Chapter 7: Plant Assets, Natural Resources, and Intangibles

Introduction

This chapter covers the accounting for long-term assets used in operations, focusing on Property, Plant, and Equipment (PP&E), Natural Resources, and Intangible Assets. These assets are essential for generating future revenues and are reported on the balance sheet.

Learning Objectives

• Explain how to account for the cost of plant assets

• Distinguish a capital expenditure from an immediate expense

• Explain how to account for depreciation on plant assets

• Analyze the effect of a plant asset disposal

• Apply GAAP for natural resources and intangible assets

• Explain the effect of an asset impairment on the financial statements

• Analyze rate of return on assets

• Analyze the cash flow impact of long-lived asset transactions

• Calculate depreciation expense using Excel functions

Plant Assets, Natural Resources, and Intangibles

Classification and Financial Statement Presentation

Long-lived assets are reported on the balance sheet and are classified as follows:

Accounting for the Cost of Plant Assets

Measurement of Asset Cost

The cost of a plant asset is the sum of all expenditures necessary to acquire the asset and prepare it for its intended use. These costs typically include:

• Purchase price

• Taxes

• Commissions

• Other costs to make the asset ready for use (e.g., installation, testing)

For land, costs include purchase price, brokerage commission, survey fees, legal fees, back property taxes, grading and clearing, and removal of unwanted buildings. Costs such as fencing, paving, security systems, and lighting are considered land improvements and are depreciated separately.

Example: Calculating Land Cost

• Purchase price: $300,000

• Real estate commission: $10,000

• Back property tax: $8,000

• Removal of old building: $5,000

• Survey fee: $1,000

• Total land cost: $324,000

Additional info: Paving costs are not included in land cost but are capitalized as land improvements.

Cost of Buildings, Machinery, and Equipment

• Buildings (construction): Architectural fees, permits, contractor charges, materials, labor, overhead, interest on construction loans

• Buildings (purchase): Purchase price, commissions, taxes, repairs/renovations for intended use

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

Land Improvements and Leasehold Improvements

• Land Improvements: Driveways, fences, sprinkler systems, lighting, etc. (depreciated over useful life)

• Leasehold Improvements: Improvements to leased property, depreciated or amortized over lease term

Lump-Sum (Basket) Purchases

Relative-Sales-Value Method

When multiple assets are purchased together for a single price, the cost is allocated based on their relative market values:

• Calculate total market value of all assets

• Determine each asset's percentage of total market value

• Allocate purchase price accordingly

Formula:

Capital Expenditures vs. Immediate Expenses

Definitions and Distinctions

• Capital Expenditures: Costs that increase asset capacity or extend useful life; added to asset account

• Immediate Expenses: Costs that do not increase useful life or capacity; expensed immediately (e.g., repairs, maintenance)

Ordinary repairs and maintenance are expensed, while improvements or major overhauls are capitalized.

Depreciation of Plant Assets

Concepts and Methods

Depreciation is the process of allocating the cost of a tangible asset over its useful life. Land is not depreciated. Depreciation matches asset cost to the periods benefiting from its use.

• Book Value:

• Depreciable Cost:

Depreciation Methods

• Straight-Line Method: Equal expense each year

• Units-of-Production Method: Expense based on usage

• Double-Declining-Balance Method: Accelerated depreciation

Comparison of Methods

Additional info: Total depreciation over asset life is the same for all methods; only the timing differs.

Disposal of Plant Assets

Accounting for Disposal

• Update depreciation to date of disposal

• Remove asset and accumulated depreciation from books

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

Formula:

Natural Resources and Intangible Assets

Natural Resources

• Long-term assets such as minerals, oil, timber

• Depletion tracks usage; similar to units-of-production method

• Depletion per unit:

Intangible Assets

• No physical substance; carry special rights

• Examples: patents, copyrights, trademarks, franchises, goodwill

• Finite lives: amortized over useful life

• Indefinite lives: tested annually for impairment

Patents, Copyrights, Trademarks, Franchises, Goodwill

• Patents: Exclusive rights for 20 years

• Copyrights: Exclusive rights for 70 years beyond author's life

• Trademarks: Distinctive identifications; may be indefinite

• Franchises/Licenses: Rights to sell products/services; may be indefinite

• Goodwill: Excess of purchase price over net asset value; not amortized, tested for impairment

Asset Impairment

Impairment Testing

• Occurs when expected future cash flows are less than asset's book value

• Carrying value is adjusted downward to fair value

Rate of Return on Assets (ROA)

Measuring Asset Efficiency

• ROA measures how effectively assets generate net income

• Formula:

Cash Flow Impact of Long-Lived Asset Transactions

Statement of Cash Flows

• Acquisitions: Investing activities (cash outflow)

• Sales: Investing activities (cash inflow)

• Depreciation/Amortization: Operating activities (added back to net income)

Calculating Depreciation Using Excel Functions

Excel Functions for Depreciation

• SLN: Calculates straight-line depreciation

• DDB: Calculates double-declining-balance depreciation

Additional info: Software tools are commonly used for quick and accurate depreciation calculations.