17/09/2024
Diyan Dimov, Ph.D.
The assets of a company can be classified into
two major categories:
▪ Short-term assets, also called current assets, are
cash and other resources that are expected to be sold,
collected, or used within one year or the company’s
operating cycle, whichever is longer; examples are
cash, short-term investments, inventory, and others
▪ Long-term assets, also called noncurrent assets, are
resources that are not intended to be turned into cash
or be consumed within one year or the company’s
operating cycle, whichever is longer; examples are
long-term investments, land, buildings, equipment,
vehicles, intangible assets, and others
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The long-term assets of a company can be
classified into four major categories:
▪ Tangible assets are long-lived assets with physical
substance that are used to produce or sell products
and services; examples are equipment, machinery,
buildings, and land
▪ Intangible assets are long-term resources that
benefit business operations, usually lack physical
form, and have uncertain benefits; examples are
patents, trademarks, copyrights, and goodwill
The long-term assets of a company can be
classified into four major categories:
▪ Long-term investments are investments that are
expected to be held for more than the longer of one
year or the operating cycle of the company; examples
are long-term notes receivable and investments in
stocks and bonds
▪ Natural resources are assets that are physically
consumed when used; examples are standing timber,
mineral deposits, and oil and gas fields
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Tangible assets are long-term assets that have
physical substance and are actively used in a
company’s operations; tangible assets are also
called plant assets, plant and equipment,
property, plant and equipment, or fixed
assets; examples of tangible assets are land,
buildings, machines, vehicles, and others
For many companies, plant assets make up the
single largest class of assets they own; not only
do they make up a large percent of many
companies’ assets, but their monetary values are
large (in other words, they are expensive)
The graph below shows plant assets as a percent
of total assets for several companies:
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Plant assets are set apart from other assets by
two important features:
▪ First, plant assets are used in operations; this makes
them different from, for instance, inventory that is
held for sale and not used in operations
▪ The second important feature is that plant assets
have useful lives extending over more than one year
or one operating cycle; this makes plant assets
different from current assets such as supplies that are
normally consumed in a short time period after they
are placed in use
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The exhibit on the previous slide shows the four
main issues in accounting for plant assets: (1)
computing the costs of plant assets, (2)
allocating the costs of most plant assets (less
any salvage amounts) against revenues for the
periods they benefit, (3) accounting for
subsequent expenditures such as repairs and
improvements to plant assets, and (4) recording
the disposal of plant assets
The following slides discuss each of these issues
Plant assets are recorded at cost when acquired;
this is consistent with the cost principle; cost
includes all normal and reasonable expenditures
necessary to get the asset in place and ready for
its intended use
The cost of a factory machine, for instance,
includes its invoice cost less any cash discount
for early payment, plus any necessary freight,
unpacking, assembling, installing, and testing
costs (examples are the costs of building a base
for a machine, providing electrical hookups, and
testing the asset before using it in operations)
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Land is the earth’s surface and has an indefinite
(unlimited) life; costs of land include
expenditures necessary to make that property
ready for its intended use
Property
Purchase taxes
price
Real estate Surveying
commissions fees
Title search and transfer fees
To illustrate cost determination, assume that on
May 4 a company paid $167,000 to acquire land
for a retail store; this land had an old service
garage that was removed at a net cost of
$13,000 ($15,000 in costs less $2,000 proceeds
from salvaged materials); closing costs total
$10,000, consisting of brokerage fees ($8,000),
legal fees ($1,500), and title costs ($500)
The cost of this land to the company is found as:
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After we know the cost of the acquired land, we
can record the transaction with the following
journal entry:
GENERAL JOURNAL
Date Account Titles and Explanation Debit Credit
May 4 Land 190 000
Cash 190 000
Purchased land for cash
Land improvements are additions to land and
have limited useful lives; examples are parking
lot surfaces, driveways, walkways, fences,
landscaping, and sprinkling and lighting systems
Costs of land improvements include
expenditures necessary to make those
improvements ready for their intended use;
while the costs of these improvements increase
the usefulness of the land, they are charged to a
separate “Land Improvements” account so that
their costs can be allocated to the periods they
benefit
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A “Buildings” account is charged for the costs of
purchasing or constructing a building that is
used in operations
Cost of purchase or
construction Title fees
Attorney fees
Brokerage
fees
Taxes
The costs of machinery and equipment consist
of all costs normal and necessary to purchase
them and prepare them for their intended use
Taxes
Purchase
price
Transportation
charges
Installing,
assembling, and
testing Insurance while
in transit
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Depreciation is the process of allocating the
cost of a plant asset to expense in the
accounting periods benefiting from its use;
depreciation does not measure the decline in the
asset’s market value each period, nor does it
measure the asset’s physical deterioration
Without depreciation, the entire cost of a plant
asset will be recognized as an expense in the
year of purchase, this will give a misleading view
of the profitability of the business entity
The only plant asset that is not depreciated is
land because land has an indefinite life
The factors that determine depreciation are:
▪ The cost of a plant asset consists of all necessary and
reasonable expenditures to acquire it and to prepare it
for its intended use
▪ Salvage value, also called residual value or scrap
value, is an estimate of the asset’s value at the end of
its benefit period; this is the amount the owner
expects to receive from disposing of the asset at the
end of its useful life
▪ The useful life of a plant asset is the length of time it
is productively used in a company’s operations; the
useful life of an asset might not be as long as the
asset’s total productive life
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Once the three factors in computing depreciation
are known, we select a depreciation method that
is used to calculate depreciation expense which is
used to allocate a plant asset’s cost over the
periods in its useful life; the most frequently used
method of depreciation is the straight-line
method; another common depreciation method
is the declining-balance method
To illustrate both methods we will use the
following data about an inspection machine:
Straight-line depreciation charges the same
amount of expense to each period of the asset’s
useful life; a two-step process is used: we first
compute the depreciable cost of the asset by
subtracting the asset’s salvage value from its total
cost and second, depreciable cost is divided by the
number of periods in the asset’s useful life
The formula for straight-line depreciation, along
with its computation for the inspection machine, is:
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If this machine is purchased on December 31,
2018, and used throughout its predicted useful
life of five years, the straight-line method
allocates an equal amount of depreciation to
each of the years 2019 through 2023; we make
the following journal entry at the end of each of
the five years to record straight-line
depreciation of this machine:
GENERAL JOURNAL
Date Account Titles and Explanation Debit Credit
Dec. 31 Depreciation Expense 1 800
Accumulated Depreciation-Machines 1 800
Recorded annual depreciation
We also can compute the straight-line depreciation
rate, defined as 100% divided by the number of
periods in the asset’s useful life; for the inspection
machine, this rate is 20% (100% ÷ 5 years, or 1/5
per period); we use this rate to compute the
machine’s straight-line depreciation schedule
shown in the exhibit on the next slide
Note three points in this exhibit: first, depreciation
expense is the same each period; second,
accumulated depreciation is the sum of current
and prior periods’ depreciation expense; third,
book value declines each period until it equals
salvage value at the end of the machine’s useful life
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Declining-balance depreciation yields larger
depreciation expenses in the early years of an
asset’s life and less depreciation in later years;
this method uses a depreciation rate that is a
multiple of the straight-line rate and applies it to
the asset’s beginning-of-period book value; the
amount of depreciation declines each period
because book value declines each period
A common depreciation rate for the declining-
balance method is to double the straight-line
rate; this is called the double-declining-balance
(DDB) method
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The double-declining-balance method is applied
in three steps: (1) compute the asset’s straight-
line depreciation rate, (2) double the straight-
line rate, and (3) compute depreciation expense
by multiplying this rate by the asset’s beginning-
of-period book value
To illustrate, let’s return to the inspection
machine and apply the double-declining-balance
method to compute depreciation expense; the
exhibit on the next slide shows the first-year
depreciation computation for the machine
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The double-declining-balance depreciation
schedule is shown in the exhibit on the next slide
The schedule follows the formula except for year
2023, when depreciation expense is $296; this
$296 is not equal to 40% x $1,296, or $518.40; if
we had used the $518.40 for depreciation
expense in 2023, the ending book value would
equal $777.60, which is less than the $1,000
salvage value; instead, the $296 is computed by
subtracting the $1,000 salvage value from the
$1,296 book value at the beginning of the fifth
year (the year when DDB cuts into salvage value)
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Both the cost and accumulated depreciation of
plant assets are reported on the trial balance;
this is demonstrated in the following example:
After a company acquires a plant asset and puts
it into service, it often makes additional
expenditures for that asset’s operation,
maintenance, repair, and improvement
In recording additional expenditures, a company
must decide whether to capitalize (to capitalize
an expenditure is to debit the asset account) or
expense them; the issue is whether these
expenditures are reported as current period
expenses or added to the plant asset’s cost and
depreciated over its remaining useful life
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Revenue expenditures are additional costs of
plant assets that do not materially increase the
asset’s life or productive capabilities; examples
of revenue expenditures are cleaning,
repainting, adjusting, and lubricating
Capital expenditures are additional costs of
plant assets that provide benefits extending
beyond the current period; capital expenditures
increase or improve the type or amount of
service an asset provides; examples are roofing
replacement, plant expansion, and major
overhauls of machinery and equipment
Ordinary repairs are expenditures to keep an
asset in normal, good operating condition; they
are necessary if an asset is to perform to
expectations over its useful life; ordinary repairs
do not extend an asset’s useful life beyond its
original estimate or increase its productivity
beyond original expectations; examples are
normal costs of cleaning, lubricating, adjusting,
oil changing, and replacing parts of a machine
Ordinary repairs are treated as revenue
expenditures; this means their costs are
reported as expenses for the current period
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To illustrate ordinary repairs, suppose a
company pays $9,500 cash on January 14 for
cleaning and lubricating a machine; this
maintains the normal operating condition of the
machine; this transaction is recorded with the
following journal entry:
GENERAL JOURNAL
Date Account Titles and Explanation Debit Credit
Jan. 14 Ordinary Repairs Expense 9 500
Cash 9 500
Ordinary repair of a machine for cash
Accounting for betterments and extraordinary
repairs is similar—both are capital expenditures:
▪ Betterments are expenditures that make a plant asset
more efficient or productive; an example is replacing
manual controls on a machine with automatic controls
▪ Extraordinary repairs are expenditures extending the
asset’s useful life beyond its original estimate; an
example is changing the engine of a car with a new one
Betterments and extraordinary repairs are capital
expenditures because they benefit future periods;
their costs are debited to the asset account; the
new book value (less salvage value) is then
depreciated over the asset’s remaining useful life
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To illustrate betterments and extraordinary
repairs, suppose a company adds an automated
control system to a machine at a cost of $1,800
cash on January 24; this results in reduced labor
costs in future periods; the cost of the
betterment is added to the “Machines” account
with the following journal entry:
GENERAL JOURNAL
Date Account Titles and Explanation Debit Credit
Jan. 24 Machines 1 800
Cash 1 800
Betterment of a machine for cash
Plant assets are disposed of for several reasons:
some are discarded because they wear out,
some are discarded because they become
obsolete, some are sold because of changing
business plans, and others are exchanged for
other plant assets
Regardless of the reason, the general steps in
accounting for a disposal of plant assets are
similar; these steps are summarized in the graph
shown on the next slide
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Whenever we dispose of a plant asset, the first
thing we do is to update depreciation to the date
of disposal; after completing the update, we can
prepare the journal entry in the following way:
▪ Record a debit to the cash account, if cash was
received, or credit the cash account, if cash was paid
▪ Remove the accumulated depreciation with a debit
▪ Determine whether a gain or loss is associated with
the disposal; a gain is recorded with a credit, and a
loss is recorded with a debit
▪ Remove the plant asset’s cost from our books (general
ledger) with a credit
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To illustrate, we consider BTO’s March 31 sale of
equipment that cost $16,000 and has
accumulated depreciation of $13,000 at March 31
If BTO receives $7,000 cash, an amount that is
$4,000 above the equipment’s $3,000 book value
as of March 31, a gain on disposal occurs:
GENERAL JOURNAL
Date Account Titles and Explanation Debit Credit
Mar. 31 Cash 7 000
Accumulated Depreciation-Equipment 13 000
Gain on Disposal of Plant Assets 4 000
Equipment 16 000
Sold plant asset for cash
To illustrate, we consider BTO’s March 31 sale of
equipment that cost $16,000 and has
accumulated depreciation of $13,000 at March 31
If BTO receives $2,500 cash, an amount that is
$500 below the equipment’s $3,000 book value as
of March 31, a loss on disposal occurs:
GENERAL JOURNAL
Date Account Titles and Explanation Debit Credit
Mar. 31 Cash 2 500
Accumulated Depreciation-Equipment 13 000
Loss on Disposal of Plant Assets 500
Equipment 16 000
Sold plant asset for cash
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Intangible assets are nonphysical assets used in
operations that confer on their owners long-
term rights, privileges, or competitive
advantages; examples are patents, copyrights,
licenses, leaseholds, franchises, and trademarks
An intangible asset is recorded at cost when
purchased; intangibles are then separated into
those with limited lives or indefinite lives; if an
intangible has a limited life, its cost is
systematically allocated to expense over its
estimated useful life through the process of
amortization; if an intangible asset has an
indefinite life, it should not be amortized
Long-term investments are investments that
are expected to be held for more than the longer
of one year or the operating cycle of the
company; examples are long-term notes
receivable, investments in stocks and bonds, and
land held for future expansion
Companies make investments for at least three
reasons: first, companies transfer excess cash
into investments to produce higher income,
second, some entities, such as mutual funds and
pension funds, are set up to produce income
from investments, third, companies make
investments for strategic reasons
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Natural resources are assets that are extracted
from the natural environment and are physically
consumed when used; examples are standing
timber, mineral deposits, and oil and gas fields
Natural resources are recorded at cost, which
includes all expenditures necessary to acquire
the resource and prepare it for its intended use;
depletion is the process of allocating the cost of
a natural resource to the period when it is
consumed; natural resources are reported on the
trial balance at cost less accumulated depletion
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