CH 4: lecture note on Plant asset PPT.pptx

Plant Assets are: Relatively permanent assets;
Physical substance (a definite size and shape),
Are used in the operations of a business,
Are not intended for sale to customers,
Are expected to provide service to the company for a number of years, except for land.When an existing building is acquired; its cost includes

1. Nature Of Assets

2. 4.1. Nature of Plant assets: Plant Assets are: Relatively permanent assets; Physical substance (a definite size and shape), A re used in the operations of a business, A re not intended for sale to customers, A re expected to provide service to the company for a number of years, except for land. Referred to as property, plant, and equipment; plant and equipment; and fixed assets. Examples; Building, Land, Equipment, Machinery

3. 4.1.1. Determination of Acquisition Cost of Plant Assets: The cost principle requires that companies record plant assets at their original/ historical cost . Cost consists of all expenditures necessary to acquire an asset and make it ready for its intended use/business operation. Land: The acquisition cost of land includes The purchase price (the negotiated cash price) plus Other expenditures incurred in connection with the purchase of land such as cost of land surveys,

4. legal fees, brokers commissions, transfer taxes, cost of preparing the land to build on, and even the demolition costs of old structures that might be torn down to get the land ready for its intended use Example-1: A business enterprise acquires a piece of land for office site. It pays a cash price of Br. 210,000, pays brokerage fees of Br. 7,500 and title fees of Br. 3,000, pays Br. 5,000 to have unwanted building removed, and pays, Br. 1,500 to have the site graded. The business receives Br. 2,000 salvage from the old building. The cost of the land is;

5. Cash prices (negotiated price )…..……… Br. 210,000 Add: Title Fees ………………………………………3,000 Brokerage Fees ……………………………………7,500 Cost of Grading ……………………………………1,500 Cost of removing (demolition) unwanted…Br . 5000 Less: Salvage receive…………….. ( 2000) …… 3,000 Total cost of land ………………………… Br . 225,000.00 Entry: Land ……………………225,000 Cash …………………….225,000

6. 2) Buildings: When an existing building is acquired; its cost includes The purchase price plus all repairs and other expenses necessary to put it in a usable condition & when a business constructs its own building, the cost includes all reasonable and necessary expenditures such as those for materials, labor, part of the overhead and other indirect costs, engineers and architects’ fees, insurance during construction, interest incurred on construction loans during the period of construction, lawyers’ fees, and building permits

7. 3) Equipment: The cost of equipment includes all expenditures associated with purchasing the equipment and preparing it for use. These expenditures include invoice price less cash discounts (if any); freight or transportation, including insurance, excise taxes and tariffs; buying expenses, installation costs, and test runs to ready the equipment for operation. Equipment is subject to depreciation

8. 4.2. Accounting for Depreciation: As plant assets are used in the operations of a business, their value to provide service decreases through usage and the passage of time. This cost allocation of plant asset, called depreciation . Depreciation means the allocation of the cost of a plant asset to the periods that benefit from the services of the asset. The term depreciation is used to describe the gradual conversion of the cost of the asset into an expense. Depreciation is not a process of valuation .

9. 4.2.1. Factors Affect Computation of Depreciation: 1) Cost: is the net purchase price plus all reasonable and necessary expenditures to get the asset in place and ready for use. 2) Residual value: also known as S alvage V alue , Disposal V alue , Scrape Value , or Trade-in-Value ; represents the estimated market value of the asset at the time of its retirement . 3) Depreciable Cost: represents the difference between the asset cost and its estimated residual value.

10. For example , an item of equipment that costs Br. 5000 and has a residual value of Br. 500 would have a depreciable cost of Br. 4500, (Br. 5000 - Br. 500). The depreciable costs must be allocated over the estimated economic life of the asset. 4) Estimated economic (useful) life: the estimated economic life of an asset is the total number of service units expected from the asset. Service units may be measured in terms of years the asset is expected to be used, units expected to be produced, miles or kilometers expected to be driven,

11. 4.2.2. Methods of Computing Depreciation: 1) Straight – Line Method Depreciation: The depreciable cost of the asset is spread evenly over the economic life of the asset. It is based on the assumption that depreciation depends only on the passage of time. Example-2: Suppose a business enterprise acquires a new computer at a cost of Birr 6000. It is estimated that the computer has an estimated residual value of Birr 1000 at the end of its estimated useful life of 4 years. The yearly (annual) depreciation would be computed as follows:  

12. Annual depreciation = 6000-1000 = 1250 5 Year Cost Yearly Depreciation Accumulated Depreciation Carrying value (Book Value) Beginning of first year Br. 6000 - - Br. 6000.00 End of first year 6000 Br. 1250.00 Br. 1250.00 4750.00 End of second year 6000 1250.00 1250.00 3500.00 End of third year 6000 1250.00 3750.00 2250.00 End of fourth year 6000 1250.00 5000.00 1000.00 Depreciation Schedules - Straight-Line Method

13. 2) Units of Production Method: B ased on the assumption that depreciation is mainly the result of use and that the passage of time plays no role in the depreciation process. If we assume that the new computer from the previous illustration has an estimated useful life of 10,000 hours, the depreciation cost per hour would be determined as follows: Hourly depreciation Rate = Cost – Salvage value Estimated units of useful life = Br. 6000 – 1000 = Br. 0.50 10,000 operating hrs

14. Year Cost Hours Depreciation Per Hour Yearly Depr. Accum . Depr. Carrying value (Book value) Beginning of the 1 st year Br. 6,000 - Br. 0.50 - - Br. 6,000.00 End of first year 6,000 2,800 0.50 Br. 1,400.00 Br. 1,400.00 4,600.00 End of second year 6,000 3,600 0.50 1,800.00 3,200.00 2,800.00 End of third year 6,000 2,400 0.50 1,200.00 4,400.00 1,600.00 End of fourth year 6,000 1,200 0.50 600.00 5,000.00 1,000.00

15. 3) Declining Balance Method: R esults in relatively large amount of depreciation in the early years of an assets life and smaller amounts in later years. It is based on the assumption of the passage of time. Since most kinds of plant assets are most efficient when new, and so they provide more and better service in the early years of their useful life.

16. Depreciation Schedule, Double-Declining Balance Method Year Cost Fixed Depr. Rate Yearly Depreciation Accumulated Depreciation Carrying Value (BV) Date of purchase Br. 6000 50% - - Br. 6000 End of first year 6000 50% Br. 3000 Br. 3000 3000 End of Second year 6000 50% 1500 4500 1500 End of third year 6000 50% 750 5250 750 End of fourth year 6000 50% 250 5500 500

17. Example-3: Assume that equipment was purchased on January 1 as follows: Initial cost Birr 24,000 , Expected useful life 5 years, estimated residual value Birr2,000. Required: Compute the Annual Depreciation Expense and Show the Depreciation Schedule. Step-1: Straight-line percentage = 20 % (100%/5) Step 2: Double-declining-balance rate = 40 % (20% * 2 ) Step 3: Depreciation expense =Birr9,600 (24,000*40 %)

18. Depreciation schedule, sum of years digit method Year Cost Rate Yearly Depreciation Accumulated Depreciation Book Value Date of purchase Birr 24,000 40% Birr 24,000 End of 1 st year 24,000 40% 9,600 9,600 14,400 End of 2nd year 24,000 40% 5,760 15,360 8,640 End of 3 rd year 24,000 40% 3,456 18,816 5,184 End of 4 th year 24,000 40% 2,073.6 20,889.6 3,110.4 End of 5 th year 24,000 40% 1,110.4 22,000 2,000

19. 4) Sum-of-year’s digits method: P rovides a higher amount of periodic depreciation expense in the earlier use of the asset's life and decline depreciation expense thereafter because a successively smaller fraction is applied each year to the depreciable cost of the asset . Under this method, the denominator of the fraction, which remains the same, is the sum of the digits representing the years of life. The numerator of the fraction, which changes each year, is the number of years of life remaining at the beginning of the year for which depreciation is being computed. For example, for an asset with an estimated life of 10 years, the denominator of the fraction is 10+9+8+7+6+5+4+3+2+1=55 for the first year; the numerator is 10, for the second years 9, and so on.

20. Depreciation schedule, sum of years digit method Year Depreciable Cost Rate Yearly Depreciation Accumulated Depreciation Book Value Date of purchase Br6000 - - - Br. 6000 End of first year 6000 4/10 Br. 2400 Br. 2400 3600 End of second year 6000 3/10 1080 4680 1320 End of third year 6000 2/10 264 4944 1056 End of fourth year 6000 1/10 56* 5000 1000

21. 4.2.3. Depreciation for Partial Years: Example-4: Assume that Equipment is purchased for Birr 5000 and that it has an estimated useful life of 5 years , and an estimated residual value of Birr 500 and assume it is purchased on October 2 and that the yearly accounting period ends on Dec.31 Solution: Depreciation must be recorded for three months, October through December; The three months’ depreciation : under the straight line method is calculated as follows: (5000-500)÷5years*3/12=Birr 225

22. If the company used the double – declining – balance method depreciation is computed as follows : ( Birr 5000-0) X 2/5 X 3/12 =Birr 500 If the company used the sum – 0f - the – years – digits method computed: Birr (5000 – 500) X 5/15 X 3/12 = birr 375, and The depreciation for the 2nd year would be: ( 5000 -500) X 5/15 X 9/12 = Birr 1125 ( 5000 -500) X 4/15 X 3/12 = 300 Total , 2nd year depreciation = Birr 1425 Entry Depreciation Expense………….225 Accumulated Depr. Expe. …….225

23. 4.3. Capital and Revenue Expenditure: Revenue expenditures are expenditures incurred in order to maintain the normal operating efficiency of the asset. Among the more usual kinds of revenue expenditures for plant asset are the repairs, maintenance, lubrication, Cleaning and inspection necessary to keep an asset in good working condition. C apital Expenditures are expenditures that improve the operating efficiency (or capacity) or costs incurred to achieve greater future benefits .

24. In addition to the acquisition of plant assets, capital expenditures included additions and betterments. Example-5: Suppose for example, a machine costing Br. 35,000 had no estimated residual value and an original estimated useful life of 10 years , has been depreciated for 7 years. At the very beginning of the 8 th 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

25. Solution: To record extraordinary repair; Jan. 4. Accumulated Depreciation – Machinery ……3000 Cash ………………………………………………………… 3000 ( 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 Acc Dep before extraordinary repair…Br . 24,500 Less : extraordinary repair (Debited ……( 3,000) ….( 21,500) Book value, after extraordinary……………………...Br.13,500 Revised Annual periodic depreciation= 13,500 = 2,250 6 years

26. 4.4. Disposal of Plant Assets: A plant asset may be disposed by: Discarding it as worthless; Selling it; or Trading it in on a new asset 1) Recording Discarding of a Plant Asset: If a plant asset is of no further use to the business and cannot be sold or traded , then it should discarded. In this case neither gain nor loss is realized. On the other hand, if a plant asset has a book value (if not fully depreciated) at the time it is discarded, the business incurs a loss.

27. Example-6: Suppose on July 5, year 5, equipment that was acquired On Jan 10, year 1, at a cost of Birr 11,000 , is discarded as worthless. The discarded equipment has a carrying value of Birr 2000 at the time of disposal. What should be the entry to record Disposal of the Equipment? Solution : The journal entry required to discard the plant asset as of July 5, year 5, is: July 5.Accumulated Depreciation, Equipment …..9,000 Loss on disposal of plant Asset ………………2,000 Equipment ………………………11,000 ( Discarding Equipment no longer used in the business)

28. 2) Recording the Sale of Plant Asset: Case 1: Sold at an amount equal to Book value, Br. 2000 July 5. Cash …………………………………………………2000 Accumulated Depreciation, Equip…….. 9000 Equipment ……………………………………11000 ( Sale of equipment at an amount equal to book value) Case 2: Sold at Br. 1500 cash July 5. Loss on sale of equipment ……………….500 Accumulated Depreciation……………… 900 Cash ……………………..…………………………1500 Equipment………………………………11,000 ( Sale of equipment at less than the book value. Loss of Br. 500)

29. Case 3: Sold at Br. 3000 cash July 5. Cash ………………………………………. 3000 Accumulated Depr, Equipment…9000 Gain on sale of plant asset ………..1000 Equipment……………………………….11,000 (Sale of equipment at more than the book value; gain of Br. 1000, (Br. 3000 – Br.2000) recorded)

30. 3) Recording Trading of Plant Assets: Exchange Losses Gains Recognized Recognized For Financial Reporting Purposes: Of similar assets …………………Yes…………………No Of Dissimilar assets ……………..Yes………….……Yes For Income Tax purposes: Of similar assets ………………….No…………….….No Of dissimilar assets ……………Yes…………………Yes

31. A) Loss Recognized on the Exchange: Example-7: A ssume that the business exchange a machine with a cost of Br. 11,000, and accumulated depreciation of Br. 9000 for a newer more modern machine on the following terms: Cost of new machine …………………Birr 12,000 Less: Trade-in Allowance for old …… ……( 1500) Cash payment required (Boot )……Birr 10,500 What should be the journal entry required to record the exchange of assets?

32. Solution : The journal entry would be as follows: July 5. Equipment (New)…………………….. 12,000 Accum . Depreciation-Equip ………….9,000 Losss on Exchange of plant assets…..500 Equipment (old )……………11,000 Cash…………………….……………10,500 (T0 Record the trading of old Machine) It can be computed as: Cost of New Asset=List Price – Unrecognized Gain Cost of New Asset=List Price + Unrecognized Loss Cost of New Asset= Cash Paid + Book Value(Old)

33. B) Loss Not Recognized on the Exchange: Example-8: Assume that the business exchange a machine with a cost of Br. 11,000, and accumulated depreciation of Br. 9000 for a newer more modern machine on the following terms: Cost of new machine …………………Birr 12,000 Less: Trade-in Allowance for old …… ……(1500) Cash payment required (Boot)……Birr 10,500 What should be the journal entry required to record the exchange of assets?

34. The Cost of the New Machine can be Computed as: Cost of New Machine= Cash Paid+ Book Value 10,500 + 2,000= 12,500 July 5. Equipment (New)…………………….. 12,500 Accum . Depreciation-Equip ………9,000 Equipment (old )……….……… 11,000 Cash …………………….…………… 10,500 (T0 Record the trading of old Machine)

35. C) Gain Recognized on the Exchange: Example-9: A ssume that the business exchange a machine with a cost of Br. 11,000, and accumulated depreciation of Br. 9000 for a newer more modern machine on the following terms: Cost of new machine ………….…….Birr 12000 Less: Trade-in Allowance for old machine … (3000 ) Cash payment required (Boot)….…Birr 9,000 What should be the journal entry required to record the exchange of assets?

36. Cost of New Machine can be Computed as: Cos of New Machine= Cash Paid + Book Value = 9,000 + 2,000 = 11,000 July 5. Equipment (New)……………………………12,000 Accumulated Depreciation ………………9,000 Equipment (old )…………………………11,000 Cash ………………………………………….9,000 Gain on exchange of Equip …………1,000 (To record the exchange of Equipment's to remove cost of old equipment and the related accumulated depreciation, new equipment recorded at cost price; gain recognized)

37. D) Gain Not Recognized on the Exchange: Example-10: Assume that the business exchange a Machine with a cost of Br. 11,000, and accumulated depreciation of Birr 9,000 for a newer more modern Machine on the following terms: Cost of new machine …………………Birr 12000 . Less: Trade-in Allowance for old machine … . (3,000) Cash payment required (Boot )………………Birr 9,000 . What should be the journal entry required to record the exchange of assets?

38. Cost of New Machine can be Computed as: Cos of New Machine= Cash Paid + Book Value = 9,000 + 2,000 = 11,000 July 5. Equipment (New )…………………………11,000 Accumulated Depreciation ……………9,000 Equipment (old )………………11,000 Cash…………………………………9,000 ( To record exchange of Equipment to remove the cost of old equipment and the related accumulated depreciation of old assets; new equipment recorded at a cost equal to BV of old asset plus cash paid)

39. Example-11: Assume that the business exchange a Machine with a cost of Birr 4,000, and accumulated depreciation of Birr 3,200 for a newer more modern Machine on the following terms: Cost of new Equipment…………………Birr 5,000. Less: Trade-in Allowance for old machine… .(1,100) Cash payment required (Boot)………………Birr 3,900. Required: 1) What should be the cost of new Equipment? 2) What should be entry to record the exchange of assets; A) If they are similar for ITP and FRP, B) If they are dissimilar for ITP and FRP?

40. 4.5. Nature of Intangible Assets: Are long-lived assets that are useful in the operations of a business and are not held for sale Are long-term assets that do not have physical substance R elate to legal rights or advantages held. They are accounted for at acquisition cost, that is , the amount paid for them. Cost allocation process of intangible assets is referred to Amortization . Examples: Goodwill, Patent, Copyright and rademarks ,

41. Goodwill : The term goodwill is widely used by business people to mean the good reputation of a company. From an accounting standpoint, goodwill exists when a purchaser pays more for a business than the fair market value of the net assets Goodwill reflects all the factors that allow a company to earn a higher than market rate of return on its investments, including customer satisfaction, good management, manufacturing efficiency, the advantage of holding a monopoly, good locations, and good employee relations

42. Goodwill is excess cash paid over Net Assets. It covers the largest portion from the Intangible assets in the Balance sheet. Example-12: Assume ABC Company has Total Assets Birr 120,000 and Liability Birr 80,000 and XYZ Company paid Birr 50,000 for the Net assets. What is the amount of Goodwill and entry to record it ? Solution: Net Asset = Total Asset – Total Liability =Birr 120,000-80,000=40,000 Entry Net Assets…………..40,000 Goodwill………………..10,000 Cash……………………50,000

43. Copyrights : The exclusive right to publish and sell a literacy, artistic, or musical composition is obtained by a copyright. The costs assigned to a copyright include all costs of creating the work plus the cost of obtaining a copyright. A copyright that is purchased from another should be recorded at the price paid for it. The maximum period of amortization for a copyright is 50 years beyond the author’s death.

44. A trademark is a name, term, or symbol used to identify a business and its products. For example, the distinctive red-and-white Coca-Cola logo is an example of a trademark. Thus, even though the Coca-Cola trademarks are extremely valuable, they are not shown on the balance sheet, because the legal costs for establishing these trademarks are immaterial. The cost of a trademark is in most cases considered to have an indefinite useful life. Thus, trademarks are not amortized over a useful life. Rather, trademarks should be tested periodically for impaired value. When a trademark is impaired from competitive threats or other circumstances, the trademark should be written down and a loss recognized. .

45. Patents: Manufacturers may acquire exclusive rights to produce and sell commodities with one or more unique features. Such rights are evidenced by patents, which are granted to inventors. Patents continue in effect for seventeen years Example-13: Assume that on Jan 2, 2002 MOHA Soft Drink Bottling Company purchased a patent on a unique bottle cap for Birr 54,000 . What should be the entry to record the purchase of patent and amortization expense of the patent for six years?

46. Solution: The Entry should be ; Jan 2. Patent…………………………….. 54,000 2002 Cash……………………………………..54,000 ( To record the purchase of Bottle cap patent) Amortization Expense……………………….. 9,000 Patent…………………………………...9,000 ( To record annual amortization of patent ( Birr 54000/ 6 years)

47. Example-14: Assume that at the beginning of its fiscal year, a business acquires patent rights for Birr 100,000 . The patent had been granted 6 years earlier by the Federal Patent Office. Although the patent will not expire for 14 years, its remaining useful life is estimated as 5 years. The entry for purchase of the patent and adjustment to amortize the patent at the end of the fiscal year is as: Dec,1, Patent……….100,000 Cash……….100,000 Dec . 31 Amortization Expense – patents ……20,000 Patent ………………………..………………20,000 (To record annual amortization of patent (Br. 100,000/ 5 years)

48. 4.6. Natural Resources: Natural resources are another group of long-term assets that are extracted from the earth such as minerals, oils, (or petroleum), and timber (or lumber ). The periodic cost allocation of these natural resources is referred to as depletion . The units-of-activity method is generally used to compute depletion since it is a function of the units extracted during the year.

49. Under the units-of-activity method, the total cost of the natural resource minus salvage value is divided by the number of units estimated to be in the resource. The result is a depletion cost per unit of product. The depletion cost per unit is then multiplied by the number of units extracted and sold. The result is the annual depletion expense . Depletion differs from depreciation because depletion focuses specifically on the physical use and exhaustion of the natural resources, while depreciation focuses more broadly on any reduction of the economic value of a plant or fixed asset.

50. Example-15: Suppose MIDROC Construction has acquired the right to use 10,000 acres of land in Kibre-Mengist territory to mine for gold at a total cost of, Birr 10,000,000. The Company estimated that the mine will provide approximately 500,000 grams of gold. The depletion rate established is computed in the following manner; Depletion cost/unit = Total cost – Salvage value Total estimated units available = Br. 10,000,000 = Br. 20/gram 500,000 units

51. Then, assume that if 100,000 grams are extracted in the first year, the depletion for the year is 2,000,000 (100, 000 x Br.20.00). The entry to record the depletion is therefore: Entry: Depletion Expense………………2,000,000 Accumulated Depletion…………2,000,000 (To Record Depletion Expense of the 1 st year) Like the accumulated depreciation account, Accumulated Depletion is a contra asset account. It is reported on the balance sheet as a deduction from the cost of the mineral deposit.

52. 4.7. Presentation of Long – Term Assets in the Balance Sheet: The amount of Depreciation and Amortization Expense of a period should be reported separately in the income statement or disclosed in a note. A general description of the method or methods used in computing depreciation should also be reported. The amount of each major class of fixed assets should be disclosed in the Balance sheet or in notes. The related Accumulated Depreciation should also be disclosed, either by major class or in total. The fixed assets should be shown at their Book Value (Cost Less Accumulated Depreciation), which can also be described as their Net Amount. Fixed Assets are normally presented under the more descriptive caption of Property, Plant and Equipment .

53. THE END OF CH FOUR!! ~~~~~~~~~~~~~~~~~~~~~~~~ QUESTIONS ?? ~~~~~~~~~~~~~~~~~~~~~~~~ “ The Weak Can Never Forgive, Forgiveness is The Attribute of Strong”