Plant Assets, Natural Resources, and Intangibles – Comprehensive Study Notes

Plant Assets, Natural Resources, and Intangibles

Introduction

This chapter covers the accounting for long-term assets used in business operations, including property, plant, and equipment (PP&E), natural resources, and intangible assets. These assets are essential for generating future revenues and require specialized accounting treatment to reflect their acquisition, use, and disposal.

Accounting for the Cost of Plant Assets

Definition and Measurement

• Plant assets (also called fixed assets) are tangible long-term assets used in the production of goods and services.

• 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 and Land Improvements

• Land costs include: purchase price, brokerage commission, survey fees, legal fees, back property taxes, grading, clearing, and removal of unwanted buildings.

• Costs not included in land: fencing, paving, security systems, and lighting (these are land improvements and are depreciated).

Buildings, Machinery, and Equipment

• Building (construction): architectural fees, permits, contractor charges, materials, labor, overhead, and interest during construction.

• Building (purchase): purchase price, commissions, taxes, repairs, and renovations.

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

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: $\text{Asset Cost} = \text{Total Cost} \times \frac{\text{Asset Market Value}}{\text{Total Market Value}}$

Capital Expenditures vs. Immediate Expenses

Definitions and Distinctions

• Capital expenditures increase an asset’s capacity or extend its useful life. These costs are added to the asset account (capitalized).

• Immediate expenses are costs that maintain the asset’s current condition and are expensed as incurred (e.g., repairs and maintenance).

• Small, immaterial costs are usually expensed immediately.

Depreciation of Plant Assets

Concept and Purpose

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

• It matches the cost of the asset with the revenues it helps generate (matching principle).

• Land is not depreciated.

Key Terms

• Book value: Cost of asset minus accumulated depreciation.

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

• Depreciable cost: $\text{Depreciable Cost} = \text{Cost} - \text{Residual Value}$

Depreciation Methods

• Straight-Line Method: Equal depreciation each year. $\text{Annual Depreciation} = \frac{\text{Cost} - \text{Residual Value}}{\text{Useful Life}}$

• Units-of-Production Method: Depreciation based on usage. $\text{Depreciation per Unit} = \frac{\text{Cost} - \text{Residual Value}}{\text{Total Estimated Units}}$ $\text{Annual Depreciation} = \text{Depreciation per Unit} \times \text{Units Produced in Year}$

• Double-Declining-Balance Method: Accelerated depreciation. $\text{DDB Rate} = \frac{1}{\text{Useful Life}} \times 2$ $\text{Depreciation Expense} = \text{Beginning Book Value} \times \text{DDB Rate}$

Example: Straight-Line Depreciation Calculation

• Cost: $550,000; Residual Value: $35,000; Useful Life: 10 years

• Depreciable Cost: $550,000 - $35,000 = $515,000

• Annual Depreciation: $515,000 / 10 = $51,500

Example: Units-of-Production Depreciation Calculation

• Cost: $550,000; Residual Value: $35,000; Total Units: 1,980,000

• Depreciation per Unit: $515,000 / 1,980,000 = $0.26

• If 500,000 units produced in Year 1: $0.26 × 500,000 = $130,000 depreciation

Example: Double-Declining-Balance Depreciation Calculation

• Cost: $550,000; Useful Life: 10 years

• DDB Rate: $\frac{1}{10} \times 2 = 20\%$

• Year 1 Depreciation: $550,000 \times 20\% = $110,000$

Comparison of Methods

• Straight-line: Even expense over time; best for assets generating revenue evenly.

• Units-of-production: Expense varies with use; best for assets that wear out with use.

• Double-declining-balance: Higher expense early; best for assets generating more revenue early in life.

Disposal of Plant Assets

Accounting for Disposal

• Update depreciation to the date of disposal.

• Calculate book value: $\text{Book Value} = \text{Cost} - \text{Accumulated Depreciation}$

• Record gain or loss: - If sale price > book value: Gain - If sale price < book value: Loss

Natural Resources and Intangible Assets

Natural Resources

• Examples: oil, minerals, timber.

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

Intangible Assets

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

• Intangibles with finite lives are amortized; those with indefinite lives are tested 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 recognized.

Return on Assets (ROA)

Definition and Calculation

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

• Formula: $\text{ROA} = \frac{\text{Net Income}}{\text{Average Total Assets}}$

• 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