Plant & equipment depreciation and intangible assets

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Plant & Equipment Depreciation

And Intangible Assets

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Depreciation



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



MATCHING PRINCIPLE

Offset the revenue of an accounting period with

the cost of services being consumed



RELATIONHIP BETWEEN

DEPRECIATION & MATCHING PRINCIPE

REVENUE

EXPENCE

DEPRECIATION

BALANCESHEET

INCOME STATMENT



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





Plant & Equipment



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.



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



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.



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



Land

• Expenditures such as commissions, legal

fees etc, also become part of the cost of

land.



Apportionment of

Lump-Sum Purchase



Apportionment of a Lump-Sum

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.



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



Land Improvements

• They should be recorded in a separate

account entitled “Land Improvements”

• Such as fences, parking lots etc.



Buildings

• Repairs made under these circumstances are

charged to the building account.

• Such as ordinary repairs are considered as

maintenance expenses.



Capital Expenditures & Revenue

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.



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.



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 &

Related Estimates



Management’s Responsibility for

Depreciation Methods & Related

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.



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



Inflation and Depreciation

• Inflation: It is the persistent increase in

prices of goods and services.

• Depreciation: Gradual decrease in the

value of fixed asset.



Disposal of Plant And

EquipmentCase 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

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.



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.



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



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



Intangible Assets



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.



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.



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.



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.



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.



Recording Goodwill in

Accounting Records

• Recorded only when it is purchased.

• Debited to an asset account entitled Goodwill.



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.



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.



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.



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.



Other Intangibles & Deferred

Charges • Moving costs.

• Plant Re-arrangement Costs.

• Organization Cost.

• Film Rights. etc



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.



Natural Resources



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.



Depreciation of Buildings &

Equipment Closely Related to

Natural Resources



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



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

DEPRICIATION



Methods of Computing

Depreciation

• Straight Line

• Declining Method

• Double Declining Method

• Sum of Year Digit



Straight Line Method

Cost – Residual Value

Years of Useful LifeDepreciation



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 valueuseful life

= 80000 – 50004

= 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



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



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



UNIT OF OUTPUT

Depreciation per Unit Output

Cost – Residual Value

Estimated Units of Output



Declining Method

Depreciation Expense =Remaining

ValueAccelerated

Depreciation

Rate



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

220000 20000 60000

2nd 60000*50% 30000 50000 30000

3rd 30000*50% 15000 65000 15000

4th 15000*50% 10000 75000 5000




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Plant & equipment depreciation and intangible assets