Plant Assets, Natural Resources, and Intangibles

Introduction

This chapter explores the accounting for plant assets, natural resources, and intangible assets. It covers the measurement, depreciation, disposal, and financial analysis of these long-lived assets, as well as the impact of environmental, social, and governance (ESG) factors and international accounting standards.

Accounting for the Cost of Plant Assets

Definition and Classification

• Plant assets (also called property, plant, and equipment) are tangible long-lived assets used in operations.

• Examples: Land, buildings, machinery, equipment, furniture, fixtures, and land improvements.

• Natural resources and intangible assets are also long-term but differ in physical substance and usage.

Measuring Cost of Plant Assets

• The cost of a plant asset is the sum of all expenditures necessary to acquire the asset and prepare it for its intended use.

• Costs include purchase price, taxes, commissions, and other expenditures to make the asset ready for use.

Land

• Includes purchase price, brokerage commission, survey and legal fees, back property taxes, grading, clearing, and removal of unwanted buildings.

• Excludes fencing, paving, security systems, and lighting (these are land improvements and are depreciated).

Buildings, Machinery, and Equipment

• Building construction: architectural fees, permits, contractor charges, materials, labor, overhead, and interest during construction.

• Building purchase: purchase price, commissions, taxes, and renovation costs.

• Equipment: purchase price (less discounts), transportation, insurance in transit, taxes, commissions, installation, testing, and special platforms.

Land Improvements and Leasehold Improvements

• Land improvements: driveways, signs, fences, sprinkler systems, etc. (depreciated over useful life).

• Leasehold improvements: improvements to leased property, depreciated or amortized over the lease term.

Lump-Sum (Basket) Purchases

• When multiple assets are purchased together, the total cost is allocated based on relative market values (relative-sales-value method).

Capital Expenditures vs. Immediate Expenses

Definitions

• Capital expenditures: Costs that increase an asset’s capacity or extend its useful life; capitalized as part of the asset.

• Immediate expenses: Ordinary repairs and maintenance; expensed as incurred.

Examples

• Capital expenditures: major engine overhaul, body modification, addition to storage capacity.

• Immediate expenses: oil change, tire replacement, paint job.

Leased Assets

• Leased assets are typically capitalized, with both the right-to-use asset and lease liability recorded on the balance sheet.

Depreciation of Plant Assets

Concept and Purpose

• Depreciation is the systematic allocation of the cost of a plant asset to expense over its useful life.

• Book Value = Cost – Accumulated Depreciation

• Land is not depreciated.

Depreciation Methods

• Straight-line method: Allocates equal depreciation each year.

• Units-of-production method: Depreciation based on usage or output.

• Double-declining-balance (DDB) method: Accelerated method, higher depreciation in early years.

Straight-Line Method

• Formula:

Units-of-Production Method

• Formula:

• Annual Depreciation = Depreciation per Unit × Units Produced

Double-Declining-Balance Method

• Formula:

• Annual Depreciation = DDB Rate × Book Value at Beginning of Year

Comparison of Methods

• Straight-line: Even expense, best for assets generating steady revenue.

• Units-of-production: Best for assets whose wear depends on use.

• DDB: Best for assets generating more revenue early in life.

Other Depreciation Issues

• Depreciation for tax purposes often uses accelerated methods (e.g., MACRS).

• Partial-year depreciation is prorated based on acquisition date.

• Changes in useful life are treated as changes in accounting estimates.

Disposal of Plant Assets

Accounting for Disposal

• Update depreciation to disposal date.

• Remove asset and accumulated depreciation from books.

• Record any gain or loss (difference between proceeds and book value).

GAAP vs. IFRS: Depreciation and Asset Accounting

• U.S. GAAP uses historical cost and composite asset depreciation.

• IFRS uses a component approach, depreciating each significant part separately.

• IFRS allows reversal of impairment losses in some cases; GAAP does not.

Natural Resources and Intangible Assets

Natural Resources

• Examples: Oil, minerals, timber (wasting assets).

• Depletion allocates cost as resources are extracted and sold.

Intangible Assets

• No physical substance; carry special rights (e.g., patents, copyrights, trademarks, franchises, goodwill).

• Finite life intangibles are amortized; indefinite life intangibles are tested for impairment.

Patents

• Exclusive right to produce/sell an invention for 20 years.

Copyrights, Trademarks, Franchises, Goodwill

• Copyrights: Exclusive right to reproduce/sell a work; lasts 70 years beyond author’s life.

• Trademarks: Distinctive identification; amortized if finite, otherwise tested for impairment.

• Franchises/Licenses: Right to sell products/services under specified conditions.

• Goodwill: Excess of purchase price over fair value of net assets acquired; not amortized, tested for impairment.

Research and Development (R&D) Costs

• Expensed as incurred under U.S. GAAP; some development costs may be capitalized under IFRS.

Asset Impairment

Definition and Process

• Impairment occurs when expected future cash flows are less than the asset’s book value.

• Impairment loss = Net book value – Fair value

Financial Analysis: Rate of Return on Assets (ROA)

Calculation

• ROA measures how efficiently assets generate net income.

• Formula:

• DuPont Analysis:

ESG Factors and Long-Lived Assets

• ESG factors can affect the useful life, value, and impairment of plant assets, natural resources, and intangibles.

• Examples: Environmental regulations, societal values, and reputational risks can impact asset values and depreciation estimates.

Cash Flow Impact of Long-Lived Asset Transactions

• Acquisitions and sales of long-lived assets are reported as investing activities on the statement of cash flows.

• Depreciation and amortization are non-cash expenses added back to net income in operating activities.

Depreciation Calculations Using Excel Functions

• SLN function: Calculates straight-line depreciation.

• DDB function: Calculates double-declining-balance depreciation.

Additional info: These notes provide a comprehensive overview of the accounting for plant assets, natural resources, and intangibles, including key definitions, methods, and practical examples. They are suitable for exam preparation and reference in a financial accounting course.