CHAPTER 2

ACCOUNTING FOR PLANT ASSETS, NATURAL RESOURCES, AND

INTANGIBLE ASSETS
2.1. NATURE OF PLANT ASSETS
Long-lived assets are assets of permanent or relatively fixed nature owned by a business
enterprise. Long- lived assets are classified as tangible assets and intangible assets.
Plant assets are long-term or relatively permanent nature tangible assets that used in the
normal operations. They are owned by the business and are not held for sale in normal
operations. Plant assets are also named as fixed assets or property, plant, and equipment.
It includes:

Machinery and Equipment

Furniture
Tools
Building and
Land

There is no standard rule as to the minimum length of life necessary for an asset
to be classified as a plant asset. Such assets must be capable of providing
repeated use or benefit, and are normally expected to last more than a year.
However, an asset need not actually be used on an ongoing basis or even often.
For example, items of stand by equipment held for use in the event of a break
down of regular equipment or for use only during g peak periods of activity are
included in plant assets.
Long-term assets acquired for resale in the normal course of business are not
classified as plant assets, regardless of their permanent nature or the length of
time they are held. For example, undeveloped land or other real estate Acquired
as an investment for resale should be listed on the balance sheet in the asset
section entitled investments.
Characteristics of plant Assets
An asset to be considered as a plant asset it must fulfill the following three
characteristics:
(1)
(2)
(3)

T he asset must be owned and held for use and not for resale (investment)
The asset must have an expected life of more than one year (are long-lived).
The asset must have physical characteristics (be tangible in nature)

4.2 Initial Cost of Acquiring Plant Assets

What is included in the cost of acquiring a plant asset? The cost of acquiring a plant
asset includes all amount spent (cash and/or cash equivalent given up) to acquire an asset
in a place and condition ready for use. Thus, costs include all normal, reasonable, and
necessary expenditures to obtain the asset and get it ready for use.
Costs not necessary for getting an asset ready for use do not increase the assets
usefulness and should not be included in its cost.
(1) Land includes costs of:

Purchase price

Sales taxes

Permits from government agencies

Brokers commissions

Title fees

Surveying fees

Delinquent real estate taxes

Razing or removing unwanted buildings, less the salvage

Grading and leveling

Paving a public street bordering the land

(2) Buildings
The costs of constructing a building include:
Architects fees
Engineers fees
Insurance costs incurred during construction
Interest on money borrowed to finance construction
Walkways to and around the building, and
All other necessary costs related to the project

The costs of purchasing an existing building include:

Purchase price
Sales taxes
Repairs (purchase of existing building)
Reconditioning (purchase of an existing building)
Modifying for use
Permits from governmental agencies
(3) Machinery and Equipment includes costs of:
Purchase price, less cash discounts, if any
Sales taxes
Freight
Installation
Repairs (purchase of used equipment)
Reconditioning (purchase of used equipment)
Insurance while in transit
Assembly
Modifying for use
Testing for use
Permits from governmental agencies
(4) Land Improvements
Trees and shrubs
Fences
Parking areas
Outdoor lighting
Concrete sewers and drainage
Paved parking areas
Cost of Acquiring Fixed Assets Excludes:
Vandalism
Mistakes in installation
Uninsured theft
Damage during unpacking and installing
Damage due to employees carelessness or improper handling of an asset
Fines for not obtaining proper permits from government agencies
Example1: ABC Company acquired land to construct a new warehouse, paying Br
40,000 and giving a short term note for Br 80,000. Legal fees paid were Br 6,000. Fees
paid to remove the old building from the land were Br 16,000. Materials salvaged from
the demolition of the building were sold for Br 4,200. A contractor was paid Br 260,000
to construct the warehouse.
Required:
1) Determine the cost of the land to be reported on the balance sheet.
2) Journalize the acquisition of the land.

Solution:
(1) Purchase price
Cash
Short term note
Legal fees
Cost of demolishing an old building
Less: Salvage value
Acquisition cost of the land

Br 40,000
80, 000
Br120, 000
6,000
Br 16,000
(4,200)

11,800
Br 137,800

(2) Land
137,800
Cash
57,800
Notes Receivable
80,000
Example 2: L Company purchased a heavy machine to be used in its factory for
Br 150,000, less a 2% cash discount. The company paid a fine of Br 5,750 because an
employee hauled the machine over city streets without securing the required permits.
The machine was installed at a cost of Br 4,000 and testing costs of $1,500 were incurred
to place the machine in operation.
Required:
1) Determine the cost of the machinery to be reported on the balance sheet.
2) Journalize the acquisition of the machinery.
Solution:
(1) Purchase price
Br 150,000
Less: Cash discounts
3,000
Br 147,000
Installation cost
4,000
Testing costs
1,500
Br 152,500
(2) Machinery
152,500
Cash
152,500
4.3. Depreciation of Plant Assets
Land has unlimited life and therefore can proved unlimited services. On the other
hand, other plant assets such as equipment, buildings, and land improvements lose
their ability, over time, to provide services. As a result, the costs of equipment
buildings and land improvements should be transferred to expense accounts in a
systematic manner during their expected useful lives. This periodic cost
expiration is called depreciation.

Depreciation is recorded on plant assets except land. Depreciation is the amount

of plant asset cost allocated to each accounting period benefiting from the assets
use and is a process of allocation not valuation.
Since eventually all assets except land wear out or become so in adequate or
outmoded that they are sold, discarded or exchanged depreciation must be
recorded on every plant asset except land. Depreciation is recorded even when
the market value of a plant asset temporarily rises and is greater than its original
cost, because eventually the asset will no longer be useful
Major causes of depreciation are

(1) Physical depreciation: Caused by wear and tear from use and from the action of
the elements decreases usefulness.
(2) Functional depreciation: Caused by in adequacy and obsolescent decreases
usefulness
- A plant asset becomes inadequate if its capacity is not able to meet the
demands of increased production.
- A plant asset is obsolete if the item it produces is no longer in demands or
if a newer machine can produce in item of better quality at the same or
lower cost
- The obsolescence of an asset is its decline in usefulness brought a bout by
inventions and technological progress.
The use of a plant asset in business operations transforms a plant asset cost into an
operating expense. Depreciation, then, is a cost of operating a business.

Common Misconceptions
The meaning g of the term depreciation as used in accounting is often
misunderstood because the same term is also used in business to mean a
decline in market value of an asset. However, the amount of a plant
assets unexpired cost reported in the balance sheet usually does not agree
with the amount that could be realized from its sale. Plant assets are held
for use in a business rather than for sale. It is assumed that the business
will continue as a going concern. Thus a decision to dispose of a plant
asset is based mainly on the usefulness of the asset to the business and not
on its market value.
Another common misunderstandings that depreciation accounting
provides cash needed to replace plant assets as they wear out. The cash
account is neither increased nor decreased by the periodic entries that
transfer the cost of plant assets to depreciation expense accounts. The
misunderstanding probably occurs because depreciation unlike expense
accounts. T he misunderstanding probably occurs because depreciation
unlike most expenses, does not require an outlay of cash in the period in
which it is recorded.
5

When a plant asset is acquired it often requires an outlay of cash. This

outlay affects the cash flows of the business. Although depreciation is a
major expense for many businesses it does not require a cash outlay.
Therefore, in evaluating a businesss cash generating ability, many
creditors and investment analysts add back depreciation expense to the
reported net income of the business. This added back Feature of
depreciation expense gives rise another misconception that it is a source of
cash flow. The adding back however is simply a recognition that no cash
outflow occurred, since depreciation does not require cash outlay (non
cash expense). Although the initial acquiring cost of a plant asset is a cash
flow (out lay), it is the only cash flow. The periodic allocation the cost of
a plant asset as a period expense only requires a book entry.
Because depreciation does not require a current cash outlay, it is often
called a noncash expense cash was given up in the period when the asset
was acquired not during periods when depreciation expense is recorded.
Accounting for Depreciation
To compute Depreciation Expense accountants consider three major factors:
1. The plant assets initial cost
2. Its expected useful life and
3. Its estimated values at the end its useful life. This third factor is called the residual
value, scrap value salvage value or trade in value.

The initial cost of acquiring an asset includes all amounts spent to get an asset in
place and ready for use.
Useful life refers to the length of time the company owning the asset intends to use it
useful life is not necessarily the same time period as either economic life or physical
life. The economic life of a car may be seven years and its physical life may be l0
year but if a company was a policy of tracing cars every three years the useful life for
depreciation purposes is three years.
Useful life may be expressed in year months working yours hours units of
production
Residual value (or salvage value) is the amount of money the company expects to
recover less disposal costs on the date of plant asset is scrapped sold or trade - in.
The relationship among the three factors and the periodic depreciation expense can be
show as follows
Initial cost

Minus

Residual Value

equals

Depreciable
Cost
(3) Useful life

Y
r
1

Y
r
2
1

Y
r
3
1

Y
r
4
1

Y
r
5
1

Periodic depreciation expense

If a plant asset is expected to have no or to be very small (insignificant) residual value
compared to the cost of the asset, then its initial cost should be spread over its expected
useful life as depreciation expense.
If a plant asset expected to have a significant residual value the difference between is
initial cost and this value is the cost (called depreciable cost) that should be spread over
the assets useful life as depreciation expense.
In determining the amount of periodic depreciation both residual value and useful life of
the plant asset must be estimated at the time the asset is placed in to service.
There are no set rules for estimating both factors may be affected by management polices
climate use and maintenance will also affect the estimates.
In addition to the many factors that may affect the useful life of an asset various degrees
of accuracy may be used in the computations. A month is normally the smallest unit of
time used. When this period of time is used all assets placed in or taken out of service
during the first half of a month are treated as if the event occurred on the first day of that
month. Likewise, all plant asset additions and deductions during the second half of a
month are treated as if the event occurred on the firs day of the next month.
4.3.1. Depreciation Methods
Today many different methods are available for calculating depreciation on assets. The
most common methods are straight-line, units -of -production and two accelerated
depreciation methods (double-declining balance and sum- of- the years- digit).
As it is true for inventory costing methods, a company is normally free to adopt the
method (s) of depreciation it believes most appropriate for its business operations the
theoretical guide line is to use a depreciation method that reflects most closely the actual
underlying economic circumstances. Thus, companies should adopt the depreciation
method that allocated plant assets costs to accounting periods according to the benefits
received form the use of the asset.
It is not necessary that a business use a single method of computing depreciation for all
its depreciable assets. A company has an option to use one method for certain assets and
another method for other assets.
It is necessary for a depreciation method to meet only one standard: The depreciation
method must allocate plant asset cost to accounting periods in a systematic and
rational manner.

Regardless of the methods (s) chosen the company must disclose its depreciation method
in the footnotes to its financial statements. This information will always be included in
the first footnote which contains a summary of significant accounting polices.
The illustrations of the four depreciation methods given below are based on the following
data: On January 1, 2000 a machine was purchased for Br 27, 000 with an estimated
useful life of 10 years, or 50, 000 units of output and an estimated salvage value of
Br 2000.
1. Straight line method
The straight line method is simple and is widely used.
The straight- line depreciation method provides for equal amounts of periodic
expenses over the estimated useful life of the asset.
It provides a reasonable allocation of costs to periodic expense when the usage of the
asset and the related revenues from its use are about the same form period to period
The formula for calculating deprecation under the straight- line method is

Annual depreciation = Asset Cost- Estimated Salvage Value

No of accounting periods in estimated useful life
Using our example of machine purchased for Br 27, 000 the annual depreciation on
expense is Br 2, 500 [(27, 000-2000) 10]

When an asset is used for only part of a bear the annual depreciation is prorated for
example, Assume the previous example but the machinery purchased on January 1, 2000
was placed in a usable condition on June 20, 2000. The depreciation for 2000 would be
Br 1250 (Br2500X6/12) computed on the basis of 6 months.
For ease in applying the straight line method the annual depreciation may be converted to
percentage of depreciable cost. This percentage is determined by dividing 100% by the
number of years of useful life. For example a useful life of 20 years converts to a 5%
(100 % 20) rate, 8 years converts to a 12.5% (100% 8) rate and so on. To further
illustrate the straight line rate for the above example is 10% (100 10). The annual
depreciation of Br 2500 can be computed by multiplying the depreciable cost of Br
25,000 by 10%.
The depreciation rate may also be expressed as a fraction. For example the annual
straight line rate for an asset with 10- year useful is 1/10.
Use of the straight line method is appropriate for assets where (1) time rather than
obsolescence is the major factor limiting the assets life and (2) relatively constant
amounts of periodic services are relived from the asset. Assets that possess these features
include pipelines fencing and storage tanks.
2. Units of production (out put) method
8

The units of production depreciation method yields depreciation

expense that varies with the assets usage(Productivity)
In applying this method, the useful life of the asset is expressed in
terms of units of productive capacity such as hours

The units of - production depreciation method assigns an equal

amount of depreciation to each unit of product manufactured or
service rendered by an asset. Since this method of deprecation is
based on physical output it is applied insinuations, where the main
factor leading to the depreciation of the asset.
Under this method first the depreciation expense per unit of out put
is computed; then this figure is multiplied by the number of units
of goods or services produced during the accounting period to find
the periods depreciation expense.
The formula is:

Depreciation per unit = Asset cost Estimated salvage value

Estimated total units of production (or service)

Depreciation per period = Depreciation

per unit X number of units
of
goods or services produced.
The depreciation charge for the Br 27,000 machine is Br 0.50 per
unit [(27000-2000) 50,000 units]. If the machine produced 1000
units in 2000 and 2500 units in 2001, depreciation expense would
be Br 500 and Br 120, respectively.

Accelerated Depreciation Methods

Accelerated depreciation methods record higher amounts of depreciation during the early
years of an assets life and lower amounts in the asset later years. A business might
choose an accelerated depreciation method for the following reasons:
1. The value of the benefits received from the asset decline with age (for example.
office buildings).
2. Repairs increase substantially in the assets later years. And under this method the
depreciation repairs together remain fairly constant over the assets life (for
example, automobiles).
The two most common accelerated methods of depreciation are: the sum-of the yearsdigits (SOYD) method and the double-declining-balance (DDB) method.
3. Sum-of-the- years-digit method.
The Sum of the years digits (SOYD) method is so called because the consecutive digits
for each year of an assets estimated life are added together and used as the denominator
of a fraction. The numerator is the number of years of useful life remaining at the
beginning of the accounting period. This fraction is then multiplied by the acquisition
9

cost of the asset less the estimated salvage value to compute the periodic depreciation
expense.
The formula is:
Number of years of useful life
Periodic
remaining at beginning
Depreciation =
of accounting period

Asset - Estimated
Expense
SOYD
Cost Salvage value
The years are totaled to find SOYD. For an asset with a 10 year useful life,
SOYD=10+9+8+7+6+5+4+3+2+1=55.
Alternatively, rather than adding the digits for all year together, the following formula can
be used to find the SOYD for any given number of periods:
SOYD = n (n+1)/2
Where n is the number of periods in the assets useful life. Thus, SOYD for an asset with
a 10 year useful life is:
SOYD = 10(10 + 1) = 55
2
The SOYD method is applied to the data given earlier for the $27,000 machine as
follows. First, determine that at the beginning of year 1 (2000), the machine has 10 years
of useful life remaining. Then, using the formula above, compute the first years
depreciation as 10/55 times $25,000 (the $27,000 cost less the $2,000 salvage value). The
depreciation for the first year is $4,545. Note that the fraction gets smaller every year,
resulting in a declining depreciation charge for each successive year.
4. Double-Declining Balance Method.
The double declining-balance (DDB) method of computing periodic depreciation
charges is applied by first calculating the straight-line depreciation rate. The straight-line
rate is calculated by dividing 100% by the number of years of useful life of the asset.
Then multiply this rate by 2. The resulting rate is applied to the declining book value of
the asset. Salvage value is ignored in marking annual calculation. However at the point
where book value is equal to the salvage value no more depreciations taken. The formula
for DDB depreciation is:
Deprecation = (2 Straight-line rate) (Asset Accumulated)
Expense
Cost
depreciation
The straight-line rate is 10% (100%/10 years) which, when doubled yields a DDB rate of
20%. Since at the beginning of year 1 no accumulated depreciation has been recorded, the
calculation is based on cost. In each of the following years, the calculation is based on
book value at the beginning of the year.
In the 10th year, depreciation could be increased to $1,624 if the asset is to be retired and
its salvage value is still $2,000.

10

4.4. capital and revenue expenditure

Capital ExpendituresExpenditures- are expenditures that improve the operating efficiency (or
capacity) or costs incurred to achieve greater future benefits.
In addition to the acquisition of plant assets, capital expenditures included additions and
betterments.
An addition is an enlargement to the physical layout of a plant asset. Suppose for
example, if a new wing is added to a building, the benefits from the expenditure will be
received over several years, and the amount paid for it should be debited to the asset
account.
Betterment, on the other hand, is an improvement that does not add to the physical
layout of the asset. Installation of an air conditioning system is an example of betterment,
Replacement of a concrete floor for a wooden floor is also betterment that will provide
benefits over a number of years, so its cost should be charged (debited) to an asset
account.
Another types of capital expenditures include extraordinary repairs.
repairs. Extraordinary
repairs are repairs of a more significant nature. They affect the estimated residual value or
estimated useful life of an asset. For example, a boiler for heating a building may be
given a complete overhaul, at a cost of Br. 3000 that will prolong its economic life by 5
years.
Extraordinary repairs are recorded by debiting the accumulated depreciation account,
under the assumption that some of the depreciation previously recorded has now been
eliminated. The effect of this reduction in the accumulated depreciation account is to
increase the book value of the asset by the cost of the extraordinary repair. As a result, the
new book value of the asset should be depreciated over the new estimated useful life.
Illustration
Suppose for example, a machine costing Br. 35,000 had no estimated residual value and
an original estimated useful life of ten years, has been depreciated for 7 years. At the very
beginning of the 8th year, the machine was given a major overhaul costing Br. 3000.
This expenditure extended the useful life of the machine 3 years beyond the original
estimate. The computation of the new book value and the entry for the extraordinary
repair would be as follows:
Solution
To record extraordinary repair
Jan. 4. Accumulated Depreciation Machinery3000.00
Cash 3000.00
(Extraordinary
(Extraordinary repair to machinery)
The revised annual depreciation for each of the six years remaining in the machines
useful life would be calculated as follows:
11

Cost of Machine
Birr 35,000
Accum. Depreciation before extraordinary repair
Br. 24,500
Less: extraordinary repair (Debited to Accum. Depr.).3000
21,500
Depr.).3000
Book value (carrying value) after extraordinary repair
Br.13,500
Revised Annual periodic depreciation= 13500.
2,250
13500.2,250
6 years

Revenue expenditures
Revenue expenditures are expenditures incurred in order to maintain the normal
operating efficiency of the asset.
Among the more usual kinds of revenue expenditures for plant asset are the repairs,
maintenance, lubrication, Cleaning and inspection necessary to keep an asset in good
working condition.
Ordinary repairs are expenditures that are necessary to keep an asset in good operating
conditions. Trucks must have tune-ups, their tires and batteries must be replaced
regularly, and other routine repairs must be made. Offices and halls must be painted
regularly, and broken tiles or woodwork must be replaced. Such repairs benefits only the
current period and therefore must be charged against the revenue in the current fiscal
period.
4.5. Disposals of plant assets
A plant asset rarely lasts exactly as long as its estimated life. If it lasts longer than its
estimated life, it is not depreciated past the point at which its carrying value equals its
residual value. The purpose of depreciation is to spread the depreciable cost of the asset
over the economic life of the asset. Thus, the total accumulated depreciation should never
exceed the total depreciable cost. If the asset is still used in the business beyond the end
of its estimated life, its cost and accumulated depreciation remain in the ledger accounts.
Proper records will thus be available for maintaining control over plant assets. If the
residual value is zero, the book value of a fully depreciated asset is zero until the asset is
disposed off. If such an asset is discarded, no gain or loss result. A plant asset may be
disposed by:
(1) Discarding it as worthless; (2) Selling it; or (3) Trading it in on a new asset
4.5.1. Recording Discarding of a Plant Asset
If a plant asset is of no further use to the business and cannot be sold or traded, then the
plant asset is discarded. If the asset has no book value (i.e., if it is fully depreciated), the
plant asset account is credited for the amount of the original cost of the item being
discarded. At the same time, the accumulated depreciation account is debited for the
12

amount of the total accumulated depreciation of the item being discarded. In this case
neither gain nor loss is realized. On the other hand, if a plant asset has a book value (if
not fully depreciated) at the time it is discarded, the business incurs a loss.
Illustration
Suppose for example, on July 5, year 5, equipment that was acquired On Jan 10, year 1,
at a cost of Br. 11,000, is discarded as worthless. The discarded equipment has a carrying
value of Br. 2000 at the time of disposal. The carrying value is computed as the
difference between the cost of asset Br. 11,000 and accumulated depreciation, Br. 9000. A
loss equal to the carrying value should be recorded when the equipment is discarded.
Solution:
The journal entry required to discard the plant asset as of July 5, year 5, is:
Year 5
July 5. Accumulated Depreciation, Equipment 9000.00
Loss on disposal of plant Asset2000.00
Equipment .11000.00
(Discarding Equipment no longer used in the business)
4.5.2 Recording the Sale of Plant Asset
The entry to record the sale of an asset for cash is similar to the one illustrated above
except that the receipt of cash should also be recorded. The following entries show how
to record the sale of equipment under three assumptions about the selling price. In the
first case, the Br. 2000 cash received is exactly equal to the book value of the equipment
(which is equal to Br. 2000).
Case- 1 Sold at an amount equal to Book value, Br. 2000, no gain or loss results
Year 5
July 5. Cash 2000.00
Accumulated Depreciation, Equip...9000.00
Equipment ..11000.00
( Sale of equipment at an amount equal to book
value)
Case- 2 Sold at Br. 1500 cash; Loss of Br. 500, (BV = Br. 2000)
Year 5
July 5. Loss on sale of equipment.500.00
Accumulated Depreciation 9000.00
Cash .1500.00
Equipment11000.00
(Sale of equipment at less than the book value Loss of Br. 500)
Case- 3 Sold at Br. 3000 cash; gain of Br. 1000, cash received through
13

Sale less book value of the asset (Br. 3000 Br. 2000)
Year 5
July 5.
Cash .3000.00
Accumulated Depr, Equipment9000.00
Equipment..11000.00
Gain on sale of plant asset...1000.00
(Sale of equipment at more than the book value; gain of Br. 1000,
(Br. 3000 Br.2000) recorded)
4.5.3. Recording Exchange of Plant Assets
Businesses also dispose of plant assets by trading them in on the purchase of other plant
assets. Exchanges may involve similar assets, such as an old machine traded-in on a
newer model, or dissimilar assets, such as a machine traded-in on a truck. In either case,
the purchase price is reduced by the amount of the trade-in allowance.
The basic accounting for exchanges of plant assets is similar to accounting for sales of
plant assets for cash. If the trade-in allowance received is greater than the carrying value
of the assets surrendered, there has been a gain. If the trade-in allowance is less than the
carrying value, there has been a loss.
There are special rules for recognizing these gains and losses, depending on the nature of
the assets exchanged.
Exchange
Losses
Gains
Recognized
Recognized
For Financial Reporting Purposes:
Of similar assets Yes.No
Of Dissimilar assets.. Yes.. Yes
For Income Tax purposes:
Of similar assets No..
Of dissimilar assets....Yes

No
Yes

Both Gains and Losses are recognized when a company exchanges dissimilar assets.
Assets are dissimilar when they perform different functions; assets are similar when they
perform the same function.
For financial reporting purposes, gains on exchanges of similar assets are not recognized
because the earning lives of the asset surrendered are not considered to be completed.
When a company trades-in an older machine on a newer machine of the same type, the
economic substance of the transaction is the same as that of a major renovation and
upgrading of the older machine.
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Accounting for exchange of similar assets is complicated by the fact that neither gains
nor losses are recognized for income tax purposes.
Loss Recognized on the Exchange
A loss is recognized for financial reporting purposes on all exchange in which a material
loss occurs.
Illustration
To illustrate the recognition of a loss, assume that the business exchange a machine with
a cost of Br. 11,000, and accumulated depreciation of Br. 9000 for a newer more modern
machine on the following terms:
Cost of new machine Birr 12000.
Trade-in Allowance for old machine (1500)
Cash payment required (Boot)..Birr 10500.

Solution
In the illustration above, the trade-in allowance (1500) is less than the carrying value (Br.
2000) of the old machine. The loss on the exchange is Br. 500, (Br. 2000 Br. 1500).
Therefore, the journal entry required to record the exchange of assets would be as
follows:
Year 5.
5.
July 5. Equipment (New)..12,000.00
Accum. Depreciation-Equip...9,000.00
Loss on Exchange of plant assets. 500.00
Equipment (old)11,000.00
Cash.. 10,500.00
4.6. Accounting for Intangible Assets and Natural Resources
Intangible Assets:
Assets: are long-term assets that do not have physical substance and in most
cases relate to legal rights or advantages held.
Intangible assets include patents, copyrights, trademarks, franchises, organization costs,
leaseholds, leasehold improvements, and goodwill. The allocation of intangible assets to
the periods they benefits is called amortization.
Intangible assets are accounted for at acquisition cost, that is, the amount paid for them.
Some intangible assets such as goodwill and trademarks may be acquired at little or no
cost. Even though they may have great value and be needed for profitable operations they
should not appear on the balance sheet unless they have been purchased from another
party at a price established in the market place.

15

The, Accounting Principles Board (APB) has decided that a company should record as
assets the costs of Intangible assets acquired from others. However, the company should
record as expenses the cost of developing intangible assets. Also, intangible assets that
have a determinable useful life such as patents, copyrights, and leaseholds, should be
written off through periodic amortization over that useful life in much the same way that
plant assets are depreciated.
Even though some intangible assets, such as goodwill and trademarks, have no
measurable limit on their lives, they should also be amortized over a reasonable length of
time (not to exceed forty years).
Illustration
Assume that on Jan 2, 2002 MOHA Soft Drink Bottling Company purchased a patent on
a unique bottle cap for Br. 54,000.
The entry to record the patent would be as follows:
2002
Jan 2. Patent..54,000
Cash..54,000
(To record the purchase of Bottle cap patent)
Assume that MOHAs management determines that, although the patent for the bottle cap
will last for seventeen years, the product using the cap will be sold only for the next six
years. The entry to record the annual amortization would be as follows:
Amortization Expense..9,000.00
Patent9,000.00
(To record annual amortization of patent (Br. 54000/ 6 years))
Note that the patent account is reduced directly by the amount of the amortization
expense. This is in contrast to other long-term asset accounts in which depreciation or
depletion is accumulated in a separate contra account.
If the patent becomes worthless before it is fully amortized, the remaining carrying value
is written off as a loss. For instance, assume that after the first two years MOHA soft
Drink Bottling Companys chief competitors offers a bottle with a new type of cap that
makes MOHAs cap obsolete. The entry to record the loss is:
Loss on patent36,000.00
Patent36,000.00
(To record the loss resulting from patents becoming worthless)
Depletion of Natural Resources

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We now turn our attention to another group of long-lived assets natural resources, such as
minerals, oil, and timber or lumber. These natural resources are extracted from the earth.
Depletion is the accounting measure used to allocate the acquisition cost of natural
resources. Depletion differs from depreciation because depletion focuses specifically on
the physical use and exhaustion of the natural resources, while depreciation focuses more
broadly on any reduction of the economic value of a plant or fixed asset. The costs of
natural resources are usually classified as long-terms assets.
Depletion expense is the measure of that portion of long-term assets that is used up in a
particular period.
Illustration
Suppose for example, MIDROC Construction has acquired the right to use 10,000 acres
of land in Kibre-Mengist territory to mine for gold at a total cost of, Br. 10,000.000. The
Company estimated that the mine will; provide approximately 500,000 grams of gold.
The depletion rate established is computed in the following manner.
Total cost Salvage value
= Depletion cost per unit.
Total estimated units available
Br. 10,000,000 = Br. 20 per gram
500,000 units
If 100,000 grams are extracted in the first year, then the depletion for the year is 2000.000
(1000, 000 x Br. 20.00). The entry to record the depletion is therefore:
Depletion Expense..2,000,000
Accumulated Depletion.2, 000,000

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