PRINCIPLES OF ACCOUNTING (503)

Chapter 08
ACCOUNTING FOR FIXED ASSETS:

PLANT ASSETS

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PLANT ASSETS
Plant assets (Three Characteristics)
Have physical substance (a definite size and shape) Used in the operations of a business Not intended for sale to customers

Plant assets are subdivided into four classes:

1. Land 2. Land Improvements 3. Buildings 4. Equipment
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COST OF PLANT ASSETS

Plant assets are recorded at cost in accordance with the cost principle. Cost
Consists of all expenditures necessary to acquire the asset and make it ready for its intended use Includes purchase price, freight costs, and installation costs

Expenditures that are not necessary

Recorded as expenses, losses, or other assets
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COST OF LAND
The cost of Land includes: 1. Cash purchase price 2. Closing costs such as title and attorneys fees 3. Real estate brokers commissions 4. Accrued property taxes and other liens on the land assumed by the purchaser. All necessary costs incurred to make land ready for its intended use are debited to the Land account.
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COST OF LAND
Sometimes purchased land has a building on it that must be removed before construction of a new building. In this case, all demolition and removal costs, less any proceeds from salvaged materials are debited to the Land account.

Land Cash price of property Net removal cost of warehouse Attorneys fee Real estate brokers commission Cost of land
September 2, 2013

100,000 6,000 1,000 8,000 115,000

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LAND IMPROVEMENTS
The cost of land improvements includes all expenditures needed to make the improvements ready for their intended use such as:

1. Parking lots 2. Fencing 3. Lighting

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COST OF BUILDINGS
The cost includes all necessary expenditures relating to the purchase or construction of a building costs include the purchase price, closing costs, and brokers commission Costs to make the building ready for its intended use include expenditures for remodeling and replacing or repairing the roof, floors, wiring, and plumbing If a new building is constructed, costs include contract price plus payments for architects fees, building permits, interest payments during construction, and excavation costs
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COST OF EQUIPMENT
Cost of equipment
consists of the cash purchase price and certain related costs costs include sales taxes, freight charges, and insurance paid by the purchaser during transit includes all expenditures required in assembling, installing, and testing the unit

Recurring costs such as licenses and insurance are expensed as incurred.

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COST OF MACHINERY
Factory Machinery Cash price Sales taxes Insurance during shipping Installation and testing Cost of factory machinery 50,000 3,000 500 1,000 54,500

The summary entry to record the cost of the factory machinery and related expenditures is as follows:

September 2, 2013

Factory Machinery Cash

54,500 54,500
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COST OF DELIVERY TRUCK

Motor vehicle licenses and accident insurance on company cars and trucks are expensed as incurred, since they represent annual recurring events that do not benefit future periods.

Delivery Truck Cash price 2,200,000 Sales taxes 50,000 Painting and lettering 50,000 Cost of delivery truck 2,300,000

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DEPRECIATION
Depreciation
allocation of the cost of a plant asset to expense over its useful (service) life in a rational and systematic manner.

Cost allocation
provides for the proper matching of expenses with revenues in accordance with the matching principle.

Usefulness may decline because of wear and tear or obsolescence. Depreciation does not result in an accumulation of cash for the replacement of the asset. Land
is the only plant asset that is not depreciated.
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FACTORS IN COMPUTING DEPRECIATION

Three factors that affect the computation of depreciation are:

1. Cost: All expenditures necessary to acquire the asset and make it ready for intended use 2. Useful life: Estimate of the expected life based on need for repair, service life, and vulnerability to obsolescence

3 Salvage value: Estimate of the assets value at the end of its useful life

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DEPRECIATION

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DEPRECIATION METHODS
Three methods of recognizing depreciation are: 1. Straight-line 2. Units of activity 3. Declining-balance and 4. Sum-of-the-Year-Digits Method Each method is acceptable under GAAP. Management selects the method that is appropriate in the circumstances. Once a method is chosen, it should be applied consistently.
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DEPRECIATION METHODS

4% Declining balance 5% Units-of-activity 82% Straight-line

9% Other

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OFFICE EQUIPMENT DATA

Compare the three depreciation methods, using the following data for an office equipment purchased by Badal on January 1, 2005.

Cost Expected salvage value Estimated useful life in years Estimated useful life in units

Tk. 13,000 Tk. 1,000 5 100,000

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STRAIGHT-LINE
Straight-line method
Depreciation is the same for each year of the assets useful life. It is measured solely by the passage of time.

It is necessary to determine depreciable cost. Depreciable cost

total amount subject to depreciation and is computed as follows:

Cost of asset - salvage value

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STRAIGHT-LINE METHOD
Depreciation Expense = Depreciable Cost / Useful Life (in years)

Cost

Salvage Value

Depreciable Cost

Tk. 13,000

Tk. 1,000

= Tk. 12,000

Depreciable Cost

Useful Life (in Years)

Annual Depreciation Expense

Tk. 12,000
September 2, 2013

Tk. 2,400
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UNITS-OF-ACTIVITY
Useful life = total units of production or total expected use expressed in hours, miles, units, etc.
Depreciable Cost Total Units of Activity = Depreciation Cost per Unit Depreciation Cost per Unit x Units of Activity During the Year = Annual Depreciation Expense
It is often difficult to make a reasonable estimate of total activity. When productivity varies from one period to another, this method results in the best matching of expenses with revenues.
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UNITS-OF-ACTIVITY METHOD
Depreciable Cost

Total Units of Activity

Depreciable Cost per Unit

Tk. 12,000
Depreciable Cost per Unit

100,000 units = Tk. 0.12

Units of Activity during the Year

Annual Depreciation Expense

Tk. 0.12
September 2, 2013

15,000 units = Tk. 1,800

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DECLINING-BALANCE
Decreasing annual depreciation expense over the assets useful life Periodic depreciation is based on a declining book value (cost - accumulated depreciation) To compute annual depreciation expense Multiply the book value at the beginning of the year by the declining-balance depreciation rate Depreciation rate remains constant from year to year book value declines each year
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DECLINING-BALANCE
Book value for the first year is the cost of the asset. Balance in accumulated depreciation at the beginning of the assets useful life is zero In subsequent years, book value is the difference between cost and accumulated depreciation at the beginning of the year. Formula :
Book Value at Beginning of Year x Declining Balance Rate = Annual Depreciation Expense

Method compatible with the matching principle the higher depreciation in early years is matched with the higher benefits received in these years.
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DECLINING-BALANCE METHOD
Unlike the other depreciation methods, salvage value is ignored in determining the amount to which the declining balance rate is applied. A common application of the declining-balance method is the double-declining-balance method, in which the decliningbalance rate is double the straight-line rate. If Badal uses the double-declining-balance method, the depreciation is 40% (2 x the straight-line rate of 20%).

Depreciable Cost (Book Value)

Depreciation Rate

Annual Depreciation Expense

Tk. 13,000
September 2, 2013

40%

Tk. 5,200
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Sum-of-the-Year-Digit
The sum-of-the-year-digit method provides decreasing charges by applying a series of fractions, each of a smaller value, to depreciable assets.
Denominator for the fraction =
N = useful life of the assets

n(n + 1) 2

Numerator for the fraction = Weight assigned to the specific year (remaining period the asset will be used)

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PATTERNS OF DEPRECIATION

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REVISING PERIODIC DEPRECIATION

Changes should be made
Excessive wear and tear or obsolescence indicate that annual depreciation estimates are inadequate.

When a change is made

No correction of previously recorded depreciation expense Depreciation expense for current and future years is revised

To determine the new annual depreciation expense

The depreciable cost at the time of the revision is divided by the remaining useful life.

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REVISED DEPRECIATION
Badal decides on January 1, 2008, to extend the useful life of the equipment one year because of its excellent condition. The company has used the straight-line method to depreciate the asset to date, and book value is (Tk. 13,000 Tk. 7,200 = Tk. 5,800) The new annual depreciation is;
Book value, 1/1/08 Less: Salvage value Depreciable cost Remaining useful life (2008-2010) = Tk. 5,800 1,000 Tk. 4,800 3 years

Revised annual depreciation (Tk. 4,800 3) Tk 1,600

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EXPENDITURES DURING USEFUL LIFE

Ordinary repairs
expenditures to maintain the operating efficiency and productive life of the unit such repairs are debited to Repairs Expense as incurred and are often referred to as revenue expenditures.

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EXPENDITURES DURING USEFUL LIFE

Capital expenditures Additions and improvements increase the operating efficiency, productive capacity, or useful life of a plant asset 1. Usually material in amount and occur infrequently. 2. Increase the companys investment in productive facilities. Debit the plant asset affected.

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PLANT ASSET DISPOSALS

Retirement Plant asset is scrapped or discarded. Eliminate the book value of the plant asset at the date of sale by debiting Accumulated Depreciation and crediting the asset account for its cost. Debit Cash to record the cash proceeds from the sale. Compute gain or loss. If the cash proceeds > the book value recognize a gain by crediting Gain on Disposal for the difference. If the cash proceeds are < the book value recognize a loss by debiting Loss on Disposal for the September 2, 2013 30 difference.

PLANT ASSET DISPOSALS

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GAIN ON DISPOSAL
On July 1, 2005, Wright Company sells office furniture for $16,000 cash. Original cost was $60,000 and as of January 1, 2005, had accumulated depreciation of $41,000. Depreciation for the first 6 months of 2005 is $8,000. The entry to record depreciation expense and update accumulated depreciation to July 1 is as follows:

Depreciation Expense Accumulated Depreciation

September 2, 2013

8,000 8,000
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GAIN ON DISPOSAL
After the accumulated depreciation is updated, a gain on disposal of $5,000 is computed:
Cost of office furniture Less: Accumulated depreciation ($41,000 + $8,000) Book value at date of disposal Proceeds from sale Gain on disposal $ 60,000 49,000 11,000 16,000 $ 5,000

The entry to record the sale and the gain on disposal is as follows:

Cash Accumulated Depr.-Office Furniture Office Furniture

September 2, 2013 Gain on Disposal

16,000 49,000 60,000 5,000

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LOSS ON DISPOSAL
Instead of the selling the office furniture for $16,000, Wright sells it for $9,000. In this case, a loss of $2,000 is computed:
Cost of office furniture Less: Accumulated depreciation ($41,000 + $8,000) Book value at date of disposal Proceeds from sale Loss on disposal $ 60,000 49,000 11,000 9,000 $ 2,000

The entry to record the sale and the loss on disposal is as follows:
Cash Accumulated Depr.-Office Furniture Loss on Disposal
September 2, 2013

9,000 49,000 2,000 60,000

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Office Furniture

LOSS TREATMENT
Losses on exchange of similar assets
recognized immediately

Cost of the new asset received

equal to the fair market value of the old asset exchanged plus any cash or other consideration given up

Losses result when the book value is greater than the fair market value of the asset given up. September 2, 2013

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COMPUTATION OF COST OF NEW OFFICE EQUIPMENT

Roland Company exchanges old office equipment for new similar office equipment. The book value of the old office equipment is $26,000 ($70,000 cost less $44,000 accumulated depreciation), AND its fair market value is $10,000, and $81,000 of cash is paid. The cost of the new office equipment, $91,000, is calculated as follows:

Fair market value of old office equipment Cash Cost of new office equipment
September 2, 2013

$ 10,000 81,000 $ 91,000

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COMPUTATION OF LOSS ON DISPOSAL

Through this exchange, a loss on disposal of $16,000 is incurred. A loss results when the book value is greater than the fair market value of the asset given up. The calculation is as follows:
Book value of old office equipment ($70,000 $44,000) Fair market value of old office equipment Loss on disposal $ 26,000 10,000 $ 16,000

In recording the exchange at a loss three steps are required: 1) eliminate the book value of the asset given up, 2) record the cost of the asset acquired, and 3) recognize the loss on disposal.
Office Equipm ent (new ) Accum ulated Depreciation-Office Equipm ent Loss on Disposal Office Equipm September 2, 2013 ent Cash (old) 91,000 44,000 16,000 70,000 37 81,000

GAIN TREATMENT Gains of similar assets

not recognized immediately, but, are deferred by reducing the cost basis of the new asset

Cost of the new asset

fair market value of the old asset exchanged plus any cash or other consideration given up

Gains result when the fair market value is greater than the book value of the asset given up
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COST OF NEW EQUIPMENT (BEFORE DEFERRAL OF GAIN)

Marks Express Delivery exchanges old delivery equipment plus $3,000 cash for new delivery equipment. The book value of the old delivery equipment is $12,000 ($40,000 cost less $28,000 accumulated depreciation), its fair market value is $19,000. The cost of the new delivery equipment, $22,000, is calculated as follows:

Fair market value of old delivery equipment Cash Cost of new delivery equipment (before deferral of gain)
September 2, 2013

$ 19,000 3,000 $ 22,000

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COMPUTATION OF GAIN ON DISPOSAL

For Marks Express Delivery, there is a gain of $7,000, calculated as follows, on the disposal:

Fair market value of old delivery equipment Book value of old delivery equipment ($40,000 $28,000) Gain on disposal
September 2, 2013

$ 19,000 12,000 $ 7,000

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COST OF NEW DELIVERY EQUIPMENT (AFTER DEFERRAL OF GAIN)

The $7,000 gain on disposal is then offset against the $22,000 cost of the new delivery equipment. The result is a $15,000 cost of the new delivery equipment, after deferral of the gain.
Cost of new delivery equipment (before deferral of gain) Less: Gain on disposal Cost of new delivery equipment (after deferral of gain) $ 22,000 7,000 $ 15,000

The entry to record the exchange is as follows:

Delivery Equipment (new ) Accumulated Depreciation - Delivery Equipment (old) Delivery Equipment (old)
September 2, 2013

15,000 28,000 40,000 3,000

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Cash

ACCOUNTING RULES FOR PLANT EXCHANGES

Type of Event Recognition

Loss Gain

Recognize immediately by debiting Loss on Disposal Defer and reduce cost of new asset

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Exercise- Change of estimation

At the beginning of 2003, Belal & Co. acquired equipment costing Tk. 60,000. It was estimated that this equipment would have a useful life of 6 years and a residual value of Tk. 6,000 at that time. During 2005, the companys engineers reconsidered their expectations, and estimated that the equipments useful life would probably be 7 years instead of 6 years. The residual value was not changed at that time. However, during 2008 the estimated residual value was reduced to Tk. 3,000. How much depreciation expense should be recorded for this equipment each of the year under straight-line method?
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