Plant Assets, Natural Resources, and Intangibles: Accounting for Long-Term Assets

Plant Assets, Natural Resources, and Intangibles

Overview

This chapter covers the accounting treatment for long-term assets, including tangible plant assets, natural resources, and intangible assets. It explains how to determine historical cost, allocate cost over useful life, distinguish capital expenditures from expenses, and account for asset disposals, depletion, and amortization.

Long-Term Asset Categories

Definitions and Concepts

• Asset: A resource with probable future economic benefit.

• Long-Term Asset: An asset with a useful life greater than one year from the balance sheet date. These are real accounts (not closed at period end) and have a normal debit balance.

• Cost Allocation Concept: The process of converting the historical cost of a long-term asset into an expense as the asset is used up.

• Expense: A decrease in net assets from day-to-day operations (normal debit balance, closed at period end).

Categories and Cost Allocation Methods

Asset Category	Examples	Cost Allocation	Purpose
Tangible Assets - Plant, Property & Equipment (PP&E)	Buildings, Machinery, Equipment, Fixtures, Land Improvements	Depreciation	Spread out the historical cost over the asset’s useful life (except land)
Tangible Asset - Land	Land	None	Land is not depreciated
Natural Resources	Oil, Gas, Timber, Coal	Depletion	Spread out the cost as the resource is physically consumed
Intangible Assets	Patents, Copyrights, Goodwill, Trademarks	Amortization	Spread out the cost over the asset’s useful life (only for finite life intangibles)

Accounting for Tangible Assets

Historical Cost Principle

• Historical Cost: Assets are recorded at their original cost, not adjusted for market value changes.

• Measurement Principle: Historical cost includes the purchase price plus all expenditures to get the asset ready for intended use.

• Capitalization: Recording an expenditure as an asset rather than an expense.

Determining Historical Cost

• Land: Includes purchase price, closing costs, grading, survey fees, assumption of encumbrances, costs of removing unwanted structures (less salvage), and permanent improvements (e.g., landscaping, roads).

• Land Improvements: Recorded separately; includes fencing, paving, lighting, etc. These have limited useful lives and are depreciated.

• Equipment and Machinery: Includes purchase price, freight, insurance in transit, assembly, installation, special preparation, initial training, and trial runs (less purchase discounts). Excludes repairs from installation, ordinary maintenance, and repairs.

• Building: Includes purchase price, closing costs, commissions, taxes, legal and architect fees, permits, renovation, and construction costs from site excavation to completion.

Lump-Sum (Basket) Purchases

• When multiple assets are purchased for a single price, allocate cost using the relative-sales-value method based on each asset’s fair market value.

Asset	Fair Market Value	% of Total FMV	Allocated Cost
Land	$300,000	10%	$280,000
Building	$2,700,000	90%	$2,520,000

Example: If a company pays $2.8 million for land and building with FMVs of $300,000 and $2,700,000 respectively, allocate 10% of the price to land and 90% to building.

Capital Expenditures vs. Immediate Expenses

Definitions

• Capital Expenditure: Costs that increase an asset’s capacity, enhance quality, or extend useful life. These are capitalized and depreciated over the asset’s remaining life.

• Immediate Expense: Normal recurring costs to maintain an asset (e.g., repairs, maintenance). These are expensed as incurred.

Example: A major engine overhaul (capitalized) vs. an oil change (expensed) for a truck.

Depreciation: Cost Allocation for Tangible Assets

Key Terms

• Depreciation: Allocation of the cost of a tangible asset over its useful life (not a measure of value decline).

• Useful Life: Estimated period or activity level over which the asset will be used.

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

• Depreciable Cost (Base): $\text{Depreciable Cost} = \text{Historical Cost} - \text{Residual Value}$

• Depreciation Expense: Portion of the asset’s cost allocated to the current period (income statement).

• Accumulated Depreciation: Total depreciation charged to date (contra-asset on balance sheet).

• Book Value: $\text{Book Value} = \text{Historical Cost} - \text{Accumulated Depreciation}$

Recording Depreciation

• Adjusting Journal Entry (AJE): Depreciation Expense     xxx        Accumulated Depreciation - Asset     xxx

Depreciation Methods

Time-Based Methods

• Straight-Line (SL) Method: Allocates equal depreciation each year. $\text{SL Rate} = \frac{1}{\text{Useful Life in years}}$ $\text{SL Depreciation Expense per year} = \frac{\text{Historical Cost} - \text{Residual Value}}{\text{Useful Life in years}}$ $\text{SL Depreciation Expense per year} = \text{SL Rate} \times \text{Depreciable Base}$

• Accelerated Method (Double-Declining Balance, DDB): Allocates more depreciation in early years. $\text{DDB Rate} = \frac{2}{\text{Useful Life}}$ $\text{DDB Depreciation Expense per year} = \text{DDB Rate} \times \text{Book Value at Beginning of Year}$ Note: Salvage value is ignored in the formula but not exceeded in total depreciation.

Activity-Based Method

• Units-of-Production Method: Depreciation is based on usage or output. $\text{Depreciation Rate per unit} = \frac{\text{Historical Cost} - \text{Residual Value}}{\text{Total Estimated Units}}$ $\text{Depreciation Expense} = \text{Depreciation Rate per unit} \times \text{Units Used in Period}$

Disposal of Plant Assets

Accounting for Asset Disposal

• Update depreciation to the date of disposal.

• Remove asset’s historical cost and accumulated depreciation from the books.

• Compare cash proceeds to book value to determine gain or loss:

Outcome	Condition	Effect
Gain	Proceeds > Book Value	Increase assets and equity
Loss	Proceeds < Book Value	Decrease assets and equity
No Gain/Loss	Proceeds = Book Value	No effect

Example: If equipment with a historical cost of $25,000 and accumulated depreciation of $6,000 is sold for $10,000 (after $500 selling costs), compare proceeds to book value to determine gain or loss.

Journal Entries for Disposal

• Fully depreciated, no proceeds: Remove asset and accumulated depreciation; no gain or loss.

• Not fully depreciated, no proceeds: Remove asset and accumulated depreciation; record loss equal to book value.

• Sale: Record cash, remove asset and accumulated depreciation, record gain or loss.

Accounting for Natural Resources

Definition and Depletion

• Natural Resources: Physically consumed assets (e.g., oil, timber, minerals) with useful lives > 1 year.

• Depletion: Allocation of the cost of a natural resource as it is extracted and converted to inventory.

Depletion Calculation (Units-of-Production)

• $\text{Depletion Rate per unit} = \frac{\text{Total Cost} - \text{Residual Value}}{\text{Estimated Total Units}}$

• $\text{Depletion for period} = \text{Depletion Rate per unit} \times \text{Units Extracted in Period}$

As resources are extracted, cost is transferred to inventory; when sold, cost is transferred to COGS.

Accounting for Intangible Assets

Definition and Historical Cost

• Intangible Assets: Long-lived assets with no physical substance, acquired for use (not resale).

• Historical Cost: Includes purchase price and all costs to get asset ready for use. If purchased, capitalize all costs at fair value; if internally created, capitalize only direct legal costs (not R&D).

Amortization of Finite Life Intangibles

• Amortize over the shorter of legal or useful life, usually using straight-line method.

• Journal Entry: Amortization Expense     xxx        Intangible Asset     xxx

Types of Intangible Assets

• Finite Life (Amortized): Patents (20 years), Copyrights (life + 70 years), some trademarks.

• Indefinite Life (Not Amortized): Trademarks, franchises, goodwill. These are tested annually for impairment.

• Goodwill: Only recorded when a business is purchased. $\text{Goodwill} = \text{Purchase Price} - (\text{Fair Value of Assets} - \text{Fair Value of Liabilities})$

Research & Development (R&D)

• R&D costs are expensed as incurred, not capitalized.

Summary Table: Key Journal Entries

Transaction	Debit	Credit
Depreciation	Depreciation Expense	Accumulated Depreciation
Depletion	Inventory	Accumulated Depletion
Amortization	Amortization Expense	Intangible Asset
Asset Disposal (Sale)	Cash, Accumulated Depreciation, Loss (if any)	Asset, Gain (if any)

Additional info:

• All methods of depreciation allocate the same total depreciable base over the asset’s life; the difference is the timing of expense recognition.

• For partial years, prorate depreciation based on time (except for activity-based methods).

• Impairment and rate of return analysis are omitted in this summary as per the source notes.