Plant Assets, Natural Resources, and Intangibles

Introduction

This chapter covers the accounting for property, plant, and equipment (PP&E), natural resources, and intangible assets. It explains how to measure, depreciate, and report these assets, as well as how to account for their disposal and evaluate business performance using asset-related ratios.

Property, Plant, and Equipment (PP&E)

Definition and Characteristics

• PP&E are long-lived, tangible assets used in business operations, such as land, buildings, equipment, furniture, fixtures, and vehicles.

• They are recorded at historical cost, which includes the purchase price and all costs necessary to get the asset ready for use.

• The cost of a plant asset is allocated to expense over its useful life through depreciation, following the matching principle.

Measuring the Cost of PP&E

• Historical cost includes purchase price, taxes, commissions, and other costs to prepare the asset for use.

• Land costs include purchase price, brokerage, legal fees, delinquent taxes, title fees, and clearing costs.

• Land improvements (e.g., fencing, paving) are recorded separately and depreciated.

Buildings, Machinery, and Equipment

• Building costs include construction (architectural fees, permits, contractor charges) or purchase price plus renovation costs.

• Machinery and equipment costs include purchase price (less discounts), transportation, insurance in transit, taxes, commissions, installation, and testing.

• Furniture and fixtures are recorded at purchase price plus costs to ready for use.

Lump-Sum (Basket) Purchases

• When multiple assets are purchased together, the total cost is allocated based on each asset's relative fair market value (relative-market-value method).

Capital vs. Revenue Expenditures

• Capital expenditures increase asset capacity, efficiency, or useful life (e.g., extraordinary repairs).

• Revenue expenditures maintain the asset in working order (e.g., routine repairs).

Data Analytics in Accounting

• Data analytics helps companies optimize property investments, maintenance, and resource consumption.

• Examples include analyzing geographical data for property acquisition and monitoring energy/water usage for cost savings.

Depreciation of Plant Assets

What Is Depreciation?

• Depreciation allocates the cost of a plant asset (except land) over its useful life.

• Depreciation is based on: cost, estimated useful life, and estimated residual value.

• Depreciable cost = Cost – Estimated residual value.

Depreciation Methods

• Straight-Line Method: Allocates equal depreciation each year.

• Units-of-Production Method: Depreciation varies with asset usage.

• Double-Declining-Balance Method: Accelerated method, higher depreciation in early years.

Depreciation for Tax Purposes

• The IRS requires the Modified Accelerated Cost Recovery System (MACRS) for tax depreciation, which is not GAAP-compliant.

• MACRS ignores residual value and uses IRS-specified asset lives.

Partial-Year Depreciation

• Depreciation is prorated for assets purchased during the year, often using the modified half-month convention.

Changing Estimates

• If useful life or residual value estimates change, recalculate depreciation for current and future years only.

• Revised depreciation formula:

Reporting PP&E

• PP&E are reported at book value (cost minus accumulated depreciation) on the balance sheet.

• Details may be disclosed in the notes to financial statements.

Disposal of Plant Assets

Recording Disposals

• Disposals may involve discarding, selling, or exchanging assets.

• Steps: Update depreciation, remove asset and accumulated depreciation, record cash received/paid, and recognize gain or loss.

Discarding Plant Assets

• If fully depreciated, remove asset and accumulated depreciation from the books.

• If not fully depreciated, recognize a loss for the remaining book value.

Selling Plant Assets

• If sold at book value, no gain or loss is recognized.

• If sold above book value, recognize a gain; if below, recognize a loss.

Natural Resources

Accounting for Natural Resources

• Natural resources (e.g., oil, minerals) are depleted over time using the units-of-production method.

• Depletion expense is recorded as the resource is extracted and used.

• Accumulated Depletion is a contra asset account.

Intangible Assets

Definition and Types

• Intangible assets lack physical substance but provide economic value (e.g., patents, copyrights, trademarks, franchises, goodwill).

Accounting for Intangibles

• Purchased intangibles are recorded at cost.

• Intangibles with definite lives are amortized over their useful life.

• Intangibles with indefinite lives are tested annually for impairment, not amortized.

Patents

• Patents grant exclusive rights for 20 years; acquisition cost is capitalized and amortized over the shorter of useful or legal life.

Copyrights and Trademarks

• Copyrights protect creative works for the creator's life plus 70 years.

• Trademarks identify products/services and may be renewed indefinitely.

Franchises and Licenses

• Franchises and licenses grant rights to sell goods/services or use public property under specific conditions.

Goodwill

• Goodwill is the excess paid over the fair value of net assets in a business acquisition.

• Goodwill is not amortized but tested for impairment annually.

Evaluating Asset Performance

Asset Turnover Ratio

• Measures efficiency in generating sales from assets.

• Formula:

• A higher ratio indicates more efficient use of assets.

Exchanges of Plant Assets

Accounting for Exchanges

• Exchanges with commercial substance require recognition of gains or losses.

• Journal entries reflect the removal of old asset, recognition of gain/loss, and recording of new asset and any cash paid/received.

Summary Table: Key Journal Entries for Plant Assets

Additional info: This summary includes expanded academic context and formulas for clarity and exam preparation.