Plant Assets, Natural Resources, and Intangibles: Study Notes

Plant Assets, Natural Resources, and Intangibles

Accounting for the Cost of Plant Assets

Definition and Measurement

• Plant assets (also called fixed assets) are tangible long-lived assets used in the operations of a business.

• The cost of a plant asset is the sum of all expenditures necessary to acquire the asset and prepare it for its intended use.

• Costs include: purchase price, taxes, commissions, installation, and other expenditures to make the asset ready for use.

Land costs include purchase price, brokerage commission, survey and legal fees, back property taxes, grading, clearing, and removal of unwanted buildings. Costs such as fencing, paving, and lighting are classified as land improvements and are depreciated separately.

Example: Capitalizing Plant Assets

• When purchasing land, only costs necessary to prepare the land for use are capitalized. Maintenance and land improvements are recorded separately.

• Example Calculation: If a company pays $300,000 for land, plus $10,000 commission, $8,000 back taxes, $5,000 for building removal, and $1,000 survey fee, the total land cost is $324,000. Paving and maintenance are not included in the land cost.

Building, Machinery, and Equipment

• Building construction costs include architectural fees, permits, contractor charges, materials, labor, overhead, and interest during construction.

• Building purchase costs include purchase price, commissions, taxes, and renovation costs.

• Equipment costs include purchase price (less discounts), transportation, insurance in transit, taxes, commissions, installation, testing, and special platforms.

Land Improvements and Leasehold Improvements

• Land improvements include driveways, signs, fences, and sprinkler systems. These are depreciated over their useful lives.

• Leasehold improvements are improvements made to leased property and are amortized over the lease term.

Lump-Sum (Basket) Purchases

When multiple assets are purchased together for a single price, the total cost is allocated to each asset based on their relative market values using the relative-sales-value method.

• Allocation formula: Asset Cost = (Asset Market Value / Total Market Value) × Total Cost

Capital Expenditures vs. Immediate Expenses

Definitions

• Capital expenditures increase an asset’s capacity or extend its useful life and are added to the asset account.

• Immediate expenses are costs that do not increase the asset’s value or useful life and are expensed as incurred (e.g., routine repairs and maintenance).

Most companies expense small, immaterial costs immediately. Proper classification is essential for accurate financial reporting.

Depreciation of Plant Assets

Concept and Purpose

• Depreciation is the process of allocating the cost of a plant asset to expense over its useful life.

• It matches the asset’s cost with the revenue it helps generate (Matching Principle).

• Land is not depreciated because it is assumed to have an indefinite life.

Key Terms

• Book value: Cost of asset minus accumulated depreciation.

• Residual (salvage) value: Estimated value at the end of the asset’s useful life.

• Depreciable cost: Asset cost minus residual value.

Depreciation Methods

• Straight-Line Method: Allocates equal depreciation each year. $depreciation\ expense = \frac{cost - residual\ value}{useful\ life}$

• Units-of-Production Method: Depreciation based on usage. $depreciation\ per\ unit = \frac{cost - residual\ value}{total\ estimated\ units}$ $annual\ depreciation = depreciation\ per\ unit \times units\ produced$

• Double-Declining-Balance Method: Accelerated depreciation, higher in early years. $DDB\ rate = \frac{1}{useful\ life} \times 2$ $annual\ depreciation = beginning\ book\ value \times DDB\ rate$

Comparing Depreciation Methods

• Straight-line: Best for assets generating revenue evenly over time.

• Units-of-production: Best for assets that wear out due to use.

• Double-declining-balance: Best for assets generating more revenue early in their life.

• Total depreciation is the same over the asset’s life, but annual expense patterns differ.

Disposal of Plant Assets

Accounting for Disposal

• Update depreciation to the date of disposal.

• Calculate book value: $book\ value = cost - accumulated\ depreciation$

• Record gain if sale price > book value; record loss if sale price < book value.

Natural Resources and Intangible Assets

Natural Resources

• Examples: iron ore, oil, timber.

• Depletion is calculated similarly to units-of-production depreciation.

Note: Detailed depletion calculations not covered in this class.

Intangible Assets

• Long-term assets with no physical form but with special rights (e.g., patents, copyrights, trademarks, franchises, goodwill).

• Intangibles with finite lives are amortized; those with indefinite lives are tested annually for impairment.

Asset Impairment

Definition and Accounting

• An asset is impaired if its expected future cash flows are less than its book value.

• If impaired, the asset’s carrying value is written down to fair value, and an impairment loss is recorded.

Return on Assets (ROA)

Definition and Calculation

• ROA measures how efficiently a company uses its assets to generate net income.

• Formula: $ROA = \frac{net\ income}{average\ total\ assets}$

• A higher ROA indicates better asset utilization and profitability.

Cash Flow Impact of Long-Lived Asset Transactions

Statement of Cash Flows

• Acquisitions and sales of long-lived assets are reported as investing activities.

• Depreciation and amortization are non-cash expenses added back to net income in operating activities.

Calculating Depreciation Using Excel Functions

Excel Functions

• SLN function: Calculates straight-line depreciation.

• DDB function: Calculates double-declining-balance depreciation.

Summary Table: Lump-Sum Purchase Allocation Example

Asset	Market (Sales) Value	Total Market Value	Percentage of Total Market Value	Total Cost	Cost of Each Asset
Land	$300,000	$3,000,000	10%	$2,800,000	$280,000
Building	$2,700,000	$3,000,000	90%	$2,800,000	$2,520,000
Total	$3,000,000	$3,000,000	100%	$2,800,000	$2,800,000