Plant & equipment depreciation and intangible assets

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Plant & Equipment Depreciation
And Intangible Assets

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Depreciation

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DEPRECIATION
• Allocating the cost of plant & equipment over the ear of
use
• Allocation of the cost of the tangible plant asset to
expense in the periods in which services are received
from the asset

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MATCHING PRINCIPLE
Offset the revenue of an accounting period with
the cost of services being consumed

BALANCESHEET
INCOME STATMENT
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RELATIONHIP BETWEEN
DEPRECIATION & MATCHING PRINCIPE
REVENUE
EXPENCE
DEPRECIATION

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Depreciation is not a process of
valuation but a process of cost
allocation
• BOOK VALUE:
COST – RELATED ACCUMULATED DEPRCIATION
• CAUSES OF DEPRECIATION
• Physical deterioration
• obsolescence

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Plant & Equipment

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Plant & Equipments
• The term plant and equipment is used to describe long-lived
assets acquired for use in the operation of the
business and not intended for resale to customers
• The term Fixed Assets has long been used in accounting
literature to describe , all types of plant and equipment.

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Major Categories of
Plant & Equipment
1. Tangible Assets:
These are physical substances such as land,
building or a machine. These are further
classified into two sub-classes:
a) Plant property: Subject to depreciation
b) Land: Not subject to depreciation

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2. Intangible Assets:
They are non-physical and non-current.
3. Natural Resources:
Site acquired for the purpose of extraction or removing
some valuable resources such as oil, minerals, or
timber is classified as natural resource.

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Determining the Cost of
Plant & Equipment
• Cost is easily determined when an asset is purchased
for cash.
• Purchased on installment plan.
• Recorded as interest expense

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Land
• Expenditures such as commissions, legal
fees etc, also become part of the cost of
land.

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Apportionment of
Lump-Sum Purchase

Apportionment of a Lump-Sum
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Purchase
• Separate ledger accounts are necessary for land and
building.
• Land is non-depreciable asset But building is.
• The purchase price must be apportioned between land
and building.

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Apportioning cost between
Land & Building
Particulars Value per
Appraisal
Percentage of
Total
Apportionment
of Cost
Land $200,000 40% $160,000
Building $300,000 60% $240,000
Total $500,000 100% $400,000

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Land Improvements
• They should be recorded in a separate
account entitled “Land Improvements”
• Such as fences, parking lots etc.

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Buildings
• Repairs made under these circumstances are
charged to the building account.
• Such as ordinary repairs are considered as
maintenance expenses.

Capital Expenditures & Revenue
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Expenditures
• Expenditures for the purchase or expansion of plant
assets are called capital expenditures and are recorded
in asset account.
• Expenditures for ordinary repairs maintenance, fuel and
other items necessary to the ownership and use of plant
and equipment are called revenue expenditures and are
recorded by debiting expense accounts.

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Capital Budgeting
• The process of planning and evaluating proposals for
capital expenditures is called capital budgeting.
• It includes decisions such as whether to build a new
factory or renovate the old ones. Etc.

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Capital Expenditure
Budget
• Cash budget are forecasts of expected cash
receipts and cash payments for the coming year.
• Capital expenditure budget forecasts the
company’s capital expenditures over a period of
several years.

Management’s Responsibility
for Depreciation Methods &
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Related Estimates

Management’s Responsibility for
Depreciation Methods & Related
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Estimates
• Principal of Consistency:
A company should not change from year to year the
method used in computing the depreciation expense.
• Financial Statement Disclosures:
A company should disclose in notes to its financial
statements the methods used to depreciate plant assets.

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Continued..
• Estimates of Useful Life & Residual Value:
Estimating the useful lives and residual values
of plant assets also is a responsibility of
management.
• Revision of Estimated Useful Lives:
A revised estimate of useful life should be made
and the periodic depreciation expense
decreased or increased accordingly

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Inflation and Depreciation
• Inflation: It is the persistent increase in
prices of goods and services.
• Depreciation: Gradual decrease in the
value of fixed asset.

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Disposal of Plant And
Equipment
Case 1: When Asset is Fully Depreciated.
Assume that office equipment purchased 10 years ago
at a cost of 20,000 has been fully depreciate and is no
longer useful . The entry to record is as follows:
Accumulated Depreciation: Office Equipment……...20,000
Office Equipment………………….…………. 20,000
• To remove from the accounts the cost and the
accumulated depreciation on fully depreciated office
equipment now being scrape.

Gains & Losses on Disposals of
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Plant & Equipment
• When plant assets are sold, an gain or loss on
the disposal is computed by comparing the
book value with the amount received from the
sale.
• A sales price in excess of the book value
produces a gain.
• A sales price below the book value produces
a loss.
• These gains or losses; if material in amount,
should be shown separately in the income
statement in computing the income from
operations.

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Case 2
• Disposal at a Price Above Book Value: (Gain on disposal
of plant asset)
Assume that a machine which cost $10,000 and has a book
value of $2,000 is sold for $3,000. The journal entry to record
this Is as follows:
Cash………………………………………………………. 3,000
Accumulated Depreciation: Machinery……………….. 8,000
Machinery………………………………………… 10,000
Gain on Disposal of Plant Assets………………. 1,000
To record sale of machinery at a price above book value.

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Case 3
• Disposal at a Price Below Book Value: (Loss on disposal of
plant asset)
Now assume that the same machine is sold for $500. The journal
entry for this is as follows:
Cash…………………………………………………… 500
Accumulated Depreciation: Machinery……………. 3,000
Loss on Disposal of Plant Assets………………….. 1,500
Machinery…………………………………. 10,000
• To record sale of machinery at a price below book value

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Trading in Used Assets
on New
Assume that Rancho Landscape has an old pickup truck which
originally cost $10,000 but which now has a book value of $2,000.
Rancho trades in this old truck on a new one with a fair market
value of $15,000. The truck dealership grants Rancho a “trade-in
allowance” of $3500 for the old truck, and Rancho pays the
remaining $11,500 cost of the new truck in cash. Transaction is as
follows:
Vehicles (new truck)…………………………………………. 15,000
Accumulated Depreciation: Truck (old truck)……………… 8,000
Vehicles (old truck)…………………………………………..... 10,000
Gain on Disposal of Plant Assets……………………………. 1,500
Cash……………………………………….……………………. 11,500
Traded-in old truck on a new one costing $15,000. Received $3,500
trade-in allowance on the old truck, which had a book value of $2,000

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Intangible Assets

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Intangible Assets
Definition:
Intangible assets are
assets which are used in
the operation of the
business but which have
no physical substance and
are non-current.

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Operating Expenses v/s Intangible
Assets
Operating expenses are the expenses not
directly connected in production of income,
such as salary & wages, rent, utilities, office
supplies and alike.

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Amortization
• This term is used to describe the systematic write-off to
expense of the cost of an intangible asset over its useful
life.
• The usual accounting entry of a debit to amortization
expense and a credit to the intangible asset account.

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Goodwill
• It is the present value of future earning in
excess of the normal return on net
identifiable assets.
• Goodwill itself is not an
identifiable asset.
• The extra amount that a buyer
would pay to purchase a product
represents the value the business’s
goodwill.

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Estimating Goodwill
• Goodwill estimation is in large part a
matter of personal opinion.
Methods of estimating goodwill:-
1. Through negotiation between
buyer and seller.
2. Determined as multiple of the
amount by which average annual
earnings exceed normal earnings.
3. Capitalizing the amount by which
average earnings exceed normal
earnings.

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Recording Goodwill in
Accounting Records
• Recorded only when it is purchased.
• Debited to an asset account entitled Goodwill.

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Patents
• A patent is an exclusive right granted by
the federal government for
manufacture, use, and sale of a
particular product.
• Are recorded by debiting the intangible
asset account Patents.
• Patents are granted for a period of 17
years.

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Trademarks & Trade
Names
• A trademark is a word, symbol, or
design the identifies a product or a
group of products.
• A permanent exclusive right to the
use of a trademark, brand name, or
commercial symbol may be
obtained by registering with federal
government.
• Should be treated as a expense
when incurred.

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Franchises
• A franchise is a right granted by a
company or a governmental unit to
conduct a certain type of business in a
specific geographical area.

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Copyrights
• A copyright is an exclusive right
granted by federal government to
protect the production and sale of
literary or artistic materials for the life
of the creator plus 50-years.
• Are Expenses when paid.

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Other Intangibles & Deferred
Charges
• Moving costs.
• Plant Re-arrangement Costs.
• Organization Cost.
• Film Rights. etc

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Research &
Development Cost
• Some companies treat all research and
development costs as expense in the year
incurred.
• Other companies in the same industry
recorded these costs as intangible assets to
be amortized over future years.
• All R&D expenditure should be charged to
expense when incurred.

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Natural Resources

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Natural Resources
• Natural resources don’t depreciate but
are gradually depleted as they are used.
• Accumulated depletion is a contra-asset
account similar to the accumulated
Depreciation account.

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Depreciation of Buildings &
Equipment Closely Related to
Natural Resources

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Depreciation, Amortization
and Depletion All have Common
Goal
• That is to allocate the acquisition cost of a
long-lived asset to expense over the years
in which the asset contribute to revenue

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Impairment of Long Lived
Assets
• If the cost of the asset cannot be
recovered through future use or sale the
asset should be written down to its net
realizable value.
• The offsetting debit is to a loss account

METHODS OF COMPUTING
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DEPRICIATION

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Methods of Computing
Depreciation
• Straight Line
• Declining Method
• Double Declining Method
• Sum of Year Digit

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Straight Line Method
Cost – Residual Value
Depreciation Years of Useful Life

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Problem 10B-3
Cost of equipment = 80000
Useful life = 4 years
Residual value = 5000
Condition : Depreciation is charged until the equipment becomes fully
depreciated
(A)
Straight line method = cost – residual value
useful life
= 80000 – 5000
4
= 18750 (4/12)
= 6250 (depreciation for 1st year)
= 18750 (depreciation 2nd,3rd,4th year)
= 12500 (depreciation for 5th year) until the
equipment becomes fully depreciated

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Sum of Year Digit Method
To illustrate , consider our example of the
delivery truck with a 5-year life. Sum of years is :
1+2+3+4+5 = 15
Year Computation Depreciation
Expense
1st $15,000 x 5/15 $ 5,000
2nd $15,000 x 4/15 $4,000
3rd $15,000 x 3/15 $3,000
4th $15,000 x 2/15 $2,000
Total $15,000

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Problem 10B-3
• (B)
• Sum of the year digits method (Half year convention)
• Total sum of years = 1+2+3+4 = 10
• Cost – residual value = 80000 – 5000 = 75000
Expense
Accumulated
Depreciation
1st 75000*4/10*6/12 15000 15000
2nd 75000*3/10 22500 37500
3rd 75000*2/10 15000 52500
4th 75000*1/10 22500 75000

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UNIT OF OUTPUT
Depreciation per
Unit Output
Cost – Residual Value
Estimated Units of Output

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Declining Method
Depreciation Expense =
Remaining
Value
Accelerated
Depreciation
Rate

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Problem 10B-3
(C)
Double declining method (Half year convention)
Straight line rate = 100%/useful life
= 100%/4 = 25%
Double declining rate = 2* straight line rate
= 2*25% = 50%
Expense
Accumulated
Expense
Book Value
1st 80000*50%*6/1
2
20000 20000 60000
2nd 60000*50% 30000 50000 30000
3rd 30000*50% 15000 65000 15000
4th 15000*50% 10000 75000 5000

Plant & equipment depreciation and intangible assets

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