Financial Accounting

(PGDM- 2015-16)

Session -15: Accounting for Long-lived Assets

Sriranga Vishnu
Faculty (F&A Area)

Long-lived Assets Introduction

Tangible Assets Building, Plant, Machinery, Furniture, etc.
Depreciate over a period of time

Intangible Assets Non-physical entities Patents, Software, Goodwill,

etc.
Amortized over a period

Natural Resources Land, Coal, Oil, etc.

Deplete with passage of time

Acquiring Plant and Equipments

Low Cost Items Generally expensed; Limit
varies
Capitalized facility may contain low cost items;
expensed when replaced

Maintenance and Betterment- Maintenance

is upkeep; Generally expensed. Betterment is
up-gradation; Treated as asset and capitalized
Replacement Can be an asset or expanse
Replacement of a component / part of asset is
expensed

Acquiring Plant and Equipments

Items included in cost All expenditure done
in order to make an equipment ready to use.
Capitalization is higher if all costs are included
For simplicity and property tax purposes, only purchase
price is considered

For self-constructed assets- All material,

direct labour and fair amount of indirect costs are
added. Interest cost is also added for
capitalization
If Interest cost is capitalized and not expensed, current
year Income increases but decreases for subsequent
years of assets useful life

Acquiring Plant and Equipments

Non-Cash Items During exchanges, fair market
value of the acquired tangibles is estimated; if
not possible, value of new asset is used
Assets acquired through donations or at
substantially low prices are recorded at fair
value.
Basket Purchase A group of items clubbed
together. The firm should make prudent
estimates to separate the cost of items
component-wise

Accounting for Depreciation

Depreciation
item

Expensing

the

capitalized

Deterioration and Obsolescence limit the life of an

asset

Residual or Salvage value

Useful life of the asset Service Life
Methods of Depreciation

Straight Line
Declining Balance (Written Down method)
Sum of years' digit method
Units of Production method

Methods of Depreciation
Straight Line Method Net acquisition cost is
expensed over useful life of asset in equal amounts
Calculation is relatively simple
Cost and revenue are matched

Written Down Method A depreciation percentage

is applied on the acquisition cost at the beginning of
the accounting period. Asset is never completely
written-of

The amount for final period is simply written of

The method matches the services provided by an asset
Risk of obsolescence is reduced
Lower income in the initial years, higher subsequently

Methods of Depreciation
Sum of years' digit method Similar to Written down
method. Depreciation is applied to net cost. The rate of
depreciation is determined by dividing the remaining
useful life of the asset by the sum of the useful life
Units-of-Production method The depreciation rate is
determined by dividing the net cost by the estimated
total no. of units that will be produced during useful life.
This rate is then multiplied by no. of units
produced/year
This method is related with usage of assets
Depreciation is matched with level of activity
Estimation of products to be produced is difficult

Accounting for Depreciation

For tax purposes, firms normally use the
written-down method, For Financial Reporting,
any of the methods can be chosen consistently
For diferent kinds of assets, diferent methods
can be adopted. However, firms generally stick
to a single method
If an item has been fully depreciated and is still
in possession of the firm, it is shown in B/S at
zero amount

Accounting for Natural

Resources
For natural resources, the term Depletion is used.
When extracted, they are treated as inventory
Cost allocation for extraction of natural resources:
Full cost method all costs are capitalized
Successful eforts method success costs are
capitalized, others are expensed

Depletion of natural resources is shown by unitsof-production method. For taxation, percentage of

revenue is taken

Accounting for Intangible Assets

For intangible assets having limited useful
life, amortization is done Patents and
copyrights
They should be amortized according to legal
provisions

If the intangible asset has indefinite useful

life, periodic impairment is done Goodwill
Improvements in lease occupations should be
amortized by the end of probable lease life

Accounting for Intangible Assets

Deferred charges for long-lived intangibles are
expensed. If capitalized, amortization is done in a
short period
R&D expenses are treated as period costs expensed
because future benefits are very uncertain (matching
and conservatism concepts)
If R&D is done for a client, it is treated as revenuecosts are charged as expense
In case of Software development, costs
capitalized when product feasibility is assured

are