Accounting for fixed ASSETS AND INTANGIBLE ASSETS

CHAPTER FIVE
PLANT ASSETS AND INTANGIBLE ASSETS
1. Plant assets (non-current assets) represent future
economic benefits which are expected to be
consumed at a slow pace (generaly over more than
one financial year.
• Every fixed asset can be considered an unexpired
expense, and at balance sheet date a company must
review to what extent the individual asset has been
consumed during the accounting period.
• The cost of the plant asset is entered in an asset
account, which in essence represents the advance
purchase services.

Con’d
• For example, a building represents the advance
purchase of many years of housing services.
• As the years go by, these services are utilized by
the business, and the cost of the plant asset
gradually is transferred to depreciation expense
to reflect the cost of using the asset to
generate revenue.

Major Categories of plant assets
a) Intangible
 Do not have physical existence
 Examples, include goodwill, copyrights, patents,
trademarks, franchises, etc
 The costs of acquired intangible assets amortized
over their estimated economic lives.
Activity: Are accounts receivable included in the
category of Intangible assets?
b) Tangible
 They do have physical existence
 They are sub classified into plant assets and natural
resources

Con’d
i) Acquired for use in operation but they are not incorporated into finished goods as raw
materials do.
 Examples of plant assets include land; buildings,
machinery, equipment, leasehold improvements, etc.
 Almost all plant assets have limited economic lives.
 As a result their cost is converted to expense over the
period of economic lives through the process of
depreciation. The only exception to this limited life
feature is land, so land is not going to depreciate.
ii) Natural Resources: A site acquired for the purpose of
extracting or removing some valuable resources such as oil,
minerals, or timber is classified as a natural resource.
 The costs of acquiring and developing natural resources is
allocated to expenses through a process of depletion

Accounting issues of Plant assets
• Three basic accounting issues of the plant assets:
 Accounting for the acquisition of plant assets
 Allocation of the acquisition of cost to expense over
the asset’s useful life
 Accounting for disposal of plant assets.

How to Value Plant Assets: At Cost or at Market Value?
• The accounting profession is moving toward market-
value accounting.
• However;
• The business community is not yet ready to apply
market-value accounting to tangible plant assets.

Cost of a plant asset.
• The cost of a plant asset includes all expenditures that are
reasonable and necessary for getting the asset to the
desired location and ready for use.
• Only reasonable and necessary costs should be included.
• Activity : Assume that an asset is dropped and damaged
resulted from carelessness of the laborers while it is
being unloaded . How do you treat the cost requires to
repair this asset ? ( It should be expensed, it should be
added to the cost of asset). Give your justification.

Con’d
• The cost of repairing this damage should be
recognized as an expense of the current period, not
added to the cost of the machine.
• Although it is necessary to repair the machine, it was
not necessary to drop it-and that's what brought about
the need for the repairs.

Elements of acquisition cost
• Elements of acquisition costs may be differ from one item
of asset to another. Keeping the general statement given
above on cost of a plant asset, the cost of an item of
property, plant and equipment comprises:
 its purchase price, including import duties and
non-refundable purchase taxes, after deducting
trade discounts.
 any costs directly attributable to bringing the
asset to the location and condition necessary for
it to be capable of operating in the manner
intended by management.

Con’d
Examples of directly attributable costs are:
• costs of employee benefits arising directly from the
construction or acquisition of the item of property, plant and
equipment;
o costs of site preparation;
o initial delivery and handling costs;
o installation and assembly costs;
o costs of testing whether the asset is functioning properly, after
deducting the net proceeds from selling any items produced
while bringing the asset to that location and condition (such
as samples produced when testing equipment); and
o professional fees.

CONT….
 Consider the following examples for determining the
acquisition cost of a plant asset
 Determining the Cost of Land
• Eg. A business signs a $300,000 note payable to
purchase land for a new store site. It pays $10,000 in
back property tax, $8,000 in transfer taxes, $5,000 for
removal of an old building, a $1,000 survey fee, and
$260,000 to pave the parking lot.
• What is the cost of the land?

Con’d
Purchase price of land $300,000
Add related costs:
Back property taxes $10,000
Transfer taxes 8,000
Removal of buildings 5,000
Survey fees 1,000
24,000
Total cost of land $324,000

CONT…
Determining the Cost of Buildings
 Purchase price
 Brokerage commissions
 Sales and other taxes
 Repairing or renovating building
Determining the Cost of Machinery and Equipment
Purchase price less discounts
 Transportation charges
 Insurance in transit
 Sales and other taxes
 Purchase commission
 Installation costs
Expenditures to test the asset

Lump-Sum (or Basket) Purchases of Assets
• When land and buildings (and perhaps other assets) are
purchased for a lump sum, the purchase price (cost)
must be allocated among the types of assets acquired.
• An appraisal may be needed for this purpose
• Assume, for example, Sports company Purchases a
complete facilities ( include: land, land improvements,
building, and equipment) at a bargaining price of $
800,000. The allocation of this cost on the basis of
appraised value of purchased assets is illustrated as
follows:

Con’d
Assets
Purchased
Value per
appraisal
Percentage of
total Appraised
value
Allocation of
$ 800,000
cost
Land $ 250,000 25% $ 200,000
Land
Improvements
50,000 5 40,000
Building 300,000 30 240,000
Equipment 400,000 40 320,000
Total $ 1,000,000 100% $ 800,000

DEPRECIATION
 Depreciation is the allocation of cost of a tangable asset to an
expense in the period in which service are recieved from the
asset.
 depreciation is not the process of valuation rather the process
of cost allocation
 Terms in deprciation:
– book value
– depreciable cost
– depreciated cost
– salvage value,scrap value, usage value
 Cause for depreciation: physical obsolocence or deteroration
-

CONT..
methods of computing depreciation:
stright line method
units of production method
double declining balance method
sum the year digit method

a) stright line method
• It is based on the assumption that a plant
asset declines in usefulness at a constant rate.
• It relates depreciation directly to the passage
of time rather than to the asset’s use,
resulting in a constant amount of depreciation
recognized per time period.
• Annual SL depreciation = cost – salvage value
estimated useful life

Con’t
Example: Assume that a machine is acquired on January
2, 2000 for Br. 7, 000 and that the net residual value of
the machine at the end of four years of economic life is
estimated at Br. 1, 000. The depreciation expense of
the machine over its economic life is:
• Annual depreciation expense = 7000 - 1000 = Br. 1, 500
4
• At the end of each year, depreciation expense of this
machine is recorded as follows:
Depreciation Expense……………………….1, 500
Accumulated depreciation-machine…………….1, 500

Con’t
• Activity: Assume in the above example the
machine was purchased on march 3,2000. what
the depreciation for the first year?
b) units of production method
• This method assumes that depreciation is a
function of use or productivity instead of the
passage of time. The life of the asset is
considered in terms of either the output it
provides (units it produces), or an input
measure such as the number of hours it works.

Con’t
• Depreciation expense = cost – sv x hours this year
estimated hours
The major limitation of this method is that it is
not appropriate in situations in which
depreciation is a function of time instead of
usage.
C) Double Declining Balance Method
 This method utilizes a depreciation rate (expressed as
a percentage) that is some multiple of the straight-
line method.

Con’t
 The declining-balance rate remains constant and is
applied to the reducing book value each year.
 Unlike other methods, in the declining-balance method
the salvage value is not deducted in computing the
depreciation base.
• Example: Assume that Famine Company recently
purchased a machine . Pertinent data concerning the
purchase of the machine are:
Cost of machine ……………….…………..Br. 500, 000
Estimated Economic life…………………5 years
Estimated salvage value………………..Br. 50, 000
Productive life in hours………… ………30, 000 hours.

Solution
• Using the doubles declining approach the depreciation expense per year is as follow:
Accumulated Book value
Year Asset at beg of year. Rate Depn
. Expense Depn
. End of year
1 Br. 500, 000 40% Br. 200, 000 Br. 200, 000 Br. 300, 000
2 300, 000 40% 120, 000 320, 000 180, 000
3 180, 000 40% 72, 000 392, 000 108, 000
4 108, 000 40% 43, 200 435, 200 64, 800
5 64, 800 40% 14, 800*
450, 000 50, 000
*
Limited to Br. 14, 800 because book value should not be less than salvage value.

d) sum the year digit method
• This method results in a decreasing depreciation
charges based on a decreasing fraction of depreciable
cost (original cost less salvage value)
• Each fraction uses the sum of the years as a
denominator and the number of years of estimated
life remaining as of the beginning of the year as a
numerator. The denominator is calculated as n(n + 1)
2
• where n is the economic life of the asset.

Con’t
• Using the data for Famine Company above, the
depreciation expense per year is calculated as follows
Depreciation Remaining life Depreciation Depreciation Book value
Year Base in year Fraction Expense End of year
1 Br. 450, 000 5 5/15*
Br. 150, 000 Br. 350, 000
2 450, 000 4 4/15 120, 000 230, 000
3 450, 000 3 3/15 90, 000 140, 000
4 450, 000 2 2/15 60, 000 80, 000
5 450, 000 1 1/15 30, 000 50, 000
 The depreciation rate under the sum-of-years’-digits-method should be used for one full year
(12 months)

Exercise
• A plant asset Cost Br. 56, 000, had an economic life of
8 years, and an estimated net residual value of Br. 2,
000. Assume that this asset was acquired on April 1,
2000. Compute depreciation expense for the full year
ended Dec. 31, 2001, under the sum-of-the-years’-
digits method of depreciation.

Disposal of plant and equipment
• Depreciable assets are disposed of by three methods
retiring, selling, or exchanging .
When a depreciable asset is disposed off, there are three
procedures to be performed
 Update accumulated depreciation account
 Remove the PA and its corresponding accumulated
depreciation account from the book
 Record other events if any e.g. cash paid or received, new PA,
gains or losses.
• Any recognized losses or gains associated with the
disposition appear in the portion of the income
statement named other income/ (expense), net.

a) Disposal through discarding(Retirement):
• This involves abandoning the asset(taken out of service) without receiving
anything in return
• A gain never occurs when an asset is retired. If the entire cost of an asset has
been depreciated before it is retired, however, there is no loss. But if the asset
is not fully depreciated, loss results to the extent of the assets book value.
Example:
• Suppose the $90,000 truck reaches the end of its useful life with a net book
value of $10,000, but the truck is in such poor condition that a another
company simply agrees to take it away for free.
• Required: Record the retirement of the truck.
So/n
Acc. Depreciation- Truck ………80,000
Loss on retirement of Truck….. 10,000
Truck ……………………………………………. 90,000

b) Disposal by Selling
• The asset is given out and cash is received
There are three possibilities:
If cash > BV = gain
If cash < BV = loss
If cash = BV = neither gain nor loss
Example:
Suppose the truck sells for $7,000 when its net book value is $10,000,
resulting in a loss of $3,000.
• Required: Record the sale of the truck.

c) Disposal through Exchange
• The valuation of the acquired asset is the substantive accounting
issue in nonmonetary asset exchange. This valuation determines
whether a gain or loss is recognized.
• The general rule in accounting states that fair value is the proper
measure of exchanges of nonmonetary assets and any gain or
loss should be immediately recognized.
• Note that, a gain or loss on the exchange is determined as
follows:
• In the exchange, trade-in allowance is the money value attached to the
asset being given up.
• It may or may not be the fair value of the asset. It is used to compute
the cash boot involved to make the exchange even, not to compute gain
or loss.

----
• Boot is additional cash paid or received to make the exchange
even and is computed as follows:
 The cost of the new asset = The Boot + the Book Value
• Example: On June 19, 2002 equipment with a cost of Br 4,000.00
and an accumulated depreciation of Br 3, 200.00, was traded for
new equipment with a price of Br 5,000.00 and trade in allowance
given by the seller for the old asset was Br 1,100.00.
Boot or Cash Paid:
Price of new equipment Br 5,000.00
Trade in allowance on old equipment (1,100.00)
Boot Given (Cash) 3,900.00
The cost of the new equipment = Boot + Book value of old Asset
= 3,900.00 + (4,000.00- 3,200.00)
= 4,700.00

Journal entry:
Equipment- new ……………………..… 4,700
Acc. Depn ……………………………….….3,200
Equipment- old ………………………………….. 4,000
cash …………………………………………………….. 3,900
 Gain of br. 300 is not been recognized. Because here cash is paid not
received

Accounting for fixed ASSETS AND INTANGIBLE ASSETS

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Accounting for fixed ASSETS AND INTANGIBLE ASSETS