Chapter 8 Reporting and Interpreting Property Plant and Equipment Natural Resources and Intangibles ACQUISITION AND MAINTENANCE OF PLANT AND EQUIPMENT The resources that determine a company s productive capacity are often Classifying Long Lived Assets called long lived assets o Tangible and intangible resources owned by a business and used in its operations over several years o Tangible assets have physical substance that is they can be touched Property plant and equipment or fixed assets Land Buildings fixtures and equipment Natural resources o Intangible assets long lived assets without physical substance that confer specific rights on their owner Patents copyrights franchises licenses and trademarks Measuring and Recording Acquisition Cost Expenditures are capitalized when they are recorded as part of the cost of an asset instead of as expenses in the current period When a company purchases land all of the incidental costs of the purchase such as title fees sales commissions legal fees title insurance delinquent taxes and surveying fees should be included in its cost Sometimes a company purchases an old building or used machinery for the business operations Renovation and repair costs incurred by the company prior to the asset s use should be included as a part of its cost Acquisition cost the net cash amount paid for the asset or when non cash assets are used as payment the fair value of the asset given or asset received Chapter 8 Reporting and Interpreting Property Plant and Equipment Natural Resources and Intangibles For Cash For Debt For Equity By Construction The cost of an asset includes all the necessary costs associated with construction such as labor materials and in most situations a portion of the interest incurred during the construction period called capitalized interest o Refers to interest expenditures included in the cost of a self constructed asset The amount of interest expense that is capitalized is recorded by debiting the asset and crediting cash when the interest is paid Repairs Maintenance and Additions Most assets require substantial expenditures during their lives to maintain or enhance their productive capacity These expenditures include cash outlays for ordinary repairs and maintenance major repairs replacements and additions Expenditures made after an asset has been acquired are classified as 1 Ordinary repairs and maintenance also called revenue expenditures are expenditures for the normal maintenance and upkeep of long lived Chapter 8 Reporting and Interpreting Property Plant and Equipment Natural Resources and Intangibles assets These expenditures are recurring in nature involve relatively small amounts at each occurrence and do not directly lengthen the useful life of the asset 2 Additions and improvements are expenditures that increase the productive life operating efficiency or capacity of the asset These capital expenditures are added to the appropriate asset accounts They occur infrequently involve large amounts of money and increase an asset s economic usefulness in the future through either increased efficiency or longer life USE IMPAIRMENT AND DISPOSAL OF PLANT AND EQUIPMENT Depreciation Concepts Except for land that is considered to have an unlimited life a long lived asset with a limited useful life such as an airplane represents the prepaid cost of a bundle of future services or benefits The matching principle requires that a portion of an asset s cost be allocated as an expense in the same period that revenues are generated by its use Depreciation is the process of allocating the cost of buildings and equipment over their productive lives using a systematic and rational method When an asset is depreciated the remaining balance sheet amount probably does not represent its current market value On balance sheets subsequent to acquisition the undepreciated cost is not measure on a market or fair value basis The amount of depreciation recorded Chapter 8 Reporting and Interpreting Property Plant and Equipment Natural Resources and Intangibles during each period is reported on the income statement as depreciation expense The amount of depreciation expense accumulated since the acquisition date is reported on the balance sheet as a contra account accumulated depreciation and deducted from the related asset s cost Net book value of a long lived asset is its acquisition cost less the accumulated depreciation from the acquisition date to the balance sheet date To calculate depreciation expense three amounts are required for each asset o Acquisition cost o Estimated useful life to the company o Estimated residual value at the end of the asset s useful like to the company Estimated useful life represents management s estimate of the asset s useful economic life to the company rather than its total economic life to all potential users The asset s expected physical life is often longer than the company intends to use the asset Residual or salvage value represents management s estimate of the amount the company expects to recover upon disposal of the asset as salvage or scrap or its expected value if sold to another user Alternative Depreciation Methods Managers may choose from several acceptable depreciation methods that match depreciation expense with the revenues generated in a period Once Chapter 8 Reporting and Interpreting Property Plant and Equipment Natural Resources and Intangibles selected the method should be applied consistently over time to enhance comparability of financial information Straight Line Method Under this method an equal portion of an asset s depreciable cost is allocated to each accounting period over its estimated useful life Cost minus Residual Value is the amount to be depreciated depreciable cost 1 Useful life is the straight line rate Companies often create a depreciation schedule that shows the computed amount of depreciation expense each year over the entire useful life of the machine Notice that o Depreciation expense is a constant amount each year o Accumulated depreciation increases by an equal amount each year o Net Book value decreases by the same amount each year until it equals the estimated residual value Units of Production method relates depreciable cost total estimated Units of Production productive output Dividing the depreciable cost by the estimated total production yields the depreciation rate per unit of production which is then multiplies by the actual production for the period to determine
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