Chapter 9 Reporting and Analyzing Long Lived Assets Nine learning objectives a Plant Assets 1 Describe how the historical cost principle applies to plant assets i Plant assets are resources that have 1 Physical substance a definite size and shape 2 Are used in operations of a business 3 Are not intended for sale to customers 4 Are expected to provide service to the company for a number of years except for land ii Plant assets are critical to a company s success b Determining the Cost of Plant Assets i Historical Cost Principal requires that companies record plant assets at cost 1 Cost consists of all expenditures necessary to acquire an asset and make it ready for its intended use a Capital expenditures costs included in a plant asset account b Revenue expenditure costs incurred to acquire a plant asset that is expensed immediately ii Cost cash paid in a cash transaction or the cash equivalent price paid 1 Cash equivalent price is either the a Fair value of the asset given up b Fair value of the asset received 2 Whichever is more clearly determinable iii Land 1 All necessary costs incurred in making land ready for its intended use increase debit the Land account 2 Costs typically include a Cash purchase price b Closing costs such as title and attorney s fees c Real estate brokers commissions d Accrued property taxes and other liens on the land assumed by the purchaser 3 In addition to all the costs necessary to purchase or acquire land increase the Land account s balance by other costs incurred to ready the land for its intended use Therefore increase debit the Land account for the cost of a Clearings draining filling and grading the land b Demolition and removal less any proceeds from salvaged materials Note removing a building is sometimes called razing a building iv Land Improvements 1 Includes all expenditures necessary to make the improvements ready for their intended use a Examples driveways parking lots fences landscaping and underground sprinklers b Limited useful lives c Expense depreciate the cost of land improvements v To Buy or Lease over their useful lives 1 A lease is a contractual agreement in which the owner of an asset lessor allows another party lessee to use the asset for a period of time at an agreed price 2 Some advantages of leasing a Reduced risk of obsolescence b Little or no down payment c Shared tax advantages d Assets and liabilities not reported I e operating leases 3 Capital Lease lessees show the asset and liability on the balance sheet vi Buildings 1 2 Purchase costs Includes all costs related directly to purchase or construction a Purchase price closing costs attorney s fees tittle insurance etc and real estate broker s commission b Remodeling and replacing or repairing the roof floors electrical wiring and plumbing 3 Construction Costs a Contract price plus payments for architects fees building permits and excavation costs i Depreciation ii Process of allocating to expense the cost of a plant asset over its useful service life in a rational and systematic manner 1 Process of cost allocation not asset valuation 2 Depreciable because the revenue producing ability of asset will decline over the asset s useful life 3 Applies to land improvements buildings and equipment not land iii Factors in Computing Depreciation 1 Cost all expenditures necessary to acquire the asset and make it ready for intended use 2 Useful life estimate of the expected life based on need for repair service life and vulnerability to obsolescence 3 Salvage value estimate of the asset s value at the end of its useful life 2 Explain the concept of depreciation a Accounting for Plant Assets 3 Compute periodic depreciation using the straight line method and contrast its expense pattern with those of other methods a Accounting for Plant Assets i Depreciation Methods 1 Management selects the method it believes best measures an asset s contribution to revenue over its useful life 2 Examples include a Straight line method i Expense is same amount for each year ii Depreciable cost Cost less Salvage value iii Depreciable Cost Useful Life in years Depreciation Expense b Declining balance method i Expense is not the same amount for each year ii Depreciable cost Cost less salvage value iii We will focus on the double declining balance method iv Depreciation Expense Beginning of the year book value x double the straight line rate 1 Straight line rate 1 useful life in years v Accelerated Method vi Decreasing annual depreciation expense over the vii Double declining balance rate is double the asset s useful life straight line rate viii Rate applied to the book value c Units of activity method i Companies estimate total units of activity to calculate depreciation cost per unit ii Expense varies based on units of activity iii Depreciable cost is cost less salvage value iv Depreciable cost total units of activity depreciable cost per unit v Depreciable cost per unit x units of activity during the year annual depreciable expense ii Comparison of Depreciation Methods 1 Each method is acceptable because each recognizes the decline in service potential of the asset in a rational and systematic manner iii Depreciation and Income Taxes 1 2 IRS does not require taxpayer to use the same depreciation method on the tax return that is used in preparing financial statements IRS requires the straight line method or a special accelerated depreciation method called the Modified Accelerated Cost Recovery System MACRS 3 MACRS is not acceptable under GAAP 4 Describe the procedure for revising periodic depreciation a Accounting for Plant Assets i Revising Periodic Depreciation 1 Accounted for in the period of change and future periods change in Estimate 2 Not handled retrospectively 3 Not considered error ii Expenditure During Useful Life 1 Ordinary Repairs expenditures to maintain the operating efficiency and productive life of the unit a Debit Repair or maintenance expense 2 Additions and improvements costs incurred to increase the operating efficiency productive capacity or useful life of a plant asset 5 Explain how to account for the disposal of plant assets a Debit the plant asset affected a Accounting for Plant Assets i Plant Asset Disposals 1 Companies dispose of plant assets in three ways a Retirement equipment is scrapped or discarded b Sale equipment sold to another company c Exchange existing equipment is traded for new equipment 2 Record depreciation up to the date of disposal 3 Eliminate asset by 1
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