financial accounting

2

Chapter 9

Plant Assets,

Natural Resources, and

Intangible Assets

Financial Accounting, IFRS Edition

Weygandt Kimmel Kieso

3

1. Describe how the cost principle applies to plant assets.

2. Explain the concept of depreciation.

3. Compute periodic depreciation using different methods.

4. Describe the procedure for revising periodic depreciation.

5. Distinguish between revenue and capital expenditures, and

explain the entries for each.

6. Explain how to account for the disposal of a plant asset.

7. Compute periodic depletion of extractable natural resources.

8. Explain the basic issues related to accounting for intangible

assets.

9. Indicate how plant assets, natural resources, and intangible

assets are reported.

Study Objectives

4

Plant Assets

Determining the

cost of plant

assets

Depreciation

Revaluation of

plant assets

Expenditures

during useful life

Plant asset

disposals

Natural

Resources

Intangible

Assets

Statement

Presentation and

Analysis

Presentation

Analysis

Accounting for

intangibles

Types of

intangibles

Research and

development

costs

Plant Assets, Natural Resources, and Intangible

Assets

Accounting for

extractable

natural resources

Financial

statement

presentation

5

Used in operations and not for resale.

Long-term in nature and usually depreciated.

Possess physical substance.

Plant assets include land, land improvements, buildings,

and equipment (machinery, furniture, tools).

Major characteristics include:

Section 1 Plant Assets

Referred to as property, plant, and equipment; plant and

equipment; and fixed assets.

6

Section 1 Plant Assets

Illustration 9-1

Percentages of plant assets

in relation to total assets

7

Includes all costs to acquire land and ready it for use.

Costs typically include:

Land

Determining the Cost of Plant Assets

(1) purchase price;

(2) closing costs, such as title and attorneys fees;

(3) real estate brokers commissions;

(4) costs of grading, filling, draining, and clearing;

(5) assumption of any liens, mortgages, or encumbrances

on the property.

SO 1 Describe how the cost principle applies to plant assets.

8

Illustration: Assume that Hayes Manufacturing Company

acquires real estate at a cash cost of $100,000. The property

contains an old warehouse that is razed at a net cost of $6,000

($7,500 in costs less $1,500 proceeds from salvaged materials).

Additional expenditures are the attorneys fee, $1,000, and the

real estate brokers commission, $8,000. The cost of the land is

$115,000, computed as follows.

Required: Determine amount to be reported as the cost of the

land.



9

Land

Required: Determine amount to be reported as the cost of the

land.



Cash price of property of $100,000

Net removal cost of warehouse of $6,000

Attorney's fees of $1,000 1,000

6,000

$100,000

$115,000Cost of Land

Real estate brokers commission of $8,000 8,000

Land 115,000

Cash 115,000

Journal Entry

10

All expenditures necessary to make the improvements

ready for their intended use.

Land Improvements


Driveways, parking lots, fences, landscaping, and

underground sprinklers.

Limited useful lives.

Expense (depreciate) the cost of land improvements

over their useful lives.


11

All costs related directly to purchase or construction.

Buildings

Purchase costs:

Purchase price, closing costs and real estate brokers

commission.

Remodeling and replacing or repairing the roof, floors,

electrical wiring, and plumbing.

Construction costs:

Contract price plus payments for architects fees, building

permits, and excavation costs.



12

All costs incurred in acquiring the equipment and

preparing it for use.

Costs typically include:

Equipment

purchase price,

sales taxes,

freight and handling charges,

insurance on the equipment while in transit,

assembling and installation costs, and

costs of conducting trial runs.



13

Illustration: Assume Merten Company purchases factory

machinery at a cash price of $50,000. Related expenditures are

for sales taxes $3,000, insurance during shipping $500, and

installation and testing $1,000. Determine amount to be

reported as the cost of the machinery.



Machinery

Cash price

Sales taxes

Insurance during shipping 500

3,000

$50,000

$54,500Cost of Machinery

Installation and testing 1,000

14Answer on notes page

15

Process of cost allocation, not asset valuation.

Applies to land improvements, buildings, and

equipment, not land.

Depreciable, because the revenue-producing ability of

asset will decline over the assets useful life.

Depreciation is the process of allocating the cost of

tangible assets to expense in a systematic and rational

manner to those periods expected to benefit from the use

of the asset.

Depreciation

SO 2 Explain the concept of depreciation.

16

Factors in Computing Depreciation

Cost

Depreciation

SO 2 Explain the concept of depreciation.

Useful Life Residual Value

Illustration 9-6

17

Objective is to select the method that best measures an

assets contribution to revenue over its useful life.

Examples include:

Depreciation Methods

(1) Straight-line method.

(2) Units-of-Activity method.

(3) Declining-balance method.

Depreciation

SO 3 Compute periodic depreciation using different methods.

18

Illustration: Barbs Florists purchased a small delivery truck on

January 1, 2011.

Required: Compute depreciation using the following.

(a) Straight-Line (b) Units-of-Activity (c) Declining Balance.

Depreciation


Illustration 9-7

19

Straight-Line

Depreciation


Expense is same amount for each year.

Depreciable cost - cost of the asset less its residual

value.Illustration 9-8

20

Depreciable Annual Accum. Book

Year Cost x Rate = Expense Deprec. Value

Depreciation


Illustration: (Straight-Line Method)

2011 $ 12,000 20% $ 2,400 $ 2,400 $ 10,600

2012 12,000 20 2,400 4,800 8,200

2013 12,000 20 2,400 7,200 5,800

2014 12,000 20 2,400 9,600 3,400

2015 12,000 20 2,400 12,000 1,000

2011

Journal

Entry

Depreciation expense 2,400

Accumulated depreciation 2,400

Illustration 9-9

21

Companies estimate total units of activity to calculate

depreciation cost per unit.

Expense varies based on units of activity.

Depreciable cost is

cost less residual

value.

Units-of-Activity

Depreciation


Illustration 9-10

22

Units Annual

of Cost / Depreciation Accumulated Book

Year Activity x Unit = Expense Depreciation Value

Depreciation

Illustration: (Units-of-Activity Method)

2011 15,000 $ 0.12 $ 1,800 $ 1,800 $ 11,200

2012 30,000 0.12 3,600 5,400 7,600

2013 20,000 0.12 2,400 7,800 5,200

2014 25,000 0.12 3,000 10,800 2,200

2015 10,000 0.12 1,200 12,000 1,000



2011

Journal

Entry

Illustration 9-11


23

Decreasing annual depreciation expense over the assets

useful life.

Declining-balance rate is double the straight-line rate.

Rate applied to book value.

Declining-Balance

Depreciation


Illustration 9-12

24

Declining Annual

Beginning Balance Deprec. Accum. Book

Year Book value x Rate = Expense Deprec. Value

Depreciation

Illustration: (Declining-Balance Method)

2011 13,000 40% $ 5,200 $ 5,200 $ 7,800

2012 7,800 40 3,120 8,320 4,680

2013 4,680 40 1,872 10,192 2,808

2014 2,808 40 1,123 11,315 1,685

2015 1,685 40 685* 12,000 1,000

* Computation of $674 ($1,685 x 40%) is adjusted to $685.



2011

Journal

Entry

Illustration 9-13

25SO 3 Compute periodic depreciation using different methods.

Comparison of Methods

Depreciation

Illustration 9-14

Illustration 9-15

26

Depreciation is a process of:

a. valuation.

b. cost allocation.

c. cash accumulation.

d. appraisal.

Review Question

Depreciation


27

The following four slides are included to illustrate the

calculation of partial-year depreciation expense.

The amounts are consistent with the previous slides

illustrating the calculation of depreciation expense.

Depreciation for Partial Year


28

Illustration: Barbs Florists purchased a small delivery truck on

October 1, 2011.



Required: Compute depreciation using the following.

(a) Straight-Line (b) Units-of-Activity (c) Declining Balance.

Illustration 9-7

29

Current

Depreciable Annual Partial Year Accum.

Year Cost Rate Expense Year Expense Deprec.

2011 12,000$ x 20% = 2,400$ x 3/12 = 600$ 600$

2012 12,000 x 20% = 2,400 2,400 3,000

2013 12,000 x 20% = 2,400 2,400 5,400

2014 12,000 x 20% = 2,400 2,400 7,800

2015 12,000 x 20% = 2,400 2,400 10,200

2016 12,000 x 20% = 2,400 x 9/12 = 1,800 12,000

12,000$

Journal entry:

2011 Depreciation expense 600

Accumultated depreciation 600



Illustration: (Straight-line Method)

30

Hours Cost / Annual Accum. Book

Year Used x Unit = Expense Deprec. Value

Illustration: (Units-of-Activity Method)

2011 15,000 $ 0.12 $ 1,800 $ 1,800 $ 11,200

2012 30,000 0.12 3,600 5,400 7,600

2013 20,000 0.12 2,400 7,800 5,200

2014 25,000 0.12 3,000 10,800 2,200

2015 10,000 0.12 1,200 12,000 1,000



2011

Journal

Entry

Illustration 9-12



31

Illustration: (Declining-Balance Method)

Declining Current

Beginning Balance Annual Partial Year Accum.

Year Book Value Rate Expense Year Expense Deprec.

2011 13,000$ x 40% = 5,200$ x 3/12 = 1,300$ 1,300$

2012 11,700 x 40% = 4,680 4,680 5,980

2013 7,020 x 40% = 2,808 2,808 8,788

2014 4,212 x 40% = 1,685 1,685 10,473

2015 2,527 x 40% = 1,011 1,011 11,484

2016 1,516 x 40% = 607 Plug 516 12,000

12,000$

Journal entry:

2011 Depreciation expense 1,300

Accumultated depreciation 1,300



32

Tax laws often do not require the taxpayer to use the

same depreciation method on the tax return that is used

in preparing financial statements.

Many corporations use straight-line in their financial

statements to maximize net income. At the same time,

they use an accelerated-depreciation method on their

tax returns to minimize their income taxes.

Depreciation and Income Taxes

Depreciation


33

Revising Periodic Depreciation

Accounted for in the period of change and future

periods (Change in Estimate).

Not handled retrospectively.

Not considered error.

Depreciation

SO 4 Describe the procedure for revising periodic depreciation.

34

Illustration: Assume that Barbs Florists decides on January 1,

2014, to extend the useful life of the truck one year because of

its excellent condition. The company has used the straight-line

method to depreciate the asset to date, and book value is

$5,800 ($13,000 - $7,200).

Questions:

1. What is the journal entry to correct

the prior years depreciation?

2. Calculate the depreciation expense

for 2014.

No Entry Required

Depreciation


35

Depreciation



Journal entry for 2014


Book value, 1/1/14 $5,800

Residual value

Depreciable cost

Useful life (revised) /

Annual depreciation

First,

establish

Book Value at

the date of

change in

estimate.

- 1,000

4,800

3 years

$ 1,600

Illustration 9-17

36

When there is a change in estimated depreciation:

a. previous depreciation should be corrected.

b. current and future years depreciation should be

revised.

c. only future years depreciation should be revised.

d. None of the above.

Review Question

Depreciation


37

IFRS allows revaluation of plant assets to fair value

If revaluation is used, it must be applied to all assets in

a class of assets.

Assets that are experiencing rapid price changes must

be revalued on an annual basis, otherwise less

frequent revaluation is acceptable.

Revaluation of Plant Assets


38

Illustration: Pernice Company applies revaluation to plant

assets with a carrying value of $1,000,000, a useful life of 5

years, and no residual value. Pernice makes the following

journal entries in year 1, assuming straight-line depreciation.





After this entry, Pernices plant assets have a carrying amount

of $800,000 ($1,000,000 - $200,000).

39

Illustration: At the end of year 1, independent appraisers

determine that the asset has a fair value of $850,000. To report

the plant assets at fair value, Pernice makes the following entry.


Plant assets 150,000



Revaluation surplus is an example of an item reported as other

comprehensive income, as discussed in Chapter 5.

Revaluation surplus 50,000

40

Pernice now reports the following information in its statement of

financial position at the end of year 1.



$850,000 is the new basis of the asset. Pernice reports depreciation

expense of $200,000 in the income statement and $50,000 in other

comprehensive income. Depreciation in year 2 will be $212,500

($850,000 / 4).

Illustration 9-18

41

Ordinary Repairs - expenditures to maintain the operating

efficiency and productive life of the unit.

Debit - Repair (or Maintenance) Expense.

Referred to as revenue expenditures.

Expenditures During Useful Life

SO 5 Distinguish between revenue and capital expenditures,

and explain the entries for each.

Additions and Improvements - costs incurred to increase

the operating efficiency, productive capacity, or useful life of a

plant asset.

Debit - the plant asset affected.

Referred to as capital expenditures.

42

Companies dispose of plant assets in three ways

Retirement, Sale, or Exchange (appendix).

Plant Asset Disposals

SO 6 Explain how to account for the disposal of a plant asset.

Illustration 9-19

Record depreciation up to the date of disposal.

Eliminate asset by (1) debiting Accumulated Depreciation, and

(2) crediting the asset account.

43

Illustration: Assume that Hobart Enterprises retires

its computer printers, which cost $32,000. The accumulated

depreciation on these printers is $32,000. The journal entry to

record this retirement is:

Plant Asset Disposals - Retirement



Printing equipment 32,000

Question: What happens if a fully depreciated plant asset is still useful

to the company?

Retirement of Plant Assets

44

Illustration: Assume that Sunset Company discards delivery

equipment that cost $18,000 and has accumulated

depreciation of $14,000. The journal entry is:

Plant Asset Disposals - Retirement



Loss on disposal 4,000

Companies report a loss on disposal in the Other income and

expense section of the income statement.

Delivery equipment 18,000

45

Sale of Plant Assets

Compare the book value of the asset with the proceeds

received from the sale.

If proceeds exceed the book value, a gain on disposal

occurs.

If proceeds are less than the book value, a loss on

disposal occurs.

Plant Asset Disposals


46

Illustration: Assume that on July 1, 2011, Wright Company sells

office furniture for $16,000 cash. The office furniture originally

cost $60,000. As of January 1, 2011, it had accumulated

depreciation of $41,000. Depreciation for the first six months of

2011 is $8,000. Prepare the journal entry to record depreciation

expense up to the date of sale.


Plant Asset Disposals - Sale



Gain on Disposal

47

Illustration: Wright records the sale as follows.



Cash 16,000


Illustration 9-20

Computation of gain on

disposal

Office equipment 60,000

Gain on disposal 5,000

July 1

48

Illustration: Assume

that instead of selling

the office furniture for

$16,000, Wright sells it

for $9,000.



Loss on Disposal

Cash 9,000


Office equipment 60,000


July 1

Illustration 9-21

Computation of loss on disposal

49

Natural resources consist of standing timber and

resources extracted from the ground, such as oil, gas,

and minerals.

Standing timber is considered a biological asset under

IFRS.

In the years before they are harvested, the recorded

value of biological assets is adjusted to fair value each

period.

Section 2 Natural Resources

SO 7 Compute periodic depletion of extractable natural resources.

50

Depletion is to natural resources as depreciation is to plant

assets.

Companies generally use units-of-activity method.

Depletion generally is a function of the units extracted.

IFRS defines extractive industries as those businesses

involved in finding and removing natural resources located in

or near the earths crust.

Cost - price needed to acquire the resource and prepare it for

its intended use.

Depletion - allocation of the cost to expense in a rational and

systematic manner over the resources useful life.



51

Illustration: Assume that Lane Coal Company invests $5

million in a mine estimated to have 10 million tons of coal and no

salvage value. In the first year, Lane extracts and sells 800,000

tons of coal. Lane computes the depletion expense as follows:


$5,000,000 10,000,000 = $.50 depletion cost per ton

$.50 x 800,000 = $400,000 depletion expense

Depletion expense 400,000

Accumulated depletion 400,000

Journal entry:


52

Financial Statement Presentation

Illustration 9-23

Statement presentation of accumulated depletion

Extracted resources that have not been sold are reported as

inventory in the current assets section.


53

Intangible assets are rights, privileges, and competitive

advantages that do not possess physical substance.

Section 3 Intangible Assets

Patents

Copyrights

Franchises or licenses

Intangible assets are categorized as having either a

limited life or an indefinite life.

Common types of intangibles:

SO 8 Explain the basic issues related to accounting for intangible assets.

Trademarks and trade

names

Goodwill

IFRS permits revaluation of intangible assets to fair value, except for goodwill.

54

Patents

Exclusive right to manufacture, sell, or otherwise control

an invention for a specified number of years from the

date of the grant.

Legal life in many countries is 20 years.

Capitalize costs of purchasing a patent and amortize

over its legal life or its useful life, whichever is shorter.

Legal fees incurred successfully defending a patent are

capitalized to Patent account.

Types of Intangible Assets


55

Intangible assets are typically amortized on a straight-line

basis.

Illustration: Assume that National Labs purchases a patent at

a cost of $60,000. National estimates the useful life of the

patent to be eight years. National records the annual

amortization as follows.

Accounting for Intangible Assets


Amortization expense 7,500

Patent 7,500

56

Copyrights

Give the owner the exclusive right to reproduce and sell

an artistic or published work.

plays, literary works, musical works, pictures,

photographs, and video and audiovisual material.

Granted for the life of the creator plus a specified number

of years, which can vary by country but is commonly 70

years.

Capitalize costs of acquiring and defending it.

Amortized to expense over useful life.



57

Trademarks and Trade Names

Word, phrase, jingle, or symbol that identifies a particular

enterprise or product.

Wheaties, Game Boy, Frappuccino, Kleenex, Windows,

Coca-Cola, and Jetta.

Registration provides a specified number of years of

protection, which can vary by country, but is commonly 20

years.

Capitalize acquisition costs.

Renewed indefinitely, no amortization.



58

Franchises and Licenses

Contractual arrangement between a franchisor and a

franchisee.

BP (GBR), Taco Bell (USA), or Rent-A-Wreck (USA)

are franchises.

Franchise (or license) with a limited life should be

amortized to expense over the life of the franchise.

Franchise with an indefinite life should be carried at cost

and not amortized.



59

Goodwill

Includes exceptional management, desirable location, good

customer relations, skilled employees, high-quality products,

etc.

Only recorded when an entire business is purchased.

Goodwill is recorded as the excess of ...

purchase price over the fair value of the identifiable net

assets acquired.

Internally created goodwill should not be capitalized.



60Answer on notes page

61

Research and Development Costs

Frequently results in something that a company patents

or copyrights such as:

new product,

process,

idea,

formula,

composition, or

literary work.

Costs in the research phase are always expensed as

incurred.

Costs in the development phase are expensed until

specific criteria are met, primarily that technological

feasibility is achieved.


62

Presentation

Statement Presentation and Analysis

SO 9 Indicate how plant assets, natural resources,

and intangible assets are reported.

Illustration 9-24

63

Analysis

Each dollar invested in assets produced in sales. If a

company is using its assets efficiently, each investment in

assets will create a high amount of sales.

Statement Presentation and Analysis

SO 9 Indicate how plant assets, natural resources,

and intangible assets are reported.

Illustration 9-25

64

As in IFRS, under GAAP, the costs associated with research

and development are segregated into the two components.

Costs in the research phase are always expensed under

both IFRS and GAAP. Under GAAP, however, costs in the

development phase are also always expensed. As shown in

this chapter, under IFRS, development costs can be

capitalized once technological feasibility is achieved.

IFRS permits revaluation of intangible assets (except for

goodwill). GAAP prohibits revaluations of intangible assets.

GAAP does not require component depreciation.

Understanding U.S. GAAP

Key Differences Plant Assets, Natural Resources, and Intangible Assets

65

GAAP does not permit the use of revaluation accounting for

property, plant, and equipment, which is allowed under IFRS.

Under both GAAP and IFRS, changes in the depreciation

method used and changes in useful life are handled in

current and future periods. Prior periods are not affected.

GAAP recently conformed to IFRS in the accounting for

changes in depreciation methods.



66

IFRS allows reversal of impairment losses when there has

been a change in economic conditions or in the expected

use of the asset. Under GAAP, impairment losses cannot be

reversed for assets to be held and used; the impairment loss

results in a new cost basis for the asset. IFRS and GAAP are

similar in the accounting for impairments of assets held for

disposal.

The accounting for exchanges of non-monetary assets has

recently converged between IFRS and GAAP.



67

Looking to the Future


It is too early to say whether a converged conceptual framework

will recommend fair value measurement (and revaluation

accounting) for plant assets and intangibles. However, this is likely

to be one of the more contentious issues, given the long-standing

use of historical cost as a measurement basis in GAAP. The IASB

and FASB have identified a project that would consider expanded

recognition of internally generated intangible assets. IFRS permits

more recognition of intangibles compared to GAAP. Thus, it will be

challenging to develop converged standards for intangible assets,

given the long-standing prohibition on capitalizing internally

generated intangible assets and research and development in

GAAP.

Plant Assets, Natural Resources, and Intangible Assets

68

Ordinarily, companies record a gain or loss on the

exchange of plant assets.

The rationale for recognizing a gain or loss is that

most exchanges have commercial substance.

An exchange has commercial substance if the

future cash flows change as a result of the

exchange.

Exchange of Plant Assets

SO 10 Explain how to account for the exchange of plant assets.

Appendix

69

Cost of old trucks $64,000

Less: Accumulated depreciation 22,000

Book value 42,000

Fair value of old trucks 26,000

Loss on disposal $16,000

Fair value of old trucks $26,000

Cash paid 17,000

Cost of new semi-truck $43,000

Illustration: Roland Co. exchanged old trucks (cost $64,000

less $22,000 accumulated depreciation) plus cash of $17,000

for a new semi-truck. The old trucks had a fair value of

$26,000.



Loss

Treatment

70

Illustration: Roland Co. exchanged old trucks (cost $64,000

less $22,000 accumulated depreciation) plus cash of $17,000

for a new semi-truck. The old trucks had a fair market value of

$26,000.

Prepare the entry to record the exchange of assets by Roland

Co.



Semi-truck 43,000



Used trucks 64,000

Cash 17,000

71

Illustration: Mark Express Delivery trades its old delivery

equipment (cost $40,000 less $28,000 accumulated

depreciation) for new delivery equipment. The old equipment

had a fair value of $19,000. Mark also paid $3,000.



Cost of old equipment $40,000

Less: Accumulated depreciation 28,000

Book value 12,000

Fair value of old equipment 19,000

Gain on disposal $ 7,000

Fair value of old equipment $19,000

Cash paid 3,000

Cost of new equipment $22,000

Gain

Treatment

72

Illustration: Mark Express Delivery trades its old delivery

equipment (cost $40,000 less $28,000 accumulated

depreciation) for new delivery equipment. The old equipment

had a fair value of $19,000. Mark also paid $3,000.

Prepare the entry to record the exchange of assets by Mark

Express.



Delivery equipment (new) 22,000


Delivery equipment (used) 40,000

Gain on disposal 7,000

Cash 3,000

73

In exchanges of assets in which the exchange has

commercial substance:

a. neither gains nor losses are recognized immediately.

b. gains, but not losses, are recognized immediately.

c. losses, but not gains, are recognized immediately.

d. both gains and losses are recognized immediately.

Review Question



74

TERIMA KASIH

financial accounting

Documents

cost of plant assetsso

cost of plant assetsdriveways

equipment plant

plant assetsdetermining

plant assetsreferred

plant assetsillustration

cost principle

cash cost