ch16 accounting for plant assets and depreciation accounting for plant assets and depreciation 1...

Ch16 Accounting for Plant Assets and

Depreciation

1

Understanding PPE

Acquisition of PPE (cost)

Depreciation of PPE

Revenue expenditure vs. capital expenditure

Disposition of PPE (sale, trade, and discard)

Intangibles and amortization

Natural resources and depletion

Understanding PPE: Characteristics

• Have a useful life of more than one year

• Are required for use in the operations of a

business

• Are not intended for resale to customers in the

normal course of business

• Are tangible, or physical, that is, capable of being

touched

2

Acquisition of PPE - purchase

• On March 1, 20X1, Kessler Company purchase a computer

for $1,830 on account from King Office Supply Company.

• The following entry records the purchase:

3

Example

General Journal

Date Account Title P.R. Debit Credit

20X1 Mar.

Office Equipment 1,830

Accounts Payable—King

Office Supply Company 1,830

1

Acquisition of PPE - Cost

Includes all normal expenditures necessary to

acquire the asset and get it ready for use

• Invoice price

• Delivery charges

• Installation charges

• Sales taxes

• Insurance charges while in transit

4

Determining the Cost of a Plant Asset

Keesler Company purchases a new factory machine

during 20X1 and incurs the following costs:

5

Example

List price $27,500

Delivery charges 900

Insurance while in transit 360

Sales tax 1,375

Installation charges 600

Testing costs 400

Total cost $31,135

Recording Cost of a Plant Assets

• Costs necessary to get the asset into use - debited to the asset

account

• Costs that are not a normal and necessary part of getting the asset

into use - debited to an expense account

6

A machine with a list price of $10,000 was purchased with the

following additional expenditures:

$600 installation costs; $500 sales taxes; $350 delivery

charges; $75 repair for damage in unloading

The machine was paid for by issuing a $4,000 note and paying the

balance in cash. Prepare the general journal entry to record the

purchase.

Determining the Cost of Land, Buildings, and

Land Improvements

• When land and buildings are purchased for a lump sum, the

purchase price must be divided between the two.

• This is usually done by making an appraisal of the land the

buildings and dividing up the cost between the two in a fair

proportion.

7

Cost of Land

• Purchase price

• Commissions paid

• Legal fees

• Delinquent taxes paid by the buyer

• Amounts spent on draining, clearing, grading, etc. (tearing

down building)

Cost of a Building

• All construction costs

• Architect’s fees

• Insurance during construction

• Other normal and necessary costs of completing the

project

8

Land Improvements

• Sidewalks

• Driveways

• Fences

• Parking lots

• Other improvements to real estate

• Costs debited to the Land Improvements

account

Depreciation: nature

• With the exception of land, all plant assets

Wear out with the passage of time, or

Become obsolete as technology improves, or

Become inadequate to meet the needs of an

expanding business

• Depreciation: the process of allocating the cost of a plant

asset over its useful life

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• Depreciation Expense is the expense that results from this

allocation of cost, thus to record depreciation with an end-of-

period adjusting entry - debit Depreciation Expense account

and credit Accumulated Depreciation account

• The estimated useful life of an asset is its economic life, not

its physical life. Eg: The desk may last for decades, but it

may not be useful to the business for that amount of time.

Factors Needed to Calculate Depreciation

• Cost of the asset

The invoice price

The normal and necessary expenditures of getting it

ready for use

• Estimated salvage value of the asset

The amount it is expected to be worth at the end of its

productive life

• Estimated useful life of the asset

The expected period of service

Expressed in terms of use such as miles or in terms of

years 10

Depreciation: factors

Depreciation: Methods

• The Straight-Line Method

Requires equal charge for depreciation expense over

each of the accounting periods in the life of a plant asset

Annual depreciation expense = (cost of asset –

salvage value) ÷ useful life of the asset

• The Units-of-Production Method

• The Double Declining-Balance Method

• Sum-of-the-years’-digits method

• Modified Accelerated Cost Recovery System

11

Example

(cost of asset – salvage value) ÷ useful life of the asset

($18,000 – $2,000) ÷ 5 years = $3,200

Straight-Line Method

Assume on January 2, 20X1, Erwin purchases machinery for

$18,000, with a useful life of five years and an estimated

salvage value of $2,000.

To compute annual depreciation expense:

12

Depreciation Schedule, Straight-Line Method

Example

Straight-Line Depreciation for Less Than a Year

Assume on April 1, 20X1, Erwin Company purchases an

asset for $18,000 with an estimated salvage value of

$2,000, and a useful life of 5 years.

Notice the asset is only owned for 9 months in 20X1.

Depreciation expense for a full year would equal ($18,000

– $2,000) ÷ 5 years = $3,200

Depreciation expense for

20X1 = $3,200 × 9/12 = $2,400

13

The Units-of-Production Method

• Allocates cost based on the estimated productive life the

asset

• Same formula as used for the straight-line method,

except that the estimated useful life is not expressed in

years, but in terms of units produced

Hours of operation

Miles driven

Some other measure of productive output

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Example

The Units-of-Production Method


$18,000, with an estimated productive life of 100,000 units,

and an estimated salvage value of $2,000.

During 20X1, Erwin produced 22,000 units.

15

Depreciation expense/unit

= (cost of asset – salvage value) ÷ useful life of the asset

= ($18,000 – $2,000) ÷ 100,000 units

= $0.16 depreciation expense/unit

Depreciation expense for 20X1

= $0.16 × 22,000 = $3,520

The Double Declining–Balance Method

• Allows greater depreciation in the early years of an asset’s

life and less depreciation as the asset gets older

• Often referred to as an accelerated method of depreciation

• Applies a constant rate of depreciation to the declining

book value of the asset

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• Salvage value is ignored in calculating depreciation

• The rate used for most assets is twice the straight-line rate,

consequently, the name double declining-balance method

Example Double Declining – Balance Method


$18,000, with an estimated useful life of 5 years, and an

estimated salvage value of $2,000.

Since the asset has a 5 year life, each year it depreciates

20%, and 20% × 2 = 40%

Depreciation for 20X1 would equal the cost of the asset

times the declining balance or $18,000 × 40% = $7,200.

17

To compute depreciation for 20X2, we must first compute the book

value at the beginning of 20X2:

Book value on January 1, 20X2 = $18,000 – $7,200 =

$10,800

Depreciation for each succeeding year is based on book

value at the beginning of the year times the declining-

balance rate

Depreciation for 20X2 would equal

$10,800 × 40% = $4,320

Depreciation Schedule for Double Declining – Balance Method

• The declining-balance method does not consider salvage

value when calculating periodic depreciation.

• However, an asset should not be depreciated below its

estimated salvage value.

18

Depreciation is limited to $332.80($2,332.80 - $2,000.00) because the

asset cannot be depreciated below its salvage value.

Example

20X1: $75,000 × .50 × 6/12 = $18,750

20X2: $75,000 – $18,750 = $56,250 × .50 = $28,125

Double Declining – Balance Depreciation

for Less Than a Year

Assume on April 5, 20X1, Erwin Company purchases an

asset for $18,000 with an estimated salvage value of $2,000,

and a useful life of 5 years.

Notice the asset is only owned for 9 months in 20X1.

Depreciation expense for 20X1 = $18,000 × 40% × 9/12 =

$5,400.

19

Using the double declining–balance method, calculate the

depreciation expense for 20X1 and 20X2. Assume the asset

was purchased on June 19, 20X1, for $75,000, with an

estimated life of four years and an expected salvage value of

$5,000.

Comparing the Three Depreciation Methods

20

Comparing the Three Depreciation Methods

21

Popularity of the Three Depreciation Methods

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Sum-of-the-Years’-Digits Method

23

The cost of the plant asset less its salvage value, is multiplied

by a fraction.

• The Denominator

Remains constant

Obtained by adding the digits that make up the

estimated useful life of the asset

• The Numerator

Changes each year

Consists of the number of years remaining in the life of

the asset

24

Example

• In Jan. 20X1, a delivery van was purchased by Nita’s

Flowers.

• The van had a cost of $21,000, an estimated salvage value

of $3,000, and an estimated useful life of 5 years.

• The denominator of the fraction is the sum of the digits

making up the 5-year life of the van: 5 + 4 + 3 + 2 + 1 = 15.

20X1 5/15 × $18,000 = $ 6,000

20X2 4/15 × $18,000 = 4,800

20X3 3/15 × $18,000 = 3,600

20X4 2/15 × $18,000 = 2,400

20X5 1/15 × $18,000 = 1,200

$18,000

Sum-of-the-Years’-Digits Method for Less Than a

Year

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• Let’s assume that Nita’s delivery van was purchased on October 1,

20X1 instead of January 1, 20X1. We know the first year’s fraction

is 5/15. In 20X1, only 3/12 of the first year’s fraction is needed.

• In 20X2, the other 9/12 of the first year’s fraction is used. To

complete 20X2, we need 3/12 of the second year’s fraction.

20X1 5/15 × $18,000 = $6,000 × 3/12 = $1,500

20X2 5/15 × $18,000 = $6,000 × 9/12 = $4,500

20X2 4/15 × $18,000 = 4,800 × 3/12 = 1,200

$5,700

20X3 4/15 × $18,000 = $4,800 × 9/12 = $3,600

20X3 3/15 × $18,000 = 3,600 × 3/12 = 900

= $4,500

Sum-of-the-Years’-Digits Method for Less Than a

Year

26

20X4 3/15 × $18,000 = $3,600 × 9/12 = $2,700

20X4 2/15 × $18,000 = 2,400 × 3/12 = 600

$3,300

20X5 2/15 × $18,000 = $2,400 × 9/12 = $1,800

20X5 1/15 × $18,000 = 1,200 × 3/12 = 300

$2,100

20X6 1/15 × $18,000 = $1,200 × 9/12 = $900

MACRS

• Modified Accelerated Cost Recovery System

• Required by the Internal Revenue Code for federal income

taxes.

• An accelerated depreciation method required for calculating

depreciation for income taxes purposes.

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Depreciation for Federal Income Taxes

• It is not necessary to estimate an asset’s salvage value or its

useful life.

• Nor do we need to know the time of year an asset was

placed into service.

• Assets are assigned a recovery period based on property

classes.

Plant Asset Records

• If a company has many depreciable assets, a summary

general ledger account is usually kept for each major class of

assets.

• Each summary account has a related Accumulated

Depreciation account.

• These summary accounts are supported by a subsidiary

ledger in which a card or computer file is maintained for each

individual asset in the group.

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Revenue Expenditures vs. Capital Expenditures

• An expenditure for a plant asset that benefits only the current

account period.

• Examples include ordinary repairs and maintenance made to

the asset.

• Revenue expenditures are debited to Repairs Expense.

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On July 15, 20XX, DeBice Home Products Company pays

$400 for routine maintenance and repairs to its office

equipment and records the following journal entry:

General Journal


20XX July

Repairs Expense 400

Cash 400

15

Capital Expenditures

• An expenditure for a plant asset that benefits more than

one accounting period.

• Examples of capital expenditures include

Additions

Betterments

Extraordinary Repairs

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• Increase either the value or the life of the asset and,

depending on the type of expenditure, are debited to

either

A Plant Asset account, or

Its Accumulated Depreciation account

Capital Expenditures (cont.)

• An Addition

A capital expenditure that literally adds on to an

existing plant asset

The cost is debited to a plant asset account

• A Betterment

A capital expenditure that improves a plant asset,

such as placing siding on a building

The cost is debited to a plant asset account

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• An Extraordinary Repair

A capital expenditure that prolongs the life of a plant

asset, such as new wiring in a building

The cost is debited to the Accumulated Depreciation

account

Example


On July 1, 20XX, DeBice Home Products Company spends

$75,000 to replace a roof on its factory building.

This expenditure is considered a betterment.

DeBice Home Products prepares the following journal entry:

32

General Journal


20XX July

Buildings 75,000

Cash 75,000

1

Example


On July 1, 20XX, DeBice Home Products Company

spends $50,000 to replace wiring in its factory building.

This expenditure is considered an extraordinary repair

because it extends the useful life of the building.

33

General Journal


20XX July

Accumulated Depreciation-

Buildings 50,000

Cash 50,000

1

Wrap it up: Revenue Expenditure vs. Capital

Expenditure

• Revenue expenditures benefit only the current period

and are debited to expense accounts.

• Capital expenditures benefit more than just the current

period. Some capital expenditures add value to the

plant asset; others add life.

34

• Additions and betterments are capital expenditures that

add value to the plant asset and are debited to the plant

asset account.

• Extraordinary repairs are capital expenditures that

prolong the life of the plant asset and are debited to the

related Accumulated Depreciation account.

Example

PPE Disposition: Sale of a Plant Asset for Book Value

Assume Roberts Company sells office equipment on July 1, 20X5,

for $450. The equipment was purchased on January 3, 20X1, for

$4,500 and depreciates at $900 per year.

Accumulated depreciation as of date of sale would equal $900 ×

4.5 years = $4,050.

35

Book value on date of sale would equal $4,500 – $4,050 = $450.

Since book value equals the amount of cash received, there is no

gain or loss on the sale. General Journal


20X5 July

Cash 450


Office Equipment

4,500 Office Equipment

4,050

1

Example

Sale of a Plant Asset at a Gain Assume Roberts Company sells office equipment on July 1, 20X5,


$4,500 and depreciates at $900 per year. Accumulated

depreciation as of date of sale would equal $900 × 4.5 years =

$4,050.

36


Since the cash received exceeds the book value of the asset, we

will recognize a gain. General Journal


20X5 July Cash 600

Accumulated Depreciation-Office

Equipment 4,050

Office Equipment

Gain on Disposal of Plant Assets

4,500

150

1

Example Sale of a Plant Asset at a Loss

Assume Roberts Company sells office equipment on July 1, 20X5,


$4,500 and depreciates at $900 per year. Accumulated

depreciation as of date of sale would equal $900 × 4.5 years =

$4,050.


Since the cash received is less than the book value of the asset,

we will recognize a loss.

37

General Journal


20X5 July

Cash 350

Accumulated Depreciation - Office

Equipment 4,050

100

4,500

Loss on Disposal of Plant Assets Office equipment

1

Trading In Plant Assets

• When a trade occurs, a trade-in allowance is received for the

old asset

• The purchaser pays the difference between the price of the

new asset and the trade-in allowance received

• The boot: the difference between the price of the new asset

and the trade-in allowance

38

Accounting for a Gain on a Trade of Similar Assets

Assume on January 2, 20X2, a truck with a cost of $9,000

and accumulated depreciation of $7,000 is traded in for a

new truck with a list price of $12,000

A trade-in allowance of $3,000 is received for the old truck.

The book value of the old truck is $9,000 – $7,000 = $2,000

Example

Accounting for a Gain on a Trade of Similar Assets

The gain is the excess of the trade-in allowance over the book

value or $3,000 – $2,000 = $1,000

The gain isn’t recorded in the journal entry; the boot paid is

$12,000 – $3,000 = $9,000

The cost of the new truck = the book value of the old truck + the

boot paid = $2,000 + $9,000 = $11,000

39

General Journal


20X2 Jan.

Truck (new) 11,000

Accumulated Depreciation-Truck 7,000

Truck (old)

Cash

9,000

9,000

2

Example

Accounting for a Loss on a Trade of Similar Assets

Assume on January 2, 20X2, a truck with a cost of $9,000 and

accumulated depreciation of $7,000 is traded in for a new truck

with a list price of $12,000. A trade-in allowance of $1,000 is

received for the old truck. The book value of the old truck is $9,000

– $7,000 = $2,000

40

The loss is the excess of the book value over the trade-in

allowance or $2,000 – $1,000 = $1,000, the boot paid is $12,000

– $1,000 = $11,000 General Journal


20X2

Jan. Truck (new) 12,000

Accumulated Depreciation-Truck 7,000

Truck

Cash

9,000

11,000

Loss on Disposal of Plant Assets 1,000

2

Example

Discarding a Fully Depreciated Plant Asset

Assume on June 15, 20X5, Roberts Company discards a

drill press with a cost of $14,200

The asset is fully depreciated; its book value is zero

41

General Journal


20X5

Jun.


Drill Press 14,200

Drill Press 14,200

15

42

Let’s make a summary for Trading In Plant Assets here:

When a trade occurs, a trade-in allowance is received for the old

asset

The purchaser pays the difference between the price of the new

asset and the trade-in allowance received, which is called The Boot

When actually a gain occurs, do not recognize it but reflect it in the

cost of new asset, which is equal to the allowance plus boot paid

When actually a loss occurs, recognize it and use the list price of

the asset as the cost basis of the asset

For Federal income tax purposes, the gain is treated the same as is

treated in accounting, whereas the loss actually occurred would

increase the cost basis of the new asset, which is equal to the book

value of asset being traded plus boot paid

Now let’s take a look at page 738 Exercise 16-7.

Example

Discarding a Plant Asset with a Book Value

Assume on June 15, 20X5, Roberts Company discards a drill

press with a cost of $14,200

Accumulated depreciation on the drill press at date of

disposal amounts to $13,400

The loss on disposal is equal to the cost of the asset less its

accumulated depreciation = $14,200 – $13,400 = $800

43

J. WU

General Journal


20X5 Jun.

Accumulated Depreciation- Drill

Press 13,400

Drill Press 14,200

Loss on Disposal of Plant Assets 800

15

Intangible Assets and Amortization

• Lack physical substance

• Include such things

Patents

Copyrights

Trademarks

Franchises

44

• Amortization

The periodic write-off of an intangible asset

Based on the straight-line method of depreciation

Example

Intangible Assets On January 9, 20X2, Winners Company purchased a patent for a

new exercise machine at a cost of $12,000.

Winners Company assumes the patent will have a useful life of

10 years.

Winners Company prepares the following entries to purchase the

patent on January 2 and on December 31 to record annual

amortization.

45

General Journal


20X2 Jan.

Patent 12,000

Patent 1,200

Cash 12,000

Dec. Amortization Expense-Patent 1,200

9

31

Natural Assets and Depletion

• Long-term assets acquired for the purpose of removing or

extracting natural resources, such as timber, oil, coal, gold

or gas

• Depletion

The expense resulting from the using up of a natural

resource

Similar to units-of-production depreciation

46

Assume on March 2, 20X2, the Deep South Company

purchased oil-drilling rights to a well for $3,000,000.

There is no salvage value and the well is estimated to

produce 6,000,000 barrels of oil.

During 20X2, Deep South Company removed 700,000

barrels of oil.

Example Depletion

The depletion expense per barrel = $3,000,000 ÷

6,000,000 barrels of oil = $0.50.

Depletion for 20X2 = $0.50 × 700,000 barrels = $350,000.

47

General Journal


20X2 Dec.

Depletion Expense-Oil Well 350,000

Accumulated Depletion-Oil

Well

350,000

31

Plant Assets and Depreciation

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Plant Assets and Depreciation

49

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Three Categories of Capital Expenditures

ch16 accounting for plant assets and depreciation accounting for plant assets and depreciation 1...

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