Chapter 8 Reporting and Analyzing Long Term Assets Section 1 Plant Assets Plant assets are tangible assets used in a company s operations that have a useful life of more than one accounting period Plant assets are set apart from other assets by 2 important features o 1 Plant assets are used in operations a computer bought for resale is inventory a computer bought for operations is a plant asset Since plant assets are used in operations we try to match their costs with their revenues o 2 Plant assets have useful lives extending over more than one accounting period Therefore our matching of costs and revenues must extend over several periods Land cost is not allocated to expense when we expect it to have an indefinite life We value plant assets balance sheet effect then allocate their costs to periods benefiting from their use income statement effect 4 main issues in accounting for plant assets o 1 Compute cost o 2 Allocate cost to periods benefits o 3 Account for subsequent expenditures such as repairs improvements o 4 Recording disposal Cost Determination principle Plant assets are recorded at cost when acquired consistent with the cost Cost includes all the normal and reasonable expenditures necessary to get the asset in place and ready for its intended use Land o Total amount paid for land real estate commissions title insurance fees legal feeds accrued property taxes surveying clearing grading draining government assessments cost to remove structures minus any salvaged materials Land improvements parking lot surfaces driveways fences shrubs lighting systems charged to land improvement account Buildings o Purchase price brokerage fees taxes title fees attorney fees all expenditures to ready the building repairs renovations like wiring lighting flooring wall coverings materials labor overhead cost heat lighting power depreciation on machinery design fees building permits insurance during construction Machinery equipment o All costs normal and necessary to purchase them and prepare them for their intended use o Purchase price taxes transportation charges insurance while in transit installing assembling and testing of the machinery equipment Lump sum purchase o We allocate the cost of the purchase among the different type of assets acquired based on their relative market values which can be estimated by appraisal or by using the tax assessed valuations of the assets o Example I paid 90 000 for land appraised at 30 000 land improvements at 10 000 and building at 60 000 100 000 30 000 100 000 30 so 90 000 30 27 000 ect Depreciation Depreciation is the process of allocating the cost of a plant asset to expense in the accounting periods benefiting from its use o Depreciation does not measure the decline in the asset s market value each period nor does it measure the asset s physical deterioration Factors that determine deprecation o Cost salvage value useful life o Cost consists of all necessary and reasonable expenditures to acquire it and to prepare it for its intended use o Salvage value aka residual value scrap value is an estimate of the asset s value at the end of its benefit period Total amount of depreciation to be charged off asset s cost salvage value o Useful life is the length of time it is productively used in a company s operations hard to predict bc of wear tear and Inadequacy refers to the insufficient capacity of a company s plant assets to meet its growing productive demands Obsolescence refers to the condition of a plant asset that is no longer useful in producing goods services with a competitive advantage bc of new inventions and improvements Both inadequacy and obsolescence are difficult to predict because of demand changes new inventions improvements Useful life is different from productive life Methods of depreciation o Straight line method Straight line depreciation charges the same amount of expense to each period of the asset s useful life First compute the depreciable cost of the asset cost to be depreciated total cost salvage value Second depreciable cost is divided by the number of accounting periods in the asset s useful life Asset book value net balance sheet amount is computed as the asset s total cost less its accumulated depreciation Straight line depreciation rate 100 divided by the number of period s in the asset s useful life o Units of production method The use of some plant assets varys greatly from one period to another Unit of production depreciation charges a varying amount to expense for each period of an asset s useful life depending on its usage Compute depreciation per unit cost salvage value total units of production Compute depreciation expense depreciation per unit o Accelerated depreciation method units produced in period Yields larger depreciation expenses in the early years of an asset s life and less depreciation in later years Declining balance method uses a depreciation rate that is a multiple of the straight line rate and applies it to the asset s beginning of period book value Straight line rate 100 useful life Double declining balance rate 2 straight line rate Depreciation expense double declining balance rate beginning period book value o Comparing methods The book value of the asset when using straight line is always greater than the book value from using double declining balance except at the beginning and end of the asset s useful life The straight line method yields a steady pattern of depreciation expense while the units of production depreciation depends on the number of units produced Financial accounting aims to report useful information on financial performance and position where as tax accounting reflects government objectives in raising revenues Postpone tax payments accelerated depreciation Modified accelerated cost recovery system MACRS US federal income tax law for depreciating assets allows straight line depreciation for some assets but requires accelerated depreciation for most kinds of assets Change in an accounting estimate revising an estimate of the useful life or salvage value of a plant asset reflected in current and future financial statements not in prior statements Plant assets are reported on the balance sheet at their underpreciated costs book value this emphasis on costs rather than fair values is based on the going concern principle Impairment there is a permanent decline in the fair value of an asset relative to its book value Additional Expenditures Are these expenditures reported as current
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