Initial Cost of Long Lived Assets

So let's discuss how we record the purchase of our long lived assets. Let's check it out. Alright, So long lived assets, they've got a lot of names, we call them fixed assets, Plant assets, property, plant and equipment. There's a bunch of names for these things, but they're always gonna include these four categories. These are the four main categories of these plant assets. Okay, so these fixed assets, remember, these are long term assets that we're gonna use for multiple years. So the four categories here, we've got land, the next one is land improvements. So notice there's two categories, there's one for the land itself and then one for the improvements to the land. Alright, We'll talk about more of what those are. That's gonna be like fences and things like that, that we put onto the land, then we're gonna have buildings and finally machinery. Sometimes we call it equipment, whatever machinery, equipment. It's that category. Okay, so a good acronym that we use for these plant assets, we use P P. E. And that stands for property plant and equipment. Usually when you see this on a balance sheet, when you see this on a financial statement, that's the category that it's going to include all of these things because because usually when you have a big company, they're not going to list how much land they have land improvements. They're not gonna list those separately. They'll just give you one number for the bulk amount of fixed assets and they'll just say property plant and equipment and then it'll say net after it. And we'll talk about what that net means in a little bit. Okay, so remember the focus of this lesson is on that initial purchase? What is the initial cost of these plant assets? Right. So the rule here, this is the rule that's gonna go for all of these for all of these categories. The rule is that initial cost is gonna include the price. So, obviously the price we paid plus all necessary expenditures. So necessary expenditures to make the asset ready for use. Alright, so what does this mean necessary expenditures to make the asset ready for use? Well, we might have bought some machinery for, say, $10,000. But what if we have to pay other things too? We'll talk about what all those things can be, but maybe we have to pay taxes on the machinery. Right. That's a necessary expenditure. If we didn't pay those taxes, what we wouldn't get the machinery, maybe we have to pay an installation cost, right? Maybe we don't know how to install the machinery. We need an expert to come in and install it. Well, if we didn't pay for that installation cost, guess what? We can't use the machine? So it wouldn't be ready for use. So, all of these things, all these things that make it ready for use, they're included in the initial cost. Okay, So it's not just the price we pay. We have to pay attention to these other necessary expenditures when we purchase the machine. Okay, cool. So let's go ahead and think about um the the principle that we use, it's called. So when were initially recording these plant assets? What gap what gap follows is called the historical cost principle. Okay, so this historical cost principle, it means, well, there's 22 principles that gap prescribes for different things. There's this historical cost principle that we use for fixed assets and that means we're gonna record it at the historical cost what we paid for it. Plus in this case these necessary expenditures, right? So we're gonna record it at that cost and we're not going to change it, compare that to the other principle, the fair value principle. And in that case that that's more for like investments and stuff. And that means we're going to change the value based on the market of that, the market value of that item. And that doesn't really make sense for fixed assets. Right? For an investment. A fair value might make sense because well the investment, the apple stock, it might be worth this today and we might be selling it very soon. So we're gonna want to be changing the price as the price changes and keep it at its fair value. Whereas something like plant assets, something like land, right this land or a building. Well the building we're gonna use for a long time, right? We're not just going to have the building and then, oh, the building is worth 10,000 more. we should mark that up on our books. That doesn't really make sense. We're gonna be using the building for a long time. We shouldn't be changing the value of it, because we're not planning on selling it. Just like an investment like that. This is something that we're gonna be using um, throughout through our business to help us, you know, create our product, whatever it is. So there's no reason to be changing the value. We're gonna leave it at that historical cost. Cool. So, after we uh find that initial cost, which is going to be the focus of this lesson right now, Well, after that, just to kind of round out the whole life cycle of these fixed assets, After we find the initial cost, we're gonna then depreciate. So they're then depreciated over their useful life. Okay, so we're gonna take these uh, plant assets and we're gonna depreciate them over their useful life. Depreciation is an expense. So, remember when we buy them these plant assets, well, their assets, but then they're value is going to start deteriorating over their life, right? So, imagine a building, it's not gonna be worth the same the day we bought it as the time goes on, and we use it. Well, it's gonna wear and tear a machine, a machine that we bought, we're gonna use it, It's gonna start wearing and tearing the parts are not gonna be as good as the day we bought it. So we're gonna depreciate it over this useful life. Now before we move into a little example about the depreciation, um I want to talk about the one plant asset that's not depreciated. So if you look up at our categories up here, land land improvements, buildings and machinery, which one do you think is not depreciated? There's one that stands out from the others. Which one do you think it is? Well, the plant asset that is not depreciated is land. Okay, so think about land compared to these other things, a building. Well the day you bought the building and over time it's gonna deteriorate, right? If you leave a building there for long enough, it's gonna fall down a machine, you're gonna use it in your factory and it's gonna deteriorate. The gears are gonna fall apart, right? They're not gonna last forever. Land improvement, something like a fence that you built that's gonna rust over time. But the land we're talking about like the actual land, this acre of land that you bought, well that acre is still going to be an acre, whether the grass is not grass anymore and it's just dirt, it's still an acre of land. So you don't depreciate the land, Okay, It's always just gonna be that historical cost and this is important. Professors love to trick you on this. Professors love to ask quick multiple choice questions and and take easy points away from you because they don't because you don't think about this. We'll remember that land is not depreciated. Everything else we're gonna talk about is depreciated. Alright, So let's talk about a little quick example about depreciation and just kind of round out the life cycle of the fixed asset here. So as an example, we're going to see in this left box, the company purchases a machine for $10,000. So there's no other expenditures here to make it ready for use. We're not gonna talk about all that just yet. So let's just say they purchase a machine for $10,000. So what's that journal entry gonna look like, notice this is happening on the first day of the year, January 1, 2011. And we're going to debit machinery, right? So we'll debit machinery this asset because we got we purchased an asset. So we debit it for the $10,000 value. And then we're going to credit, let's say cash because we paid for it with cash and notice we just changed one asset for another asset. There's been no no no impact on our income statement at all. Right? We just bought an asset. Well, what's gonna happen is we're gonna depreciate this asset over its useful life. So let me get out of the way here and we'll do this example. So the machinery is then depreciated over its useful life. And in this case we've got a ten-year useful life. So you can imagine this machine, we're gonna start using it to create our product, and it's gonna help us for 10 years uh in creating this product. So notice, what are we gonna do over these 10 years? Well, we're going to depreciate the machine, we're going to get more into depreciation methods, how we depreciate. But for now, let's use a very simple method. The straight line method. And what we do is take the value, the 10,000 that we paid for it, and we split it up over the 10 years. So what this tells us is that there's gonna be 1000 per year in depreciation. Okay? And we'll talk more about depreciation and other videos. Uh so let's just see how this kind of plays out here. So notice now we're on december 31st, 2020 X one, whatever this year is. So, it's been a year since we bought it, right? So naturally, we should take a year's worth of depreciation, right? We're talking about one year out of the 10 year useful life. This is 1/10 of the useful life. So we need to take 1/10 of the value out, and that's exactly what we have here in the 1000 per year. So what we're gonna do is we're going to debit our depreciation expense. So notice this is an expense now, and this is going to the income statement for $1000 right? A year has passed. So we have $1000 in depreciation and that's going to the income statement. And what's the other side of this? It's going to be our accumulated depreciation. You guys might remember this from when we studied um adjusting entries, but if not, we're gonna get into a lot more detail in this unit. Don't you worry? Alright, so accumulated depreciation For that $1,000. So remember accumulated depreciation. This is a contra asset, a contra asset account to the machinery account. So this contra asset accumulated depreciation, it's going to be on our balance sheet. But look notice since it's a contra asset, it has a credit balance. So what it's doing is it's lowering the net balance of that machinery. So if you look, our machinery had an initial value of $10,000 as a debit as an asset. And then this contra asset of 1000 is lowering its value by that 1000 right? We've got 10,000 as a as a debit. 1000 as a credit. Well, that leaves us with a value a netbook value of 9000 right? We've gone 10,000 minus the 1000 of credit. And it leaves us with 9000 left, right? But notice we're not directly lowering the value of the machinery. That's because of this historical cost principle. We're leaving it at that $10,000 value and then we're depreciating it over its useful life and lowering its value through this accumulated depreciation, you see? So as as time keeps passing on, so this has been the first year we would do more years more depreciation, and it would keep lowering that net value of the machine. Okay, So we're gonna get into a lot more detail about depreciation once we get to that unit, Uh to those lessons. But for now we're going to focus on how do we get that initial cost right? We just had a really simple example where we just had 10,000 was the initial cost. So 10,000 went into our journal entry. But now we're gonna see a little bit more complicated. How do we add these necessary expenditures to make them these assets ready for use? Well, let's dive into a little more detail about land, land improvements, buildings and machinery. And let's start here with land. Alright, let's do it in the next video

Alright, let's start a discussion on the initial cost of land. So land, remember this is just the land itself, nothing on the land. So if you bought an acre of land, we're talking about just the land. Okay. So the land is often purchased as the building site, right? This is where we're gonna build something generally and we'll build a factory or an office on the land. So the cost of the land, remember it doesn't just include the purchase price, but every necessary expenditure to make it ready for use. So what could that include? Well, let's start there with the purchase price. And sometimes we pay with cash, but we can also take out a loan, right? Maybe we'll get a loan from the bank to pay for for the for the land or maybe we'll raise some equity and we'll have common stock that we used to pay for the land. So generally what you'll see is a note payable. Maybe you'll have cash along with a note payable. Okay, So that that's gonna be definitely part of the purchase price of the land. But what about some of these weird things? These are gonna be those necessary expenditures. These are the ones they like to use in your class, you'll see closing costs related to titles or attorney fees, right? You have to pay some title, search costs, something like that. Real estate broker commission. If you have to pay any commissions. Well, that's going to be included in the initial cost of the land property taxes and leans that are assumed by the buyer, right? We're going to be the buyer in this case. So if we have to pay any leans that were on the property, this is like um taxes that were never paid before and now you have to pay them. Well, that's going to be included in that cost. Now this one's pretty interesting and I want you to know All right, this is one that they usually like to trick you with. So the cost of any old structures. So the cost of removing any old structures on the land, Right? Because let's say you're gonna build an office on the site, but there's like an old dilapidated building on the site that you have to get rid of. You can't build your office until that old building is gone. Well, it's not ready for use until that old building is gone. Right? So the cost of removing that old building, we gotta include that into the cost of the land, but usually when there's gonna be some old building on the site, we're gonna get some salvage value. Maybe we have scrap metal, maybe we can sell, you know, whatever we we demolish the building and we can sell some stuff from the building. We might get a little money back. Okay, So less any salvage value. All right. And then last but not least. I want to remind you here. Remember that land is not depreciated. This doesn't have to do with the initial cost of the land, but I just want to reiterate to you guys that land is not depreciated. It is the only fixed asset that we're not gonna be depreciating. Cool. Alright so let's jump right in here to an example and let's see how we can find the initial cost of this land. So the sexy times lingerie company S. T. L. C. Just purchased a plot of land to build its new edible underpants factory. Oh man when did I write this? S. T. L. C. Paid 40,000 in cash and signed a five year note payable for an additional 160,000 in closing the sale. S. T. L. C. Also paid 1500 in attorney fees and a broker's commission of 2500. Furthermore, the land housed a dilapidated warehouse that S. T. L. C. Removed for $12,000 while receiving $3000 from the scrap metal. After removing the warehouse. S. TLC paved a portion of the land as a parking lot at a cost of 15,000. So remember after all these numbers, what is the initial cost of the land? Okay so we're gonna be looking for that initial cost of the land and then we're gonna make the journal entry. The journal entry is gonna be pretty simple but let's go ahead. The tricky part is what is included in the cost of the land. Remember it's the cash we paid maybe any loans we took out and then all necessary expenditures to get it ready for use. So let's go ahead and start listing them out. So the land is gonna include. We've got the cash we paid, right? We paid 40,000 in cash, tells us right here, 40,000 in cash. And we signed a five year note payable for another 160,000. So the bank loaned us $160,000 that we put towards this uh towards this purchase of land. So the note payable, I'll put mp for note payable. That was another 160,000 That went into the cost of the land. Right. What else did we do? We had some other closing cost to write 1500 and attorney fees that we paid Broker's commission of 2500 if we didn't pay these. Well, we wouldn't get the land. Right? So let's add those in here to 1500. And I'll put attorney. Okay, Um broker was another 2500. The broker. And what else? So here's the tricky one. We've got the furthermore that the land house, the dilapidated warehouse. So there was this old building on the land and we couldn't build our factory until we got rid of this old warehouse. Right? So we removed it and it cost us $12,000. Right? So the warehouse Removal, it cost us $12,000 to remove the warehouse. But we received 3000 in return. Right? It cost us 12,000 but we received 3000 in return. So we got to take that out. Okay so that's gonna reduce the cost of the land and that was from the scrap metal. Right? The scrap metal got us $3000 back. So we take that out of the warehouse cost. Okay? And last but not least after removing the warehouse. S. T. L. C. Paved a portion of the land as a parking lot at a cost of 15,000. So what do you guys think about that one? Well that's a land improvement. Right? Remember when I talked about land, the land itself? Just the land, the acre of land that we bought? Well that's gonna be the land, anything we put on the land. Well that's either gonna be a building when we build the building or build the factory or it's gonna be a land improvement. When we're talking about parking lots or fence, anything like that, lighting fixtures. That's all gonna be land improvements. So that is not included in the cost of the land. We would still make an asset for that. But here we're specifically focused on the land, we're gonna focus on land improvements in the next video but here it's not included in the cost of the land. Okay, so let's go ahead and let's find out what the initial cost of the land is. Pull out a calculator. We had 40,000 in cash, 160,000 in notes payable. Uh 1500 attorney fees, broker commission 2,512,000 in warehouse, removing the warehouse. And then we're going to subtract 3000 from the scrap metal. We got Okay, so we end up with 213,000 is what we paid for the land, not just the cost of the land, but with all these necessary expenditures as well. Okay. So what's our journal entry gonna look like? Well, we're gonna debit land, right? Land is our asset. And we're going to debit it for the 213,000. Now it tells us we paid cash of 40,000, but we also paid cash for quite a few other things too. Right? We paid cash for the attorney fee, cash for the broker fee notice. We don't have an expense. We're not gonna have brokers expense. We're not gonna have attorney expense, nothing like that. All of those costs were saying they got capitalized. When we say something got capitalized, That means it got put into an asset account. Okay, so we capitalize these costs and we did it correctly through gap into the land account. So we did take out a note payable, right? We have a note payable and that's a liability. Right? We have a note payable for 160,000. So that is going to be a credit here. We're gonna have a credit To notes payable for 160,000. Oops, this is a credit 160,000. And then the rest of it. We paid in cash. Right? We paid the 40,000 in cash for the land. But we paid a bunch of other things in cash as well. These attorney fees, broker fees, removing the warehouse. So how much was that in total? I'm just gonna balance out this entry. 213,000 -160000. And that comes out to 53,000. Right? This 53,000. That should make sense. Right. This is gonna be this cash we paid here, attorney fee broker fee and then the things with the warehouse, that other 9000 to 12,000 minus 2, 3000. So there we go. That's our entry. We debit land, creating that asset for land and we're going to credit notes payable and credit cash. Cool. So that's that's about as tricky as these questions get. And generally when you deal with these types of questions, they're gonna stand alone. You're usually not gonna obviously with land we don't appreciate. But usually you're not gonna have to have this insane calculation for the cost and then be dipped appreciating when we're talking about a building or equipment. The question's gonna stand alone in your class. They're just gonna say, hey, what's the cost And they're usually not gonna go as intense as this. But if you could understand what we just went through. You're doing pretty good at this point. All right, let's go ahead and let's start talking about land improvements. Alright, let's do that in the next video. Yeah. Mhm.

All right, let's move on to land improvements here. So remember there's the land itself, the acreage, right? The land. And then the land improvements things we build on the land, such as driveways, parking lots, fences, sprinklers, right? Things that we add to the land. These are improvements to the land. Well, these different from the land. These are going to have limited lives, right? So these are these aren't gonna last forever. Like land does these have limited lives? So just like any other asset, the cost of the land improvement will be debited to an asset account. In this case, the land improvements account. So this is an asset as well. Alright? Now, sometimes if if we don't own something straight out, we might lease something like when you lease a car. Well, you don't own the car, right? You're leasing it from the owner for a certain amount of years. Well, you could lease something and you could improve to it. You could have leasehold improvements just like we have land improvements. Well, let's say you didn't own the land and you you were leasing it from its owner, but you had in the contract the ability to put sprinklers to put up fences, right? Those belong to you. They don't belong to the owner. So they would still be part of your assets. So, another example here, you could lease a truck, maybe like Fedex leases a truck and they paint their logo on it, right? That that paint that logo that they painted on it. Well, that's their asset, right? And it's going to depreciate um just like any other depreciate ble asset. So the truck itself, they're not gonna depreciate but they own the improvement right now. The difference here is when we have a land improvement, right? And with most assets we are going to depreciate them over their useful life. Well, at least hold improvement. It's only gonna be over the term of the lease. Okay. And this isn't so such a big deal in your class, you're probably not gonna run into it too much, but we'll do an example of it just in case land improvements and leasehold improvements, they're pretty much the same thing here. Just remember that land improvements. This is gonna be something like you own the land and then this fence, let's say you build a fence on it and it's gonna have a useful life of 20 years. Right? So you would depreciate it over those 20 years where a leasehold improvement, maybe you don't have a you build a fence that's gonna last 20 years but you're only gonna have the lease for say five years. Well you would do it over the term of the lease, not over the whole useful life because you're only gonna have it for those five years. Alright, so that's a little tricky thing that can come up with these land improvements. Is this specific category, leasehold improvements when you're leasing something. But for the most part, I'd say focus on the land improvements and that's just like any other of our fixed assets. We're going to see that we're just appreciating over their useful life. Okay So remember land improvements they are depreciated. Okay land is the only one that is not depreciated and like I said over their useful life. Cool so let's go ahead and do this example here. Let's continue with our S. T. L. C. So they entered into an agreement to lease an office building for the next 10 years. So notice we're dealing with a lease here right? They entered an agreement to lease an office building for the next 10 years. So it's a 10 year lease. And as part of the agreement S. T. L. C. Was allowed to build walls inside of the building to separate the office space. S. T. L. C. paid $20,000 to build the walls. 20,000 to build the walls inside the office building. The walls are expected to last 20 years. The journal entry to record this transaction would include a debit to land buildings, leasehold improvements or a debit to an expense. So notice we built walls for $20,000 right? But we don't own the building. Um So it's not gonna be our building that we're gonna be debating to the building and it's not land either right? We're not gonna be debating it to land. So the trick here is that this is a leasehold improvement right? It's still an asset. We own these walls. So we're gonna have at least hold improvement. And that's gonna be the debit in this transaction. All right. So, we're not gonna expense them right away. We're gonna have this asset and we're gonna depreciate them over their useful life. So when we depreciate it, that's when it's gonna be expensed and show up on the income statement. But we started off when we initially by it, the cost of it is going to this asset leasehold improvements for 20,000 and cash is our credit. We paid for it with cash For 20,000 notice. In this case, we didn't have any extra necessary expenditures, right? They didn't mention anything about taxes or anything necessary to get into use. So, that's it. We didn't have any extra costs going on here. We just got the 20,000. All right. So, this would be the journal entry to uh to signify that we built these walls here for the 20,000. So, the answer here would be c a debit to leasehold improvements. And remember that's an asset account? A long term asset. Cool. So let's check out this other question related to the leasehold improvements. The value of the vault. The value of the walls will be depreciated over 10 years, 15 years, 20 years or not depreciated. They are gonna be depreciated, right? Because they are a long term asset and they're not land land is the only one that's not depreciated. So it's definitely not that. Now this one's a little special case because we're talking about a lease right? Generally we would use the useful life and they told us the walls are expected to last 20 years. That's the useful life right there. Right. The useful life. So if we had owned this building, well, we would depreciate it over the 20 years, but we only leased it for 10 years. This is the term of the lease. So since this is a leasehold improvement, we can only depreciate it as long as we're gonna be leasing that building. So that's the little trick here, is with the leasehold improvement, it would be 10 years If we own this building and built these walls well then we would use the 20 year useful life. Okay. So that's a little bit of a trick there In the end. Since it's at least hold improvement in this case, the answer is gonna be 10 years. It would never be 15 years. We're never going to average out the two. It's always gonna be one or the other there. Okay. So the answer there is 10 years and you can see nothing too crazy there with the the land improvements. We're gonna be treating them just just as we go on to do buildings and we go on to do machinery. You're gonna see that we're gonna be treating them very much the same. The useful life is what's important and the cost is always going to be all those necessary expenditures to get them ready for use. Alright, let's go ahead and move on to the next video.

All right, let's move on to the next plant asset buildings. So buildings, they're going to be very similar to all the other ones, you're gonna see there's a lot of similarities here, So it's similar to land and equipment purchases, even similar to those land improvement purchases in that sense. So, remember that it's going to include all the costs necessary to make the building ready for use, right? If we can't use the building without taking this expense, well then it's not ready for use and that is included in the cost, that initial cost. Okay, So one little trick with a building is if we if we constructed the building, so we bought the land and we're gonna build an office building on it. Well, if we have to take out a loan to finance that project to build the building itself, we can actually include the interest, the interest from borrowings to finance the project into the cost of the land. Now, that's something you're probably going to deal with in higher level classes, but it's good to know that if we're actually constructing the building, if we're just buying a building, that's different. No, you can't include interest in that case. But if you're building the building, building the building, if you're going to construct the building yourself, well then you can actually include interest on those borrowings for financing the project. Alright, So, remember, buildings are depreciated, right? Buildings are depreciated, just like land improvements, just like equipment only. Land itself is not depreciated and again, it's over the useful life. Alright, so you get get really familiar with that term, We're gonna be dealing with the useful life a lot. So why don't we actually let's pause right here and we'll jump into a practice problem because I think you guys are ready to try and solve what the initial cost and the journal entry would look like for this building. Alright. So it's gonna be really similar to what we did with land. Alright? So if you need to go back and check the land video to get a little more familiar or just jump in and give it a shot. Alright. Let's pause here and then you guys try this one out.

Alright. Here we go with equipment and machinery. Remember these terms are pretty much interchangeable equipment and machinery, machinery, and this is gonna be very similar to just what we've talked about with land and what we've talked about with buildings as well, where we're gonna be looking for all costs necessary to make the equipment ready for use, ready for use. Okay. So, when we have taxes, when we have any of those things that we've talked about so far, but then there's gonna be some special ones, This is actually a special one that comes up with equipment is some kind of unique accommodation for the equipment. Alright? So, sometimes you bought a piece of equipment and it doesn't really fit in your factory correctly, and you have to build, say, a special platform for the equipment. All right, before you can use it. Well, if you didn't build that special platform, then you couldn't use the equipment. Right. So, it wouldn't be ready for use. We're gonna include that in the cost of the equipment. All right, another one. Any delivery expenses, right. If they're gonna deliver the equipment to us and we have to pay for that delivery, well, guess what if we didn't pay for that delivery, we wouldn't have the equipment and it wouldn't be ready for use. So that's going to be included in the cost as well. Okay. And, um, last, but not least remember, with equipment, this is something like we would have like a machine that we're using and we're producing our product with this. Well, if we have to ensure that equipment or we have to maintain it, or we have taxes that we have ongoing taxes for using the equipment. And the main one here is this maintenance cost, right? If we have to like oil the machine every year. Well, that doesn't go into the initial cost, right? It was already ready for use once it's ready for use and going, all those other costs are gonna be expensed. Okay, That's not gonna be included in the cost. So, remember, we're gonna get it ready for use, and then there's gonna be a point where it's ready and then everything after that. Well, those are gonna be expenses. Okay, So just like we were talking about equipment is depreciated, right? This is gonna be depreciated, just like buildings and just like land improvements. Right? The land itself is not depreciated, I'm gonna keep reiterating that. So, the land improvements are depreciated, buildings are depreciated and equipment is depreciated again over the useful life of the equipment. I was just testing you guys there to see if you were paying attention. So, it's gonna be uh depreciated over the useful life of the equipment. Cool. So, let's go ahead and pause here. I think you guys are ready after that tricky one with the building. I think you're ready to find the initial cost of this equipment. Let's do this. Practice problem, and then see if you got it right? Alright, let's do it