Ch16 Accounting for Plant Assets and Depreciation 1 Understanding PPE Acquisition of PPE (cost) Depreciation of PPE Revenue expenditure vs. capital expenditure Disposition of PPE (sale, trade, and discard) Intangibles and amortization Natural resources and depletion
Understanding PPE: Characteristics Have a useful life of more than one year Are required for use in the operations of a business Are not intended for resale to customers in the normal course of business Are tangible, or physical, that is, capable of being touched 2
Example Acquisition of PPE - purchase On March 1, 20X1, Kessler Company purchase a computer for $1,830 on account from King Office Supply Company. The following entry records the purchase: General Journal Date Account Title P.R. Debit Credit 20X1 Mar. 1 Office Equipment 1,830 Accounts Payable King Office Supply Company 1,830 3
Acquisition of PPE - Cost Includes all normal expenditures necessary to acquire the asset and get it ready for use Invoice price Delivery charges Installation charges Sales taxes Insurance charges while in transit 4
Example Determining the Cost of a Plant Asset Keesler Company purchases a new factory machine during 20X1 and incurs the following costs: List price $27,500 Delivery charges 900 Insurance while in transit 360 Sales tax 1,375 Installation charges 600 Testing costs 400 5 Total cost $31,135
Recording Cost of a Plant Assets Costs necessary to get the asset into use - debited to the asset account Costs that are not a normal and necessary part of getting the asset into use - debited to an expense account A machine with a list price of $10,000 was purchased with the following additional expenditures: $600 installation costs; $500 sales taxes; $350 delivery charges; $75 repair for damage in unloading The machine was paid for by issuing a $4,000 note and paying the balance in cash. Prepare the general journal entry to record the purchase. 6
Determining the Cost of Land, Buildings, and Land Improvements When land and buildings are purchased for a lump sum, the purchase price must be divided between the two. This is usually done by making an appraisal of the land the buildings and dividing up the cost between the two in a fair proportion. Cost of Land Purchase price Commissions paid Legal fees Delinquent taxes paid by the buyer Amounts spent on draining, clearing, grading, etc. (tearing 7 down building)
Cost of a Building All construction costs Architect s fees Insurance during construction Other normal and necessary costs of completing the project 8 Sidewalks Driveways Fences Parking lots Other improvements to real estate Land Improvements Costs debited to the Land Improvements account
With the exception of land, all plant assets Wear out with the passage of time, or Depreciation: nature Become obsolete as technology improves, or Become inadequate to meet the needs of an expanding business Depreciation: the process of allocating the cost of a plant asset over its useful life Depreciation Expense is the expense that results from this allocation of cost, thus to record depreciation with an end-ofperiod adjusting entry - debit Depreciation Expense account and credit Accumulated Depreciation account The estimated useful life of an asset is its economic life, not its physical life. Eg: The desk may last for decades, but it 9 may not be useful to the business for that amount of time.
Factors Needed to Calculate Depreciation Cost of the asset The invoice price The normal and necessary expenditures of getting it ready for use Estimated salvage value of the asset The amount it is expected to be worth at the end of its productive life Estimated useful life of the asset The expected period of service Depreciation: factors 10 Expressed in terms of use such as miles or in terms of years
Depreciation: Methods The Straight-Line Method Requires equal charge for depreciation expense over each of the accounting periods in the life of a plant asset Annual depreciation expense = (cost of asset salvage value) useful life of the asset The Units-of-Production Method The Double Declining-Balance Method Sum-of-the-years -digits method Modified Accelerated Cost Recovery System 11
Example Straight-Line Method Assume on January 2, 20X1, Erwin purchases machinery for $18,000, with a useful life of five years and an estimated salvage value of $2,000. To compute annual depreciation expense: (cost of asset salvage value) useful life of the asset ($18,000 $2,000) 5 years = $3,200 Depreciation Schedule, Straight-Line Method 12
Example Straight-Line Depreciation for Less Than a Year Assume on April 1, 20X1, Erwin Company purchases an asset for $18,000 with an estimated salvage value of $2,000, and a useful life of 5 years. Notice the asset is only owned for 9 months in 20X1. Depreciation expense for a full year would equal ($18,000 $2,000) 5 years = $3,200 Depreciation expense for 20X1 = $3,200 9/12 = $2,400 13
The Units-of-Production Method Allocates cost based on the estimated productive life the asset Same formula as used for the straight-line method, except that the estimated useful life is not expressed in years, but in terms of units produced Hours of operation Miles driven Some other measure of productive output 14
Example The Units-of-Production Method Assume on January 2, 20X1, Erwin purchases machinery for $18,000, with an estimated productive life of 100,000 units, and an estimated salvage value of $2,000. During 20X1, Erwin produced 22,000 units. Depreciation expense/unit = (cost of asset salvage value) useful life of the asset = ($18,000 $2,000) 100,000 units = $0.16 depreciation expense/unit Depreciation expense for 20X1 = $0.16 22,000 = $3,520 15
The Double Declining Balance Method Allows greater depreciation in the early years of an asset s life and less depreciation as the asset gets older Often referred to as an accelerated method of depreciation Applies a constant rate of depreciation to the declining book value of the asset Salvage value is ignored in calculating depreciation The rate used for most assets is twice the straight-line rate, consequently, the name double declining-balance method 16
Example Double Declining Balance Method Assume on January 2, 20X1, Erwin purchases machinery for $18,000, with an estimated useful life of 5 years, and an estimated salvage value of $2,000. Since the asset has a 5 year life, each year it depreciates 20%, and 20% 2 = 40% Depreciation for 20X1 would equal the cost of the asset times the declining balance or $18,000 40% = $7,200. To compute depreciation for 20X2, we must first compute the book value at the beginning of 20X2: Book value on January 1, 20X2 = $18,000 $7,200 = $10,800 Depreciation for each succeeding year is based on book value at the beginning of the year times the decliningbalance rate Depreciation for 20X2 would equal $10,800 40% = $4,320 17
Depreciation Schedule for Double Declining Balance Method 18 Depreciation is limited to $332.80($2,332.80 - $2,000.00) because the asset cannot be depreciated below its salvage value. The declining-balance method does not consider salvage value when calculating periodic depreciation. However, an asset should not be depreciated below its estimated salvage value.
Example Double Declining Balance Depreciation for Less Than a Year Assume on April 5, 20X1, Erwin Company purchases an asset for $18,000 with an estimated salvage value of $2,000, and a useful life of 5 years. Notice the asset is only owned for 9 months in 20X1. Depreciation expense for 20X1 = $18,000 40% 9/12 = $5,400. Using the double declining balance method, calculate the depreciation expense for 20X1 and 20X2. Assume the asset was purchased on June 19, 20X1, for $75,000, with an estimated life of four years and an expected salvage value of $5,000. 20X1: $75,000.50 6/12 = $18,750 19 20X2: $75,000 $18,750 = $56,250.50 = $28,125
20 Comparing the Three Depreciation Methods
21 Comparing the Three Depreciation Methods
22 Popularity of the Three Depreciation Methods
Sum-of-the-Years -Digits Method The cost of the plant asset less its salvage value, is multiplied by a fraction. The Denominator Remains constant Obtained by adding the digits that make up the estimated useful life of the asset The Numerator Changes each year 23 Consists of the number of years remaining in the life of the asset
Example In Jan. 20X1, a delivery van was purchased by Nita s Flowers. The van had a cost of $21,000, an estimated salvage value of $3,000, and an estimated useful life of 5 years. The denominator of the fraction is the sum of the digits making up the 5-year life of the van: 5 + 4 + 3 + 2 + 1 = 15. 24 20X1 5/15 $18,000 = $ 6,000 20X2 4/15 $18,000 = 4,800 20X3 3/15 $18,000 = 3,600 20X4 2/15 $18,000 = 2,400 20X5 1/15 $18,000 = 1,200 $18,000
Sum-of-the-Years -Digits Method for Less Than a Year Let s assume that Nita s delivery van was purchased on October 1, 20X1 instead of January 1, 20X1. We know the first year s fraction is 5/15. In 20X1, only 3/12 of the first year s fraction is needed. In 20X2, the other 9/12 of the first year s fraction is used. To complete 20X2, we need 3/12 of the second year s fraction. 20X1 5/15 $18,000 = $6,000 3/12 = $1,500 20X2 5/15 $18,000 = $6,000 9/12 = $4,500 20X2 4/15 $18,000 = 4,800 3/12 = 1,200 $5,700 25 20X3 4/15 $18,000 = $4,800 9/12 = $3,600 20X3 3/15 $18,000 = 3,600 3/12 = 900 = $4,500
Sum-of-the-Years -Digits Method for Less Than a Year 20X4 3/15 $18,000 = $3,600 9/12 = $2,700 20X4 2/15 $18,000 = 2,400 3/12 = 600 $3,300 20X5 2/15 $18,000 = $2,400 9/12 = $1,800 20X5 1/15 $18,000 = 1,200 3/12 = 300 $2,100 20X6 1/15 $18,000 = $1,200 9/12 = $900 26
MACRS Modified Accelerated Cost Recovery System Required by the Internal Revenue Code for federal income taxes. An accelerated depreciation method required for calculating depreciation for income taxes purposes. Depreciation for Federal Income Taxes It is not necessary to estimate an asset s salvage value or its useful life. Nor do we need to know the time of year an asset was placed into service. Assets are assigned a recovery period based on property classes. 27
Plant Asset Records If a company has many depreciable assets, a summary general ledger account is usually kept for each major class of assets. Each summary account has a related Accumulated Depreciation account. These summary accounts are supported by a subsidiary ledger in which a card or computer file is maintained for each individual asset in the group. 28
Revenue Expenditures vs. Capital Expenditures An expenditure for a plant asset that benefits only the current account period. Examples include ordinary repairs and maintenance made to the asset. Revenue expenditures are debited to Repairs Expense. On July 15, 20XX, DeBice Home Products Company pays $400 for routine maintenance and repairs to its office equipment and records the following journal entry: General Journal Date Account Title P.R. Debit Credit 20XX July 15 Repairs Expense 400 29 Cash 400
Capital Expenditures An expenditure for a plant asset that benefits more than one accounting period. Examples of capital expenditures include Additions Betterments Extraordinary Repairs Increase either the value or the life of the asset and, depending on the type of expenditure, are debited to either A Plant Asset account, or 30 Its Accumulated Depreciation account
Capital Expenditures (cont.) An Addition A capital expenditure that literally adds on to an existing plant asset The cost is debited to a plant asset account A Betterment A capital expenditure that improves a plant asset, such as placing siding on a building The cost is debited to a plant asset account An Extraordinary Repair A capital expenditure that prolongs the life of a plant asset, such as new wiring in a building 31 The cost is debited to the Accumulated Depreciation account
Example Capital Expenditures On July 1, 20XX, DeBice Home Products Company spends $75,000 to replace a roof on its factory building. This expenditure is considered a betterment. DeBice Home Products prepares the following journal entry: General Journal Date Account Title P.R. Debit Credit 20XX July 1 Buildings 75,000 Cash 75,000 32
Example Capital Expenditures On July 1, 20XX, DeBice Home Products Company spends $50,000 to replace wiring in its factory building. This expenditure is considered an extraordinary repair because it extends the useful life of the building. General Journal Date Account Title P.R. Debit Credit 20XX July 1 Accumulated Depreciation- Buildings 50,000 Cash 50,000 33
Wrap it up: Revenue Expenditure vs. Capital Expenditure Revenue expenditures benefit only the current period and are debited to expense accounts. Capital expenditures benefit more than just the current period. Some capital expenditures add value to the plant asset; others add life. Additions and betterments are capital expenditures that add value to the plant asset and are debited to the plant asset account. Extraordinary repairs are capital expenditures that prolong the life of the plant asset and are debited to the related Accumulated Depreciation account. 34
Example PPE Disposition: Sale of a Plant Asset for Book Value Assume Roberts Company sells office equipment on July 1, 20X5, for $450. The equipment was purchased on January 3, 20X1, for $4,500 and depreciates at $900 per year. Accumulated depreciation as of date of sale would equal $900 4.5 years = $4,050. Book value on date of sale would equal $4,500 $4,050 = $450. Since book value equals the amount of cash received, there is no gain or loss on the sale. General Journal 35 20X5 July Date Account Title P.R. Debit Credit 1 Cash 450 Accumulated Depreciation- Office Equipment Office Equipment 4,050 4,500
Example Sale of a Plant Asset at a Gain Assume Roberts Company sells office equipment on July 1, 20X5, for $600. The equipment was purchased on January 3, 20X1, for $4,500 and depreciates at $900 per year. Accumulated depreciation as of date of sale would equal $900 4.5 years = $4,050. Book value on date of sale would equal $4,500 $4,050 = $450. Since the cash received exceeds the book value of the asset, we will recognize a gain. General Journal Date Account Title P.R. Debit Credit 20X5 July 1 Cash 600 Accumulated Depreciation-Office Equipment Office Equipment 4,050 4,500 36 Gain on Disposal of Plant Assets 150
Example Sale of a Plant Asset at a Loss Assume Roberts Company sells office equipment on July 1, 20X5, for $350. The equipment was purchased on January 3, 20X1, for $4,500 and depreciates at $900 per year. Accumulated depreciation as of date of sale would equal $900 4.5 years = $4,050. Book value on date of sale would equal $4,500 $4,050 = $450. Since the cash received is less than the book value of the asset, we will recognize a loss. General Journal 37 20X5 July Date Account Title P.R. Debit Credit 1 Cash 350 Accumulated Depreciation - Office Equipment Loss on Disposal of Plant Assets Office equipment 4,050 100 4,500
Trading In Plant Assets When a trade occurs, a trade-in allowance is received for the old asset The purchaser pays the difference between the price of the new asset and the trade-in allowance received The boot: the difference between the price of the new asset and the trade-in allowance Accounting for a Gain on a Trade of Similar Assets Assume on January 2, 20X2, a truck with a cost of $9,000 and accumulated depreciation of $7,000 is traded in for a new truck with a list price of $12,000 A trade-in allowance of $3,000 is received for the old truck. The book value of the old truck is $9,000 $7,000 = $2,000 38
Example Accounting for a Gain on a Trade of Similar Assets The gain is the excess of the trade-in allowance over the book value or $3,000 $2,000 = $1,000 The gain isn t recorded in the journal entry; the boot paid is $12,000 $3,000 = $9,000 The cost of the new truck = the book value of the old truck + the boot paid = $2,000 + $9,000 = $11,000 20X2 Jan. General Journal Date Account Title P.R. Debit Credit 2 Truck (new) 11,000 Accumulated Depreciation-Truck 7,000 39 Truck (old) Cash 9,000 9,000
Example Accounting for a Loss on a Trade of Similar Assets Assume on January 2, 20X2, a truck with a cost of $9,000 and accumulated depreciation of $7,000 is traded in for a new truck with a list price of $12,000. A trade-in allowance of $1,000 is received for the old truck. The book value of the old truck is $9,000 $7,000 = $2,000 The loss is the excess of the book value over the trade-in allowance or $2,000 $1,000 = $1,000, the boot paid is $12,000 $1,000 = $11,000 General Journal Date Account Title P.R. Debit Credit 20X2 Jan. 2 Truck (new) 12,000 Accumulated Depreciation-Truck 7,000 Loss on Disposal of Plant Assets 1,000 40 Truck Cash 9,000 11,000
Example Discarding a Fully Depreciated Plant Asset Assume on June 15, 20X5, Roberts Company discards a drill press with a cost of $14,200 The asset is fully depreciated; its book value is zero General Journal Date Account Title P.R. Debit Credit 20X5 Jun. 15 Accumulated Depreciation- Drill Press 14,200 Drill Press 14,200 41
Let s make a summary for Trading In Plant Assets here: When a trade occurs, a trade-in allowance is received for the old asset The purchaser pays the difference between the price of the new asset and the trade-in allowance received, which is called The Boot When actually a gain occurs, do not recognize it but reflect it in the cost of new asset, which is equal to the allowance plus boot paid When actually a loss occurs, recognize it and use the list price of the asset as the cost basis of the asset 42 For Federal income tax purposes, the gain is treated the same as is treated in accounting, whereas the loss actually occurred would increase the cost basis of the new asset, which is equal to the book value of asset being traded plus boot paid Now let s take a look at page 738 Exercise 16-7.
Example Discarding a Plant Asset with a Book Value Assume on June 15, 20X5, Roberts Company discards a drill press with a cost of $14,200 Accumulated depreciation on the drill press at date of disposal amounts to $13,400 The loss on disposal is equal to the cost of the asset less its accumulated depreciation = $14,200 $13,400 = $800 General Journal Date Account Title P.R. Debit Credit 20X5 Jun. 15 Accumulated Depreciation- Drill Press 13,400 Loss on Disposal of Plant Assets 800 43 J. WU Drill Press 14,200
Intangible Assets and Amortization 44 Lack physical substance Include such things Patents Copyrights Trademarks Franchises Amortization The periodic write-off of an intangible asset Based on the straight-line method of depreciation
Example Intangible Assets On January 9, 20X2, Winners Company purchased a patent for a new exercise machine at a cost of $12,000. Winners Company assumes the patent will have a useful life of 10 years. Winners Company prepares the following entries to purchase the patent on January 2 and on December 31 to record annual amortization. 20X2 Jan. General Journal Date Account Title P.R. Debit Credit 9 Patent 12,000 Cash 12,000 45 Dec. 31 Amortization Expense-Patent 1,200 Patent 1,200
Natural Assets and Depletion 46 Long-term assets acquired for the purpose of removing or extracting natural resources, such as timber, oil, coal, gold or gas Depletion The expense resulting from the using up of a natural resource Similar to units-of-production depreciation Assume on March 2, 20X2, the Deep South Company purchased oil-drilling rights to a well for $3,000,000. There is no salvage value and the well is estimated to produce 6,000,000 barrels of oil. During 20X2, Deep South Company removed 700,000 barrels of oil.
Example Depletion The depletion expense per barrel = $3,000,000 6,000,000 barrels of oil = $0.50. Depletion for 20X2 = $0.50 700,000 barrels = $350,000. General Journal Date Account Title P.R. Debit Credit 20X2 Dec. 31 Depletion Expense-Oil Well 350,000 Accumulated Depletion-Oil Well 350,000 47
Plant Assets and Depreciation 48
Plant Assets and Depreciation 49
Three Categories of Capital Expenditures 50