CHAPTER ONE

PLANT, PROPERTY AND EQUIPMENT

Property, plant, and equipment are very important components of a company’s assets. They
include assets that a company needs to conduct its business, such as land, office buildings,
factories, machinery, equipment, warehouses, retail stores, and delivery vehicles. They usually
are a major portion of a company’s total assets. In this chapter we include a discussion of the
costs of acquisition, costs subsequent to acquisition, and disposal of property, plant, and
equipment and its depreciation.
CLASSIFICATION OF OPERATIONAL LONG-TERM ASSETS

 Broadly operational long-term assets are divided into tangible and intangible as it is
explained below:
a. Intangible
- Do not have physical existence
- Examples, include goodwill, copyrights, patents, trademarks, franchises, etc
- The costs of acquired intangible assets amortized over their estimated economic lives.
b. Tangible
- They do have physical existence
- They are sub classified into plant assets and natural resources
c. Long term investments
1. Plant assets (PPE)
Acquired for use in operation but they are not incorporated into finished goods as raw
materials do.
- Examples of plant assets include land; buildings, machinery, equipment,
furniture, etc.
- Almost all plant assets have limited economic lives. As a result their cost is
converted to expense over the period of economic lives through the process of
depreciation.
2. Natural Resources
- These are resources that are going to be exhausted (i.e. finished) through
extraction.
- Examples include oil and gas deposits, timber, mineral deposits, etc.

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 - The cost of acquiring and developing natural resource is allocated to expenses
through a process of depletion.

CHARACTERISTICS OF PROPERTY, PLANT, AND EQUIPMENT

Property, plant, and equipment are the tangible noncurrent assets that a company uses in the
normal operations of its business. Alternative terms are plant assets, fixed assets, and operational
assets. To be included in this category, an asset must have three characteristics:
1. The asset must be held for use and not for investment: Only assets used in the normal course
of business should be included. A particular type of asset may be classified as property, plant,
and equipment by one company and as inventory by another.
2. The asset must have an expected life of more than one year: The asset represents a bundle of
future services that the company will receive over the life of the asset. To be included in
property, plant, and equipment, the benefits must extend for more than one year or the normal
operating cycle, whichever is longer. Therefore, a company distinguishes the asset from other
assets, such as supplies, that it expects to consume within the current year
3. The asset must be tangible in nature: There must be a physical substance that can be seen and
touched. In contrast, intangible assets such as goodwill or patents do not have a physical
substance. Unlike raw materials, generally property, plant, and equipment do not change their
physical characteristics and are not added into the product. Wasting assets are natural resources,
such as minerals, oil and gas, and timber that are used up by extraction.
ACQUISITION OF PROPERTY, PLANT, AND EQUIPMENT
The major types of assets that a company includes in the category of property, plant, and
equipment are land, buildings, equipment, machinery, furniture and fixtures, leasehold
improvements, and wasting assets. The acquisition of an item of property, plant, and equipment
raises many issues. These include the determination of the cost of an asset acquired singly or by
a lump-sum purchase, with deferred payments, through the issuance of securities, or by donation.
Also, in more complex situations, assets may be acquired in exchange for other assets or by self-
construction.
Determination of Cost
The cost of property, plant, and equipment is the cash outlay (not the “list” price) or its
equivalent that is necessary to acquire the asset and put it in operating condition. In other words,
the acquisition costs that are necessary to obtain the benefits to be derived from the asset are
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capitalized (recorded as an asset). These costs include the contract price, less discounts available,
plus freight, assembly, installation, and testing costs. As for inventory, discounts available
should be subtracted from the cost of the asset rather than recorded as discounts taken, because
the benefits to be received from the asset are not increased by a discount not taken.
Example: Recording the Acquisition
Assume that the Devon Company purchases a machine with a contract price of $100,000 on
terms of 2/10, n/30. The company does not take the cash discount of $2,000, and incurs
transportation costs of $2,500, as well as installation and testing costs of $3,000.
Sales tax is 7% of the invoice price, or $7,000. During the installation of the machine, uninsured
damages of $500 are incurred and paid by the company. The company makes the following
summary journal entry to record these costs:
Machine ($100,000 - $2,000+$2,500 +$3,000 +$7,000) - - - - - - 110,500
Repair Expense - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - 500
Discounts Lost - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - 2,000
Cash - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - 113,000
C Land

The recorded cost of land includes the:

 Purchase price
 costs of closing the transaction and obtaining title, including commissions, options, legal
fees, title search, insurance, and past due taxes costs of surveys
 costs of preparing the land for its particular use, such as clearing, grading, and razing old
buildings (net of any proceeds from salvage) when such improvements have an indefinite
life
A company should record the costs of improvements with a limited economic life, such as
landscaping, streets, sidewalks, and sewers, in a Land Improvements account and depreciate
these costs over their economic lives. Alternatively, if the local government authority is
responsible for the continued upkeep of the improvements, then effectively the improvements
have an indefinite economic life to the company. In this case, the company should add the costs
of the improvements to the cost of the land. Since land is considered not to have a limited
economic life and its residual value is unlikely to be less than its acquisition cost, land generally
is not depreciated.

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 LAND IMPROVEMENTS – some of the land improvements (such as landscaping and
drainage) are as indefinite economic lives as that of land, so included in the land account.
However, servers, streets and sidewalls are not as indefinite as that of land unless the city
administration agrees to replace them. As a result mixing them with the land may misstate the
depreciation expenses.

Buildings

The recorded cost of buildings includes:

 The acquisition/ construction price
 The costs of remodeling and reconditioning
 The costs of excavation for the specific building
 Architectural costs and the costs of building permits
 Unanticipated costs resulting from the condition of the land (such as blasting rock or
channeling an underground stream)
A company should expense unanticipated costs, such as a strike or a fire, associated with the
construction of the building. The different treatment is justified because the avoidable costs of
the unanticipated events were not necessary to obtain the economic benefits of the building.
MACHINERY AND EQUIPMENT – include several items such as furniture, fixtures,
Machinery, vehicles, tools, computers, office equipment, etc.

According to IAS 16 Cost elements to exclude:

exclude:

1. Costs after asset in place and ready for use as management intended
2. Costs to open a new facility, introduce a product, move to new location
3. General and administrative overhead type costs

ACCOUNTING FOR DEPRECIATION

The company acquired the assets for their long-term revenue-generating ability. Since the
company uses these assets to earn revenue, the matching principle requires that the company
match the expenses of the assets’ use against the revenue. Over the life of the asset, the expense
is the difference between the purchase price of the asset and its residual value (that is, future
selling price).

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Depreciation is the process of allocating in a systematic and rational manner this total expense to
each period benefited by the asset. Land is not depreciated because it generally does not have a
limited life and its residual value usually is higher than its cost.
Thus, there is no expense to be recognized over the life of the asset and, therefore, no periodic
cost allocation.
Terms used to describe this allocation process depend on the type of asset:
1. Depreciation is the allocation of the cost of tangible assets, such as property, plant, and
equipment.
2. Depletion is the allocation of the cost of natural resource assets, such as oil, gas, minerals,
and timber.
3. Amortization is the allocation of the cost of intangible assets, such as patents and copyrights.
It may be used as a general term to describe the periodic allocation of costs; in that case, it is
synonymous with depreciation and depletion.
These three terms all describe the same principle of a company allocating costs to match its
expenses with revenue. However, they differ in their application to different types of assets. It is
important to note that a company does not record depreciation, depletion, and amortization in an
attempt to report the fair value of the asset.
FACTORS INVOLVED IN DEPRECIATION
A company considers four factors in the computation of depreciation for a period:
• Asset cost
• Service life
• Residual value
• Method of cost allocation

Asset Cost
The cost of an asset includes all the acquisition costs a company incurs to obtain the benefits
from the asset. These costs include the contract price plus freight, assembly, installation, and
testing costs.
Service Life
The service life of an asset is the measure of the service units a company expects from the asset
before its disposal. Service life may be measured in units of time, such as years and months, or

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units of activity or output, such as hours of operation of a machine, tons produced for a steel mill,
or miles driven for a truck.
The factors that limit the service life of an asset can be divided into two general categories:
• Physical depreciation: - include wear and tear because of operational use, deterioration and
decay that is independent of use but is a function of time (such as rust), and damage and
destruction.
• Functional depreciation: - causes limit the service life of the asset through obsolescence and
inadequacy, even though the physical life is not exhausted.

Residual Value
The residual (salvage) value is the net amount that a company expects to obtain from disposing
of an asset at the end of its service life. It is the expected value of the asset at the end of its
service life minus the costs of disposal, such as dismantling, removing, and selling the asset.

METHODS OF COST ALLOCATION

Accounting principles require that a company use a method of cost allocation that is “systematic
and rational.” Systematic means that, the calculation should follow a formula and not be
determined in an arbitrary manner. Rational means that the amount of the depreciation should
relate to the benefits that the asset produces in each period.
Although these criteria may appear to be very general and to allow numerous methods, only the
following methods are used frequently in practice:
1. Time-based methods
a. Straight line
b. Declining balance (declining charge)
2. Activity (or use) methods
We discuss each of these methods in the following sections, using the data for the Betty
Company shown below. The depreciation base (depreciable cost) of the asset is the cost less the
estimated residual value, or $100,000.
Depreciable base = cost – estimated salvage value
The different depreciation methods all allocate the total of $100,000 over the expected service
life of the asset. However, they differ in the pattern in which the cost is allocated to each year or
each unit produced.
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Asset information of the Betty Company:
Asset cost $120,000
Date of purchase January 1, 2006
Estimated residual value $20,000
Estimated service life 5 years; 10,000 hours; 20,000 units

1. Time-Based Methods
A company should use a time-based method when the service life of the asset is affected
primarily by the passage of time and not by the use of the asset. This situation includes the
physical causes of deterioration and decay and the functional causes of obsolescence and
inadequacy. Two general categories of time-based methods are the straight-line method and the
accelerated methods. The straight-line method is appropriate when a company estimates that the
benefits it will derive from the asset will be approximately constant each period of its life.
The accelerated (or declining-charge) methods are appropriate when a company estimates that
the benefits it will derive from the asset will decline each period. Thus, the accelerated methods
match a depreciation cost that declines each period against revenues that also are declining each
period. The benefits to be derived from the asset may be measured in physical terms or in dollars
of revenue. The choice of a particular accelerated method is basically arbitrary.
Straight Line
The straight-line method allocates an equal cost to each period. See the above example; Straight-
Line Depreciation
The formula for computing periodic straight-line depreciation is:

Cost − Re sidual Value ( net )

Annual straight-line depreciation = Years of estimated Economic Life

Declining-Balance Method

The declining-balance methods produce a declining depreciation amount each period by

applying a constant rate to the book value of the asset at the beginning of the period. Also, the
residual value is ignored in the calculation of the depreciation each period. However, the asset is
not depreciated below the estimated residual value. The constant rate is a function of the straight-
line rate. The highest rate that can be used is double the straight-line rate. Since the book value
of the asset is reduced each period by the depreciation charge, the constant declining-balance rate
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is applied to a successively lower book value that results in lower depreciation charges each year.
This process continues until the book value of the asset is reduced to its estimated salvage value,
at which time depreciation is discontinued. As indicated above, various multiples are used in
practice, such as twice (200%) the straight-line rate (double-declining-balance method) and
150% of the straight-line rate etc.
To illustrate, assume the case of Troup Company;

Book value of Accumulated Book value

Year Asset at beginning of year Rate Depcn Expense Depn. End of year

2006

2007

2008

2009

2010

Another depreciation method also solves the issue of computing the correct amount of
depreciation in the last year of an asset’s life. It is the fixed-percentage-of-declining-balance
method, in which a percentage depreciation rate is calculated that is multiplied by the book
value to reduce it to the residual value at the end of the service life. The depreciation rate is
calculated as follows:
Depreciation rate = 2(100/n) n= useful life
2. Activity (or use) methods

Units-of-output method

This method assumes that depreciation is a function of use or productivity instead of the passage
of time. The life of the asset is considered in terms of either the output it provides (units it
produces), or an input measure such as the number of hours it works. Conceptually, the proper
cost association is established in terms of output instead of hours used, but often the output is not
easily measurable. In such cases, an input measure such as machine hours is a more appropriate
method of measuring the birr amount of depreciation charges for a given accounting period.

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See the case of Troup Company;

( Cost − salvage value )

Depreciation expense = Total estimated hours x Hours this year

Component Depreciation
According to IAS 16; significant parts (called components) of a depreciable item with materially
different consumption patterns must be depreciated separately to more faithfully represent the
consumption of the asset’s service potential. IFRS requires that each part of an item of property,
plant, and equipment that is significant to the total cost of the asset must be depreciated
separately.

Illustration: Ethiopian Airline purchases an airplane for €100,000,000 on January 1, 2016. The
airplane has a useful life of 20 years and a residual value of €0. EAL use the straight-line method
of depreciation for all its airplanes. EAL identifies the following components, amounts, and
useful lives.

Computation of depreciation expense for EAL for 2016.

Depreciation journal entry for 2016.

Depreciation Expense 8,600,000
Accumulated Depreciation—Airplane 8,600,000

On the statement of financial position at the end of 2016, EAL reports the airplane as a
single amount.

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 Measurement (Valuation) of Plant Assets Costs
Lump-Sum Purchase
A company may acquire several dissimilar assets for a single lump-sum purchase price.
The purchase price is allocated to the individual assets purchased. This allocation is necessary
because some of the assets may be depreciable and some not, and the depreciable assets may
have different economic lives and be depreciated by different methods. A company allocates the
acquisition price in a lump-sum purchase based on the relative fair values of the individual
assets.
Example: Suppose Sample Company pays $120,000 for land and a building. If there is no
evidence in the contract of separate prices agreed upon for the land and the building, the
company allocates the $120,000 between the two assets based on their relative fair values. The
company can obtain evidence of such values from several sources, such as an appraisal or the
assessed values for property taxes, if it considers those values to be reasonably accurate
indications of relative market values. Suppose that an appraisal of the land and building indicates
values of $50,000 and $75,000, respectively. Sample Company computes the cost of each as
follows:
Relative Fair
Appraisal Value Value Total Cost Allocated Cost
Land $ 50,000 $50,000/$125,000 * $120,000 = $ 48,000
Building 75,000 $75,000/$125,000 * $120,000 = 72,000
Total $125,000 $120,000
Sample Company records the land at a cost of $48,000 and the building at a cost of $72,000.
Deferred Payments
When a company acquires property, plant, and equipment on a deferred payment basis, such as
by issuing notes or bonds or assuming a mortgage, it records the asset at its fair value or the fair
value of the liability on the date of the transaction, whichever is more reliable. If neither is
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determinable, the company records the asset at the present value of the deferred payments at the
stated interest rate, unless the stated rate is materially different from the market rate, in which
case it uses the market rate.
Example: Suppose that Antush Company purchases equipment by issuing a $10,000 non-
interest-bearing five-year note, when the market rate for obligations of this type is 12%. The note
will be paid off at the rate of $2,000 at the end of each year. Neither the fair value of the
equipment nor the note is determinable directly. In this case the company values both the
equipment and the note at the present value of the payments, which is $7,210 ($2,000 X
3.604776) the factor from Table 4 of the Time Value of Money Module for five years and a 12%
rate). Antush Company records the acquisition of the equipment as follows:
Equipment 7,210
Discount on Notes Payable 2,790
Notes Payable 10,000

Assets Acquired by Donation

When a company acquires property, plant, and equipment through donation (usually by a
governmental unit or an individual), a strict interpretation of the cost concept would require that
the asset be valued at zero. However, these transactions are defined by APB Opinion No. 29 as
nonreciprocal transfers of nonmonetary assets. A nonreciprocal transfer is a transfer of assets or
services in one direction. A company receiving an asset in such an exchange must record it at its
fair value.
Example: Donation by Governmental Unit
Suppose the city of Julesberg (a governmental unit) donates land worth $20,000 to the Klemme
Company because the company relocates its production facilities to Julesberg.
The Klemme Company records this event as follows:
Land 20,000
Donated Capital 20,000
Example: Donation by Nongovernmental Agency
In the case of a donation by a nongovernmental unit, the company records a gain. The argument
for this treatment is that receiving something of value from a nongovernmental unit (e.g., a
stockholder) represents earnings to the company. For example, suppose the CEO of Hrouda

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Company donates a building worth $50,000 to the company. The company records this event as
follows:
Building 50,000
Gain on Receipt of Donated Building 50,000
The company reports the gain in the other items section of its income statement.
Issuance of Securities
When a company acquires assets by issuing securities such as common stock or preferred stock,
the company must determine the fair value of the transaction. In many cases two measures of fair
value are available: the fair value of the asset acquired and the fair value of the securities issued.
The determination of the current fair value of plant assets could be substantiated by evidence
than the fair value of common stock. To illustrate this point, if equipment that was appraised Br.
350, 000 is acquired in exchange for 3, 000 shares of Br. 100 par common stock, the exchange is
recorded

Equipment 350, 000

Common Stock, 100 par (3, 000 x Br. 100) 300, 000
Paid-in capital in Excess of par 50, 000
Cost incurred after initial acquisition
Some expenditure, like repairs, is made after initial acquisition. Once again the controversy of
revenue versus capital expenditures arises. The rule of thumb, at least academically, is
expenditures that result in additional asset services, more valuable asset services, or extension of
economic life are capitalized whereas expenditures to maintain plant assets in good operating
condition; such as ordinary repairs, are recognized in the current period expenses. Capital
expenditures could be categorized as follows,

ADDITIONS – expenditure for new plan asset or an extension of an existing asset. As an

example addition is going to be debited to respective plant asset accounts.

IMPROVEMENTS/RENOVATION – it could be seen from three different angles

1. To the extent that renovation involves the substitution of a new part for an old one, the proper
accounting is to remove the cost of the old part with its accumulated depreciation and to
substitute the cost of the new part.

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Suppose for example, a machine costing Br. 35,000 had no estimated residual value and an
original estimated useful life of ten years, has been depreciated for 7 years. At the very beginning
of the 8th year, the machine was given a major overhaul costing Br. 3000. This expenditure
extended the useful life of the machine 3 years beyond the original estimate. The computation of
the new book value and the entry for the extraordinary repair would be as follows:
Solution
To record extraordinary repair
Jan. 4. Accumulated Depreciation – Machinery……………3000.00
Cash …………………………………………………………3000.00
Extraordinary repair to machinery

The revised annual depreciation for each of the six years remaining in the machine’s useful life
would be calculated as follows:
Cost of Machine……………………………………… Birr 35,000
Accum. Depreciation before extraordinary repair Br. 24,500
Less: extraordinary repair (Debited to Accum. Depr.)….3000
Depr.)….3000 21,500
Book value (carrying value) after extraordinary repair… Br.13,500

Revised Annual periodic depreciation= 13500……………………….

13500……………………….2,250
2,250
6 years

2. A capital expenditure that improves the efficiency of plant assets without prolonging its
economic life is debited to the plant asset and depreciated over the remaining economic life
of the asset.
3. If the capital expenditure extends the economic life of the plant assets, it should have to be
debited to Accumulated Depreciation. Because some of the service potential previously
written-off has been restored.

DISPOSAL OF PLANT ASSETS

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There are three modes of disposing a plant asset: retiring, selling and exchanging. Two things
should have to be taken into account at the time of disposing plant assets:
(1) Updating the accumulated depreciation
(2) Removing from the accounting records all ledger account balances relating to the
plant assets
Retirements and Selling

To illustrate, machinery was acquired for Br. 250, 000 and it has a useful life of 10 years with no
salvage value. Assume straight-line method of computing depreciation. Analyze the following
independent cases:

Cast (1) The machinery retired at the end of its useful life.
Accumulated Depreciation 250, 000
Machinery 250, 000
Conclusion – no gain or loss is recognized
Case (2) the machinery retired without proceed after eight and half year of services
Accumulated Depreciation 212, 500
Loss on Retirements 37, 500
Machinery 250, 000
Conclusion – Loss is recognized
Case (3) The machinery is sold for Br. 25, 000 after eight and half year of services
Cash 25, 000
Accumulated Depreciation 212, 500
Loss on sale 12, 500
Machinery 250, 000
Conclusion – a gain or loss is recognized on sale of plant assets with some recovery of net
residual value.
Exchanges
The exchange could be carried out with:
 Similar plant assets – in this case although loss is always recognized, the recognition of
gain is not allowed unless cash is involved. The latter case is explained below. This
complexity is the result of the fact that the earning process has not yet been completed.

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  Dissimilar plant assets – Here both the gains and losses are fully recognized. Because the
earning process is completed. For example, a building that cost Br. 300, 000 could be
exchanged for machinery with current fair value of Br. 350, 000, here Br. 50, 000 gain is
recognized.
- Now, let us explain the exchange of similar plant assets with examples. An old plant asset
with cost of Br. 30, 000 and accumulated depreciation of Br. 25, 000 is exchanged for similar
plant assets. Detailed information is given in each of the following cases.
(I) Non-monetary exchange – which is when no cash is involved in the exchange.
Two of its cases are shown below:
(a) Exchanged for new plant asset with current fair value of Br. 3, 000.
Plant Asset (New) 3, 000
Accumulated Depreciation 25, 000
Loss on Exchange 2, 000
Plant Asset (old) 30, 000
Conclusion – loss is fully recognized
(b) Exchanged for new plant asset with current fair value of Br. 10, 500
Plant Asset (New) 5, 000
Accumulated Depreciation 25, 000
Plant Asset (Old) 30, 000
Conclusion – a gain of Br. 5, 500 (i.e. 10, 500 – 500) is not recognized because the
earning process is not complete.
(II) Exchange where money as well is involved
(a) Old plant asset with current fair value of Br. 2, 300 (although its book value is Br. 5, 000)
and a cash of Br. 1, 200 is paid to get new plant assets.
Plant Asset (New) 3, 500 (Br. 2, 300 i.e. FV of old + Br. 1, 200 i.e Cash paid)
Accumulated Depreciation 25, 000
Loss on Exchange 2,700
Plant Assets (old) 30, 000
Cash 1,200
(b) The old plant asset with current fair value of Br. 4, 000 is exchanged for new plant assets and
Br. 400 is received in addition
Cash 400
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 Plant Asset (New) 3, 600 (Br. 4000 i.e. FV of old – Br. 400 i.e cash received)
Accumulated Depreciation 25, 000
Loss on Exchange 1, 000
Plant Asset (Old) 30, 000
Conclusion – loss is recognized whenever it arises
(c) An old plant asset with current fair value of Br. 10, 200 and additional Br. 800 is paid to
acquire similar new plant asset.
Plant Asset (new) 5, 800 (Br. 5, 000 i.e. Book value of old + Br. 800
i.e cash paid)
Accumulated Depreciation 25, 000
Plant Asset (old) 30, 000
Cash 800
Conclusion – A gain of Br. 5, 200 (Br. 10, 200 i.e FV of old – Br. 5, 000 i.e. BV of old)
has not been recognized, because here cash is paid not received.
(d) An old plant asset with current fair value of Br. 10, 000 has been exchanged for similar new
plant asset and Br. 800 is received in addition.
Cash 800
Plant Asset (New) 4, 600 (i.e. Br. 5, 000 i.e BV of old + Br. 400 i.e Gain
recognized – Br. 800 i.e. cash receive)
Accumulated Depreciation 25, 000
Plant Asset (old) 30, 000
Gain on Exchange 400
Conclusion – part of the gain is recognized by the cash receiving party, which is calculated as,
Cash Re ceived
Gain Recognized = Total gain x Total fair value of old plant asset
In our example, the total gain is Br. 5, 000 (Br. 10, 000 i.e. FV of old – Br. 5, 000 i.e book value
of old). Therefore,
Br .800
Gain recognized = Br. 5, 000 x Br .10 ,000 = Br. 400
DEPLETION OF NATURAL RESOURCES

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Depreciable plant assets usually retain their physical characteristics as they are used in
operations. In contrast, natural resources in essence are long-term inventories of material that
will be removed physically from their sources. Examples of such resources are oil, gas, minerals,
timber, and gravel.
Estimate of Recoverable Units
The estimate of economic lives for plant assets is a relatively simple undertaking compared with
the estimate of recoverable units of natural resources. The recoverable deposit of a natural
resource should be measured in units of desired product, such as an ounce of silver or a pound of
copper rather than in units of mined product, such as a ton of raw ore.

The most widely method of depletion for financial accounting is the output (units-of-production)
method, which produces a constant depletion charge per unit of the natural resource removed. To
illustrate, assume that early in year 7, Low Company acquired mining property for Br. 720, 000.
It is estimated that there are 1.2 million recoverable units of the natural resource, and that the
land will have a net residual value (after restoration costs) of Br. 60, 000 when the resource is
exhausted. The depletion per unit of output is computed as follows:

Cost−net residual value

Depletion = Estimated total re cov erable units

Br .720,000−Br .60,000
= 1,200,000 units

= Br. 0.55 per unit

If Low Company removed 300, 000 units of the natural resources from the ground in year 7, the
journal entry to record depletion is as follows:

Depletion (300, 000 x Br. 0.55)…………………….165, 000

Accumulated depletion of mining property……………165, 000
When additional costs are incurred in the development of mining properties or estimates of
recoverable units are revised, the depletion rate is computed by dividing the carrying amount
(cost less accumulated depletion, less net residual value) of the mining property (including any
additional development costs) by the new estimate of recoverable units.

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INTANGIBLE ASSET ISSUES
Characteristics
The Coca- Cola Company’s success comes from its secret formula for making Coca-Cola, not its
plant facilities. America On line’s subscriber base, not its Internet connection equipment,
provides its most important asset. The U.S. economy is dominated by information and service
providers. For these companies, their major assets are often intangible in nature.
What exactly are intangible assets? Intangible assets have two main characteristics.
1. They lack physical existence. Tangible assets such as property, plant, and equipment have
physical form. Intangible assets, in contrast, derive their value from the rights and privileges
granted to the company using them.
2. They are not financial instruments. Assets such as bank deposits, accounts receivable, and
long-term investments in bonds and stocks also lack physical substance. However, financial
instruments derive their value from the right (claim) to receive cash or cash equivalents in the
future. Financial instruments are not classified as intangibles.

TYPES OF INTANGIBLE ASSETS

As indicated, the accounting for intangible assets depends on whether the intangible has a limited
or an indefinite life. There are many different types of intangibles, often classified into the
following six major categories.
1. Marketing-related intangible assets.
2. Customer-related intangible assets.
3. Artistic-related intangible assets.
4. Contract-related intangible assets.
5. Technology-related intangible assets.
6. Goodwill.
 Marketing-Related Intangible Assets
Companies primarily use marketing-related intangible assets in the marketing or promotion of
products or services. Examples are trademarks or trade names, newspaper mastheads, Internet
domain names, and noncompetition agreements.
A trademark or trade name is a word, phrase, or symbol that distinguishes or identifies a
particular company or product. Trade names like google, Pepsi-Cola, create immediate product
identification in our minds, thereby enhancing marketability. Under common law, the right to use
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a trademark or trade name, whether registered or not, rests exclusively with the original user as
long as the original user continues to use it. Registration with the U.S. Patent and
Trademark Office provides legal protection for an indefinite number of renewals for periods of
10 years each.
 Customer-Related Intangible Assets
Customer-related intangible assets result from interactions with outside parties.
Examples include customer lists, order or production backlogs, and contractual and non-
contractual customer relationships.
To illustrate, assume that Green Market Inc. acquires the customer list of a large newspaper for
$6,000,000 on January 1, 2012. This customer database includes name, contact information,
order history, and demographic information. Green Market expects to benefit from the
information evenly over a three-year period. In this case, the customer list is a limited-life
intangible that Green Market should amortize on a straight-line basis.
Green Market records the purchase of the customer list and the amortization of the customer list
at the end of each year as follows.
January 1, 2012
Customer List 6,000,000
Cash 6,000,000
(To record purchase of customer list)
December 31, 2012, 2013, 2014
Amortization Expense 2,000,000
Customer List (or Accumulated Customer
List Amortization) 2,000,000
(To record amortization expense)
 Artistic-Related Intangible Assets
Artistic-related intangible assets involve ownership rights to plays, literary works, musical
works, pictures, photographs, and video and audiovisual material. Copyrights protect these
ownership rights.
A copyright is a federally granted right that all authors, painters, musicians, sculptors, and other
artists have in their creations and expressions. A copyright is granted for the life of the creator
plus 70 years. It gives the owner or heirs the exclusive right to reproduce and sell an artistic or
published work. Copyrights are not renewable.
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  Contract-Related Intangible Assets
Contract-related intangible assets represent the value of rights that arise from contractual
arrangements. Examples are franchise and licensing agreements, construction permits, broadcast
rights, and service or supply contracts.
A franchise is a contractual arrangement under which the franchisor grants the franchisee the
right to sell certain products or services, to use certain trademarks or trade names, or to perform
certain functions, usually within a designated geographical area. E.g A Toyota dealer, a
McDonald’s restaurant, coca cola.

 Technology-Related Intangible Assets

Technology-related intangible assets relate to innovations or technological advances.
Examples are patented technology and trade secrets granted by the U.S. Patent and Trademark
Office. A patent gives the holder exclusive right to use, manufacture, and sell a product or
process for a period of 20 years without interference or infringement by others. The two principal
kinds of patents are product patents, which cover actual physical products, and process patents,
which govern the process of making products.
 Goodwill
Although companies may capitalize certain costs incurred in developing specifically identifiable
assets such as patents and copyrights, the amounts capitalized are generally insignificant. But
companies do record material amounts of intangible assets when purchasing intangible assets,
particularly in situations involving a business combination (the purchase of another business).
To illustrate, assume that Portofino Company decides to purchase Aquinas Company.
In this situation, Portofino measures the assets acquired and the liabilities assumed at fair value.
In measuring these assets and liabilities, Portofino must identify all the assets and liabilities of
Aquinas.

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