Plant Assets Natural Resources and Intangibles Chapter 10

Learning Objectives 1. Measure the cost of a plant asset 2. Account for depreciation using the straight-line, units-ofproduction, and doubledeclining-balance methods 3. Journalize entries for the disposal of plant assets © 2015 Pearson Education, Limited. 10 -2

Learning Objectives 4. Account for natural resources 5. Account for intangible assets 6. Use the asset turnover ratio to evaluate business performance 7. Journalize entries for the exchange of plant assets (Appendix 10 A) © 2015 Pearson Education, Limited. 10 -3

Learning Objective 1 Measure the cost of a plant asset © 2015 Pearson Education,

What Are Plant Assets? Long-lived, tangible assets used in the operation of the business. • • • Land Buildings Equipment Furniture Automobiles Cost Principle The actual cost of a plant asset is its purchase price plus all the costs necessary to get the asset ready for its intended use. © 2015 Pearson Education, Limited. 10 -5

The Cost of Land Includes: Land is not • Purchase price depreciable. • Brokerage commissions • Survey and legal fees • Delinquent property taxes • Title transfer fees • Cost of clearing the land • Cost of removing old buildings © 2015 Pearson Education, Limited. 10 -6

The Cost of Land Does Not Include: • Fencing • Paving • Sprinkler systems

The Cost of Land Smart Touch Learning purchases land on August 1, 2015, for $50, 000 with a note payable. Other costs related to this transaction include $4, 000 in delinquent property taxes, $2, 000 in transfer taxes, $5, 000 to remove an old building, and a $1, 000 survey fee. The additional costs are paid in cash. What is the cost of the land on Smart Touch Learning’s books? © 2015 Pearson Education, Limited. 10 -8

The Cost of Land © 2015 Pearson Education, Limited. 10 -9

The Cost of Land Prepare the journal entry to record the purchase of the

The Cost of Buildings When a Building is constructed, the costs include: Site Building

The Cost of Buildings When a Building is purchased, the costs include: Purchase price

The Cost of Machinery and Equipment and Furniture and Fixtures The costs include: Purchase Transportation price charges Purchase commission Installation and testing costs Insurance while in transit Sales taxes © 2015 Pearson Education, Limited. 10 -14

Lump-Sum Purchases • Purchasing several assets for a single price. – Sometimes called a “basket purchase” • Each asset must be recorded separately. • Allocate total cost to each asset based on relative market value. On August 1, Smart Touch Learning purchased land building with a $100, 000 note. The land is appraised at $30, 000 and the building is appraised at $90, 000. © 2015 Pearson Education, Limited. 10 -15

Lump-Sum Purchases © 2015 Pearson Education, Limited. 10 -16

Lump-Sum Purchases Prepare the journal entry. © 2015 Pearson Education, Limited. 10 -17

Lump-Sum Purchases © 2015 Pearson Education, Limited. 10 -18

>TRY IT! Prepare the journal entry. © 2015 Pearson Education, Limited. 10 -19

>TRY IT! © 2015 Pearson Education, Limited. 10 -20

Learning Objective 2 Account for depreciation using the straight-line, units-of-production, and doubledeclining-balance methods ©

What Is Depreciation? • Plant assets are recorded as assets when purchased. • Depreciation is Remember, to record the process of depreciation, we debit Depreciation Expense allocating an and credit asset’s cost to Accumulated expense over its Depreciation (a contrauseful life. asset). © 2015 Pearson Education, Limited. 10 -22

Factors in Computing Depreciation The Depreciation computation requires three main factors: Estimated useful life Capitalized Cost The estimated expected use from an asset. Estimated residual value The estimated value of the asset at the end of its useful life. Total amount of cost to be allocated. © 2015 Pearson Education, Limited. 10 -23

Depreciation Methods There are three common depreciation methods: Smart Touch Learning purchases a truck on January 1, 2014 • Straight-Line • Units-of. Production • Declining. Balance © 2015 Pearson Education, Limited. 10 -24

Straight-Line Method The most widely used and most easily understood method. Results in the same amount of depreciation in each year of the asset’s service life. © 2015 Pearson Education, Limited. 10 -25

Straight-Line Method Prepare the journal entry at December 31, 2014. © 2015 Pearson Education,

Straight-Line Method © 2015 Pearson Education, Limited. 10 -27

Units-of-Production Method • Depreciation is a function of how much an asset is USED, USED rather than its age. • Less predictable than other methods. Smart Touch Learning purchases a truck on January 1, 2014 © 2015 Pearson Education, Limited. 10 -28

Units-of-Production Method Assuming Smart Touch Learning drives the truck 20, 000 miles in the

Double-Declining Balance Method • An accelerated method. • More depreciation early in an asset’s life. • Total depreciation the same over the asset’s full life. Smart Touch Learning purchases a truck on January 1, 2014 © 2015 Pearson Education, Limited. 10 -31

Double-Declining Balance Method Multiply an asset’s declining book value by twice the straight-line depreciation

Learning Objective 3 Journalize entries for the disposal of plant assets © 2015 Pearson

Discarding Plant Assets • When an asset is disposed, sold, or retired, it must be removed from the books. • All related Accumulated Depreciation must also be removed from the books. • Gains/Losses on disposal are recorded. STEPS • Bring depreciation up to date. • Remove original cost of asset and accumulated depreciation from the books. • Record any cash received. • Record the difference between book value and the cash received as a gain or loss. © 2015 Pearson Education, Limited. 10 -35

Discarding Plant Assets Example #1 On July 1, Smart Touch Learning discards equipment that cost $10, 000. The accumulated depreciation on the asset is $10, 000. Prepare the journal entry at July 1, 2013. © 2015 Pearson Education, Limited. 10 -36

Discarding Plant Assets Example #1 On July 1, Smart Touch Learning discards equipment that cost $10, 000. The accumulated depreciation on the asset is $10, 000. © 2015 Pearson Education, Limited. 10 -37

Discarding Plant Assets Example #2 On July 1, Smart Touch Learning discards equipment that cost $10, 000. As of December 31 the previous year, the accumulated depreciation on the asset was $8, 000. Annual depreciation per year is $1, 000. Prepare the journal entry at July 1, 2013. © 2015 Pearson Education, Limited. 10 -38

Discarding Plant Assets Example #2 On July 1, Smart Touch Learning discards equipment that cost $10, 000. As of December 31 the previous year, the accumulated depreciation on the asset was $8, 000. Annual depreciation per year is $1, 000. First, we have to update the depreciation. © 2015 Pearson Education, Limited. 10 -39

Discarding Plant Assets Example #2 On July 1, Smart Touch Learning discards equipment that cost $10, 000. As of December 31 the previous year, the accumulated depreciation on the asset was $8, 000. Annual depreciation per year is $1, 000. © 2015 Pearson Education, Limited. 10 -40

Discarding Plant Assets Example #2 On July 1, Smart Touch Learning discards equipment that cost $10, 000. As of December 31 the previous year, the accumulated depreciation on the asset was $8, 000. Annual depreciation per year is $1, 000. Second, record the disposal. © 2015 Pearson Education, Limited. 10 -41

Discarding Plant Assets Example #2 On July 1, Smart Touch Learning discards equipment that cost $10, 000. As of December 31 the previous year, the accumulated depreciation on the asset was $8, 000. Annual depreciation per year is $1, 000. © 2015 Pearson Education, Limited. 10 -42

Discarding Plant Assets Example #3 On July 1, Smart Touch Learning sells equipment for $4, 000. The equipment cost $10, 000. As of December 31 the previous year, the accumulated depreciation on the asset was $8, 000. Annual depreciation per year is $1, 000. Prepare the journal entries at July 1, 2013. © 2015 Pearson Education, Limited. 10 -43

Discarding Plant Assets Example #3 On July 1, Smart Touch Learning sells equipment for $4, 000. The equipment cost $10, 000. As of December 31 the previous year, the accumulated depreciation on the asset was $8, 000. Annual depreciation per year is $1, 000. First, update depreciation. © 2015 Pearson Education, Limited. 10 -44

Discarding Plant Assets Example #3 On July 1, Smart Touch Learning sells equipment for $4, 000. The equipment cost $10, 000. As of December 31 the previous year, the accumulated depreciation on the asset was $8, 000. Annual depreciation per year is $1, 000. © 2015 Pearson Education, Limited. 10 -45

Discarding Plant Assets Example #3 On July 1, Smart Touch Learning sells equipment for $4, 000. The equipment cost $10, 000. As of December 31 the previous year, the accumulated depreciation on the asset was $8, 000. Annual depreciation per year is $1, 000. Second, record the sale. © 2015 Pearson Education, Limited. 10 -46

Discarding Plant Assets Example #3 On July 1, Smart Touch Learning sells equipment for $4, 000. The equipment cost $10, 000. As of December 31 the previous year, the accumulated depreciation on the asset was $8, 000. Annual depreciation per year is $1, 000. © 2015 Pearson Education, Limited. 10 -47

Learning Objective 4 Account for natural resources © 2015 Pearson Education, Limited. 10 -48

Natural Resources • Assets that come from the earth and are consumed. • The value of the “reserves” that a company owns/controls is a long-term asset. Includes: • Iron ore • Oil • Natural Gas • Coal • Timber • Diamonds • Gold and silver © 2015 Pearson Education, Limited. 10 -49

Natural Resources • As the resources are extracted, Depletion Expense is recorded. • A contra-asset Accumulated Depletion is also recorded. • Steps (similar to Units-of-Production) 1. Compute Depletion per Unit (based on estimated reserves) 2. Compute Depletion for the period (based on actual extraction) © 2015 Pearson Education, Limited. 10 -50

Natural Resources A company owns oil reserves that cost $700, 000 and is estimated to contain 70, 000 barrels of oil. During the year, 3, 000 barrels of oil are extracted. Prepare the journal entry for Depletion Expense. © 2015 Pearson Education, Limited. 10 -51

Natural Resources Step 1: Compute Depletion per Unit. © 2015 Pearson Education, Limited. 10

Natural Resources Step 2: Compute Depletion for the Period. © 2015 Pearson Education, Limited.

Natural Resources Prepare the journal entry for Depletion Expense. © 2015 Pearson Education, Limited.

Natural Resources © 2015 Pearson Education, Limited. 10 -55

>TRY IT! Amplify Petroleum holds reserves of oil representing an estimated 100 million barrels. The cost of those reserves was $80, 000. If Amplify Petroleum extracts and sells 20 million barrels in 2015, what is the depletion for the year? Prepare the journal entry. © 2015 Pearson Education, Limited. 10 -56

>TRY IT! Amplify Petroleum holds reserves of oil representing an estimated 100 million barrels. The cost of those reserves was $80, 000. If Amplify Petroleum extracts and sells 20 million barrels in 2015, what is the depletion for the year? © 2015 Pearson Education, Limited. 10 -57

Learning Objective 5 Account for Intangible Assets © 2015 Pearson Education, Limited. 10 -58

Intangible Assets • Assets that have no physical substance. • Usual convey rights to the owner. • Recorded at cost. • Research and development costs are NOT included. Includes • Patents • Copyrights • Trademarks • Franchise Agreements • Licenses • Goodwill © 2015 Pearson Education, Limited. 10 -59

Intangible Assets • As intangible assets “expire, ” they must be “amortized. ” • Amortization expense is recorded: – Based on the straight-line method – Use the shorter of the useful life or the legal life – Only for intangible assets with definite life © 2015 Pearson Education, Limited. 10 -60

Intangible Assets • There is no contra-asset account used with the amortization process. – The intangible asset is credited directly. – Each year the asset’s book value will decrease by the amount of the amortization. © 2015 Pearson Education, Limited. 10 -61

>TRY IT! On January 1, Orange Manufacturing paid $40, 000 for a patent. It has a legal life of 20 years. The patent is expected to give legal protection for 8 years. Prepare the journal entry. © 2015 Pearson Education, Limited. 10 -62

>TRY IT! On January 1, Orange Manufacturing paid $40, 000 for a patent. It has a legal life of 20 years. The patent is expected to give legal protection for 8 years. © 2015 Pearson Education, Limited. 10 -63

Learning Objective 6 Use the asset turnover ratio to evaluate business performance © 2015

Asset Turnover Ratio • Used to measure how well a company is using its

Learning Objective 7 Journalize entries for the exchange of plant assets (Appendix 10 A)

Exchange Plant Assets • An exchange includes aspects of a sale and a disposal. • Special accounting is required if the exchange transaction has commercial substance – i. e. ; the future cash flows will change as a result of the exchange. © 2015 Pearson Education, Limited. 10 -67

Exchange Plant Assets If an exchange lacks commercial substance, substance the new asset is recorded at the book value of the asset that is given up, plus/minus any cash exchanged as part of the transaction. An auto dealer trades a blue sedan to another auto dealer for a similar sedan in black to satisfy a customer’s preference. There is no commercial substance related to this transaction. The future cash flows do not change. © 2015 Pearson Education, Limited. 10 -68

Exchange Plant Assets If an exchange has commercial substance, substance the new asset is recorded at its market value on the date of the exchange. Gains or losses may have to be recorded. On December 31, Smart Touch Learning exchanges used equipment and $2, 000 cash for new equipment. The old equipment has a cost of $10, 000 and accumulated depreciation of $9, 000. The new equipment has a market value of $8, 000. © 2015 Pearson Education, Limited. 10 -69

Exchange Plant Assets 1. 2. 3. 4. Take the old equipment off the books. Record the cash payment. Record the new asset. Record any gain or loss. Prepare the journal entry. © 2015 Pearson Education, Limited. 10 -70

>TRY IT! Area Salvage Company purchased equipment for $10, 000. Over the asset’s life, they recorded accumulated depreciation of $8, 000. They exchange the old equipment and $4, 000 for new equipment with a market value of $5, 000. Prepare the journal entry. © 2015 Pearson Education, Limited. 10 -72

>TRY IT! Area Salvage Company purchased equipment for $10, 000. Over the asset’s life, they recorded accumulated depreciation of $8, 000. They exchange the old equipment and $4, 000 for new equipment with a market value of $5, 000. © 2015 Pearson Education, Limited. 10 -73