truck to continue its productive
activity but DOES NOT INCREASE FUTURE BENEFITS. This is an example of a
maintenance cost.

Ex: Aug. 1: $500 was paid for a tune-up of a delivery truck. The journal entry would be
recorded as
Date Debit Credit
Maintenance and Repairs Expense Aug. 1 500
Cash 500

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 2. Capital Expenditure: costs INCLUDED IN A PLANT ASSET ACCOUNT.
• Include the cost of additions and improvements, which are costs incurred
to increase the operating efficiency, productive capacity, or expected useful
life of a plant asset.
• Costs that are CAPITALIZED NOW and expensed later.
• “Expenditures that produce future benefits.” They are recorded as an ASSET
and EXPENSED IN FUTURE PERIODS.
• Ex: Major improvement on a truck that EXTENDS its useful life.
• The accounting varies depending on the nature of the expenditure.

Ex: July 1: The engine of a forklift near the end of its useful life is overhauled (taken apart to be
repaired) at a cost of $5,000 which extends its useful life by 6 years. The journal entry to record this
expenditure is

Date Debit Credit

(1) Forklift July 1 5,000
Cash 5,000

COST OF PLANT ASSETS

1. Land: All necessary costs incurred in making land ready for its intended use increase (debit) the
Land account. Costs typically include:
• Cash purchase price.
• Closing costs such as title and attorney’s fees.
• Real estate brokers’ commissions.
• Accrued property taxes and other liens on the land assumed by the purchaser.

2. Land Improvements: Includes all expenditures necessary to make the improvements ready for
their intended use. They have limited useful lives and they are expensed (depreciated) over their useful
lives. Costs typically include:
• Driveways.
• Parking lots.
• Fences.
• Landscaping.
• Underground sprinklers.

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3. Buildings: Includes all costs related directly to purchase or construction.
Purchase costs typically include:
• Purchase price, closing costs (attorney’s fees, title insurance, etc.) and real estate broker’s
commission.
• Remodeling and replacing or repairing the roof, floors, electrical wiring, and plumbing.
Construction costs typically include:
• Contract price plus payments for architects’ fees, building permits, and excavation costs.
• Interest costs to finance a construction project which are limited to interest costs incurred
during the construction period.

4. Equipment: Include all costs incurred in acquiring the equipment and preparing it for use.
Costs typically include:
• Cash purchase price.
• Sales taxes.
• Freight charges.
• Insurance during transit paid by the purchaser.
• Expenditures required in assembling, installing, and testing the unit.

LO 2: Apply Depreciation Methods to Plant Assets

Depreciation: “Process of allocating to expense the cost of a plant asset over its useful life in a rational
and systematic manner.”

IMPORTANT FACTS ABOUT DEPRECIATION

• Process of cost allocation, not asset valuation.
• Applies to land improvements, buildings, and equipment, NOT LAND.
o LAND DOES NOT DEPRECIATE.
• Depreciable, because the revenue-producing ability of asset will decline over the asset’s useful life.

FACTORS IN COMPUTING DEPRECIATION

1. Cost: All expenditures necessary to acquire the asset and make it ready for intended use.

2. Useful Life: Estimate of the expected productive (service) life of the asset for its owner. It may be
expressed in terms of time, units of activity (such as machine hours), or units of output.

3. Salvage Value (Residual Value): Estimate of the asset’s value at the end of it useful life.
An asset cannot be depreciated past its salvage value.

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 DEPRECIATION METHODS
1. STRAIGHT-LINE METHOD: equal amount of depreciation is taken out each year.
*Depreciable Cost (amount that gets depreciated) = Cost – Salvage Value

Depreciation Expense = Cost – Salvage Value

Useful Life in Periods

Ex: Smith Inc. bought a machine for $20,000 to use in his business. The machine’s useful life is 5 years.
What is the depreciation expense per year and what journal entry would be made at the end of the
year?

A) Depreciation Expense = ($20,000 - $0) ÷ 5 years = $4,000 per year

***Another way to compute depreciation expense would be to do depreciable cost × straight-line rate.
Straight-Line Rate= 100% ÷ Useful Life in Years ........ 100% ÷ 5 years = 20%
Depreciable Cost = Cost – Salvage Value………$20,000 - $0 = $20,000
Depreciation Expense = $20,000 x 20% = $4,000 per year

B) End of the year journal entry on December 31 to record depreciation expense.

Date Debit Credit

Depreciation Expense Dec. 31 4,000
Accumulated Depreciation- Machinery 4,000

End Book Value = Cost of Asset – Accumulated Depreciation

OR Beginning Book Value of the Current Year – Depreciation Expense

Beginning Book Value = Cost for the first year AND the End book value from the previous year for all
other years

Accumulated Depreciation: Balance in Accumulated Depreciation from previous year + Current year’s
depreciation expense

• As you can see, after year 5, the machine has fully depreciated and reached its salvage value of $0.

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2. DECLINING BALANCE METHOD: type of an accelerated depreciation method which yields larger
depreciation expenses in the early years of an asset’s life and less depreciation in the later years. It uses
a multiple of the straight-line rate and applies it to the asset’s beginning period book value.

STEP 1: Straight Line Rate = 100% ÷ Useful Life in Years

STEP 2: If Double Declining…Straight-Line Rate x 2
If 1.5 Declining….. Straight-Line Rate x 1.5

Ex: Holiday Company purchased a machine for $600,000. The company expects the service life of the
machine to be five years. The anticipated residual value is $40,000. Holiday Company uses the double
declining method.
100% ÷ 5 years = 20% x 2 =40% Double Declining Rate

STEP 3:
Use table to keep track of depreciation per year.

Depreciation Expense = Beginning Book Value X Depreciation Rate

End Book Value = Cost of Asset – Accumulated Depreciation

OR Beginning Book Value of the Current Year – Depreciation Expense

B) What journal entry would Holiday Company have to record on December 31 of the 1st year the
company had the machine to adjust for depreciation?

Date Debit Credit

Depreciation Expense Dec. 31 240,000
Accumulated Depreciation- Machinery 240,000

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3. UNITS OF ACTIVITY METHOD: charges a varying amount to expense for each period of an asset’s
useful life depending on its USAGE. May also be called the units-of-production method or units-of-
output method. The usage can be in hours, miles driven, or quantity produced.

Depreciation Cost Cost – Salvage Value

STEP 1: =
per Unit Total Units of Activity

STEP 2: Depreciation Expense = Depreciation per unit X Units of Activity for Period

Ex: Clark Company bought an airplane for $500,000 that had a total useful life of 3,000,000 miles. The
salvage value of the plane at the end of its useful life is $50,000. Year 1, the airplane flew 500,000 miles.

A) What is the depreciation expense and journal entry for the end of the 1st year?

Step 1: Depreciation Cost per Unit = ($500,000 - $50,000) ÷ 3,000,000 miles = $0.15 per mile
Step 2: Depreciation Expense = $0.15 per mile X 500,000 miles = $75,000

Date Debit Credit

Depreciation Expense Dec. 31 75,000
Accumulated Depreciation- Airplane 75,000

B) If the airplane flew 800,000 in year 2, 900,000 in year 3, and 400,000 miles in years 4 and 5, what
would the depreciation expense be in each of those years?

***Depreciation Expense = Depreciation Cost per unit X Units of Activity for Period

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 PARTIAL YEAR DEPRECIATION

Annual Depreciation X Fraction of the Year that Company Has Fixed Asset
• Assets placed in service during the first half of a month are normally treated as having been
purchased on the FIRST DAY OF THAT MONTH.
• Asset purchases during the second half of a month are treated as having been purchased
on the FIRST DAY OF THE NEXT MONTH.

Ex) Smith Inc. bought a machine for $20,000 on October 1 to use in his business. The machine’s useful
life is 10 years. What is the depreciation expense for the current year and what journal entry would be
made at the end of the year?

STRAIGHT LINE
A) Depreciation Expense = ($20,000 - $0) ÷ 10 years = $2,000 per year X 3/12 months = $500

B) End of the year journal entry on December 31 to record depreciation expense.

Date Debit Credit

Depreciation Expense Dec. 31 500
Accumulated Depreciation- Machinery 500

DECLINING BALANCE METHOD

A) Depreciation Expense for Year 1….
Step 1: Double Declining Rate= 1/10 = 10% x 2 = 20%
Step 2: First-Year Annual Depreciation - $20,000 x 20% = $4,000
Step 3: First-Year Partial Depreciation (For 3 months) = $4,000 x (3/12) = $1,000

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 Depreciation Expense for Year 2….
Step 1: Book Value After Year 1 = $20,000 - $1,000 Depreciation= $19,000
Step 2: Second-Year Annual Depreciation - $19,000 x 20% = $3,800

B) End of the year journal entry on December 31 of Year 1 and 2 to record depreciation expense.

Date Debit Credit

Depreciation Expense Dec. 31 1,000
Accumulated Depreciation- Machinery Year 1 1,000

Depreciation Expense Dec. 31 3,800

Accumulated Depreciation- Machinery Year 2 3,800

REVISING PERIODIC DEPRECIATION

• Accounted for in the period of change and future periods (Change in Estimate).
• Not handled retrospectively.
• Not considered error.

Ex) Nanki Corporation purchased equipment on January 1, Year 1 for $650,000. Years 1, 2, and 3 Nanki
depreciated the asset on a straight-line basis with an estimated useful life of eight years and a $10,000
salvage value. In Year 4, due to changes in technology, Nanki revised the useful life to a total of six years
with no salvage value. What depreciation would Nanki record for the Year 4 on this equipment?

1. Find original depreciation expense per year. ($650,000 - $10,000) ÷ 8 years = $80,000 per year

2. Find book value at start of Year 4 (when the change in estimate occurred)
Book Value = Cost – Accumulated Depreciation = $650,000 - $240,000 [$80,000 X 3 years] =
$410,000

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 3. Revised Salvage Value = $0

4. Revised Remaining Useful Life= Total Life in Number of Years – Number of Years Used

*If useful life is extended then ADD Number of Years Extended to above formula.
*If useful life is decreased then DEDUCT Number of Years Decreased to above formula.

Revised Useful Life = 6 years – 3 years Used = 3 years remaining

New Depreciation per Year = ($410,000 - $0) ÷ 3 years ≈ $136,667 a year starting in Year 4

Date Debit Credit

Depreciation Expense Dec. 31 136,667
Accumulated Depreciation- Equipment Year 4 136,667

LO 3: Explain how to account for the Disposal of Plant Assets.

DISCARDING (RETIRING) A FIXED ASSET

• No cash is received.
• Decrease (debit) Accumulated Depreciation for the full amount of depreciation taken over the life of
the asset.
• Decrease (credit) the asset account for the original cost of the asset.

Ex: Machinery acquired at a cost of $50,000 is now fully depreciated. On October 31, the machinery is
discarded. The entry to record the discard (retirement) is

Date Debit Credit

Accumulated Depreciation-Machinery Oct. 31 50,000
Machinery 50,000

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Ex: Machinery acquired at a cost of $50,000 is discarded on October 31. However, the Machinery only
had an accumulated depreciation balance of $48,000 on October 31. The entry to record the discard is

Date Debit Credit

Accumulated Depreciation-Machinery Oct. 31 48,000
Loss on Disposal of Machinery 2,000
Machinery 50,000

SELLING AN ASSET

Step 1: Find Book Value = Cost – Accumulated Depreciation

Step 2: Proceeds Received from Sale – Book Value of Asset

If POSITIVE --- Proceeds Received from Sale > Book Value of Asset then there is a GAIN ON SALE.
If NEGATIVE --- Proceeds Received from Sale < Book Value of Asset then there is a LOSS ON SALE.

Ex: Paradise Corporation sold equipment that cost $100,000 and had accumulated depreciation of
$60,000 for $45,000. Compute the gain or loss on sale and record the journal entry for the sale of
equipment.

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Step 1: Find Book Value = $100,000 – $60,000 = $40,000
Step 2: Cash Received from Sale – Book Value of Asset = $45,000 - $40,000 = $5,000 GAIN

LO 4: Describe how to account for Natural Resources and Intangible Assets.

Natural resources: consist of standing timber and underground deposits of oil, gas, and minerals
(see Helpful Hint). These long-lived productive assets have two distinguishing characteristics: (1) they
are physically extracted in operations (such as mining, cutting, or pumping), and (2) they are replaceable
only by an act of nature.

The acquisition cost of a natural resource is the price needed to acquire the resource and prepare it for
its intended use.

Depletion of Natural Resources

The allocation of the cost of natural resources in a rational and systematic manner over the resource’s
useful life is called depletion. Companies generally use the units-of-activity method to compute
depletion. The reason is that depletion generally is a function of the units extracted during the year.
Under the units-of-activity method, companies divide the total cost of the natural resource minus
salvage value by the number of units estimated to be in the resource. The result is a depletion cost per
unit. To compute depletion, the cost per unit is then multiplied by the number of units extracted.
Example: Lane Coal Company invests $5 million in a mine estimated to have 1 million tons of coal and
no salvage value>

Step 1. Computation of Depletion Cost per unit

Total Cost−Salvage Value/ Total Estimated Units Available=Depletion Cost per Unit
($5,000,000−$0)/1,000,000 tons=$5.00 per ton

Step 2: Compute Depletion Extracted

If Lane extracts 250,000 tons in the first year, then the depletion for the year is $1,250,000 (250,000
tons × $5). It records the depletion as follows.

Inventory (coal) 1,250,000

Accumulated Depletion 1,250,000
(To record depletion of coal mine)

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Accumulated Depletion is a contra asset similar to Accumulated Depreciation. Lane credits Inventory
when it sells the inventory and debits Cost of Goods Sold. The amount not sold remains in inventory and
is reported in the current assets section of the balance sheet.

Intangible Assets: are rights, privileges, and competitive advantages that result from ownership of long-
lived assets that do not possess physical substance.

• Limited life or an indefinite life.

• Common types include: patents, copyrights, franchises or licenses, trademarks, trade names,
and goodwill.

ACCOUNTING FOR INTANGIBLES

Limited-Life Intangibles
• Amortize to expense.
• Credit asset account (used more often) or accumulated amortization.
• Amortization: USING up intangible assets. It results from the passage of time or a decline in
usefulness of the intangible asset. (Like depreciation for plant assets.)

Indefinite-Life Intangibles
• No foreseeable limit on time the asset is expected to provide cash flows.
• No amortization.

TYPES OF INTANGIBLE ASSETS

1. Patents: “Exclusive right to manufacture, sell, or otherwise control an invention for a period of 20
years from the date of the grant.”

• Capitalize costs of purchasing a patent and amortize over its 20-year life or its useful
life, whichever is shorter.
• Expense any research and development costs in developing a patent.
• Legal fees incurred successfully defending a patent are capitalized to Patent account.
• Journal entry to record amortization of patents would be…..

2. Research and Development Costs: “Expenditures that may lead to patents, copyrights, new
processes, and new products.”

• NOT intangible costs.

• All research and development costs are expensed when incurred.

3. Copyrights: “Give the owner the exclusive right to reproduce and sell an artistic or published work.”

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 • Granted for the life of the creator plus 70 years.
• Capitalize costs of acquiring and defending it.
• Amortized to expense over useful life.

4. Trademarks and Trade Names: “Word, phrase, jingle, or symbol that distinguishes or identifies a
particular enterprise or product.” Examples include Wheaties, Monopoly, Sunkist, Kleenex, Coca-Cola,
Big Mac, and Jeep.

• Legal protection for indefinite number of 20 year renewal periods.

• Capitalize acquisition costs.
• No amortization.

5. Franchises: “Contractual arrangement between a franchisor and a franchisee.” Examples include

Toyota, Shell, Subway, and Marriott.

• When a company incurs costs in connection with the acquisition of the franchise or license,
it should recognize an intangible asset.
• Franchise (or license) with a limited life should be amortized to expense over the life of the
franchise.
• Franchise with an indefinite life should be carried at cost and not amortized.

6. Goodwill: EXCESS of the purchase price that a company pays OVER the fair market value of
another company’s identifiable net assets (assets – liabilities) that it acquires.
• Includes exceptional management, desirable location, good customer relations, skilled
employees, high-quality products, etc.
• Only recorded when an entire business is purchased.
• Internally created goodwill should not be capitalized.

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LO 5: Discuss how Plant Assets, Natural Resources, and Intangible Assets are
Reported and Analyzed.

• Either within the balance sheet or the notes, companies should disclose the balances of the major
classes of assets, such as land, buildings, and equipment, and of accumulated depreciation by major
classes or in total.
• The depreciation and amortization methods used and the amount of depreciation and amortization
expense for the period should also be disclosed.

ANALYSIS
Asset Turnover: indicates how efficiently a company uses its assets to generate sales.

Ex: A asset turnover ratio of 1.4 indicates that a company generated $1.40 of sales from every $1
invested in average total assets.

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