Chapter 9 Plant Assets Natural Resources and Intangible Assets Plant Assets are resources that have 3 characteristics 1 Have physical substance definite size and shape 2 Used in the operations of a business 3 Not intended for sale to customers Plant Assets AKA property plant and equipment plant and equipment and fixed assets Expected to provide services to the company for a number of years Determining the Cost of Plant Assets Land Cost principle requires that companies record plant assets at cost Cost consists of all expenditures necessary to acquire the asset and make it ready for its intended use Companies often use land as a building site for a manufacturing plant or office site Cost of land includes 1 The cash purchase price 2 Closing costs such as title and attorneys fees 3 Real estate brokers commissions 4 Accrued property taxes and other liens assumed by the purchaser Companies record as debits to the Land account all necessary costs incurred to make land ready for intended use Land Improvements are structural additions made to land Ex Driveways parking lots fences landscaping and underground sprinklers Cost of land improvements includes all expenditures necessary to make the improvements ready for their intended use Companies expense depreciate the cost of land improvements over their useful lives Land Improvements Buildings Buildings are facilities used in operations such as stores offices factories warehouses and airplane hangars Companies Dr to the Buildings account all necessary expenditures related to the purchase or construction of a building When a building is purchased When a building is constructed Companies charge certain interest costs to the Buildings account Costs include purchase price closing costs attorney fees etc and real estate brokers commission Cost consists of the contract price plus payments for architects fees building permits excavation costs Interest costs incurred to finance the project are included in the cost of the building when a significant period of time is required to get the building ready for use Inclusion of interest costs in the cost of a constructed building is limited to the construction period Equipment includes assets used in operations such as store check out counters office furniture factory machinery delivery trucks etc Cost of equipment consists of the cash purchase price sales taxes freight charges and insurance during transit paid by the purchaser Also includes expenditures required in assembling installing and testing the unit Equipment Depreciation Depreciation is the process of allocating to expense the cost of a plant asset over its useful service life in a rational and systematic manner Depreciation is a process of cost allocation not asset valuation No attempt is made to measure the change in an asset s fair value during ownership The book value cost less accumulated depreciation of a plant asset may be quite different from its fair value If an asset is fully depreciated it can have a zero book value but still have a significant fair value Chapter 9 Pg 1 Depreciation applies to three classes of plant assets known as depreciable assets the usefulness to the company and revenue producing ability of each asset will decline over the assets useful life Land improvements Buildings Equipment Depreciation does not apply to land because its usefulness and revenue producing ability generally remain intact over time In many cases the usefulness of land is greater over time because of the scarcity of good land sites Land is not a depreciable asset Wear and tear is when an assets revenue producing ability declines a truck with 100 000 miles Obsolescence is the process of becoming out of date before the asset physically wears out Recognizing depreciation on an asset does not result in accumulation of cash for replacement of the asset Balance in Accumulated Depreciation represents the total amount of the assets cost that the company has charged to expense Not a cash fund Factors in Computing Depreciation Three factors affect the computation of depreciation 1 Cost All expenditures necessary to acquire the asset and make it ready for intended use 2 Useful Life Useful life is an estimate of the expected productive life service life of the asset for its owner May be expressed in terms of time units of activity machine hours or units of output Useful life is an estimate 3 Salvage Value Salvage Value is an estimate of the assets value at the end of its useful life May be based on the assets worth as scrap or as its expected trade in value Depreciation is generally computed using one of the three following methods Depreciation Methods 1 Straight Line life Under this method company s expense the same amount of depreciation for each year of the assets useful Measured solely by the passage of time In order to determine under this method companies must determine depreciable cost cost of the asset less its salvage value To determine annual depreciation expense divide depreciable cost by the assets useful life Compute an annual rate of depreciation by dividing 100 by the amount of years left in the useful life Under this method useful life ie expressed in terms of the total units of production or use expected from the asset rather than as a time period Ideally suited for factory machinery delivery equipment miles driven and airplanes hours in use 2 Units of activity Depreciable Cost Total Units of Activity Depreciable Cost per Unit Depreciable Cost per Unit x Units of activity during the year Annual Depreciation Expense Method is easy to apply for assets purchased mid year 3 Declining Balance Declining Balance method produces a decreasing annual depreciation expense over the assets useful life Based on declining book value cost less AD of the asset The depreciation rate remains constant from year to year but the book value to which the rate is applied declines each year Ignores salvage value in determining the amount to which the declining balance rate is applied Common method is to double the straight line rate Known as the double declining balance method Book Value at Beginning of Year x Declining Balance rate Annual Depreciation Expense Because the declining balance method produces higher depreciation expense in the early years than in the later years it is considered to be an accelerated depreciation method Chapter 9 Pg 2 Comparison of Methods Depreciation and Income Taxes Revising Periodic Depreciation Expenditures During Useful Life