Chapter 9.

Plant Assets,
Natural Resources, and
Intangible Assets

Prof. Sorah Park

Ewha Womans University
Non-current Assets

Definition:
Resources held for extended time that provide economic benefit to the firm for a number of
future periods

Two basic types:

1. Plant Assets (PPE, Fixed Assets)
• Physical long-lived assets used in operations
• Land, buildings, equipment, machinery, etc.
2. Intangible Assets
• Rights or economic benefits that are not physical in nature
• Patents, trademarks, copyrights, goodwill, etc.
Main issues associated with accounting for plant assets

1. Measuring the cost of plant assets

• At what cost should we initially record an asset?
2. Capitalize vs. Expense
• Should we report this cost as an asset (capitalization; SoFP) or an expense (I/S)?
3. Depreciation
• At what rate should the asset’s cost be allocated to future periods?
1. Measuring the cost of plant assets:
At what cost should we initially record an asset?

• Record at the amount paid to acquire the assets and ready it for its intended use (Historical
cost)
• Purchased asset
• The cost includes:
• The purchase price and applicable taxes,
• Purchase commissions,
• Other (transportation fees, legal fees, etc.)
• Self-constructed asset
• The cost includes:
• Direct costs (labor, material, overhead)
• Indirect costs (fixed overhead) other charges
1. Measuring the cost of plant assets

• Interest on Borrowings
• Purchased Asset: Expense
• Constructed Asset: Capitalize into cost all interest paid prior to completion
• Land Improvements
• Separate (limited life) depreciable fixed assets including the cost of fencing, paving, lighting, etc.
• Leasehold Improvements
• Separate assets representing improvements to leased assets which will remain with the owner,
depreciated over the term of the lease
o Non-Monetary Exchanges (Exchange of non-cash goods)
o Recorded at the Fair Value of the asset which is more readily determinable

o Assets purchased in a group or Basket for a

lump-sum amount require the identification of cost for each asset
o The total cost is divided among the assets according to their relative market values
Construction of a new office building – increase Land, Building, Land Improvements or Leasehold Improvements
account?
Cost of land 210,000
Legal fees relating to land purchase 2,000
Cost of removing old building 1,000
Payment of delinquent property taxes 4,500
Grading the site 5,000
Payment to building contractor 1,000,000
Cost of building permits 4,500
Interest cost incurred during construction 40,000
Cost of paving parking lot A (on the land) 20,000
Cost of fencing 5,000
Cost of repaving parking lot B (leased nearby) 11,000
Construction of a new office building – increase Land, Building, Land Improvements or Leasehold Improvements
account? Land
Cost of land 210,000
Legal fees relating to land purchase 2,000 Land

Cost of removing old building 1,000 Land

Payment of delinquent property taxes 4,500 Land

Grading the site 5,000 Land

Payment to building contractor 1,000,000 Building

Cost of building permits 4,500 Building
Interest cost incurred during construction 40,000 Building
Cost of paving parking lot A (on the land) 20,000 Land Imp
Cost of fencing 5,000 Land Imp
Cost of repaving parking lot B (leased nearby) 11,000 Lease Imp
Suppose a combined purchase price of land and building is $2,800,000. The
following table presents the market values for the land and building, along with
the ratio of each asset’s market value to the total market value:

Asset Market Total Market Value % Total Total Cost of Individual Asset
Land Value
300,000 Market Value Cost
Practice 2,700,000
#1-2
Building
3,000,000

2,800,000
What journal entry do we record?
Suppose a combined purchase price of land and building is $2,800,000. The
following table presents the market values for the land and building, along with
the ratio of each asset’s market value to the total market value:

Asset Market Total Market Value % Total Total Cost of Individual Asset
Land Value
300,000 Market Value Cost 280,000
10%
Practice 2,700,000
#1-2
Building 90% 2,520,000
3,000,000 3,000,000 2,800,000 2,800,000

2,800,000
What journal entry do we record?

Dr. Land 280,000

Dr. Building 2,520,000
Cr. Cash 2,800,000
2. Capitalize vs. Expense
Should we report the cost as an asset on SoFP (Capitalization) or
an expense on I/S?

• When a company purchases a good or service, will that good or service be ‘used up’ in the
current period (Expense) or will it be used over a number of periods (Capitalize)?
• Capitalization: Adding the cost of a good or service to an asset account rather than
expensing the cost immediately
• Capitalized costs are expensed over the time period in which company receives
benefits from such costs (Depreciation)
2. Capitalize vs. Expense

• There are not always hard and fast rules about which costs to capitalize and which to expense
immediately. The guiding question is:
“Are there probable future economic benefits?”

• Examples of capitalized costs that we have already discussed:

• Inventory -> COGS

• Fixed Assets -> Depreciation
• Prepaid Rent -> Rent Expense

• The decision has an affect on the bottom line both today and in the future: Capitalization results

in higher earnings in the current period but lower earnings in future periods
2. Capitalize vs. Expense
Journal entries

Capitalization
Current Period:
Dr. (Fixed) Asset 100
Cr. Cash 100
Future Periods:
Dr. (Depreciation) Expense 100
Cr. (Contra-) Asset 100

Immediate Expensing
Current Period:
Dr. Expense 100
Cr. Cash 100

Future Periods: No entry

2. Capitalize vs. Expense

When a company spends money on an asset, it must determine whether the cost was an
improvement to the asset or simply a repair expense
o Capital Expenditures increase the asset’s capacity or effi ciency or extend its useful life
• Debit the asset account
• Book value of asset is increased by the amount of the expenditure and depreciation
schedule is revised to account for increased BV and increase useful life
• Often called capital improvements or CAPEX

o Repairs and maintenance merely maintain the asset or restore it to working order
• Debit the expense account as they occur
2. Delivery Truck Expenditures:
Capital Expenditure or Ordinary Repair?

Debit an Asset account for Debit repair and maintenance

Capital expenditures Expense

•Repair of transmission or other

•Major engine overhaul mechanism

•Modification of body for new use of •Oil change, lubrication, etc.

truck
•Replacement tires, windshield
•Addition to storage capacity of truck
•Paint job
3. Depreciation
At what rate should the asset’s cost be allocated to future periods

o We allocate the cost of the fixed asset (less its residual value) to expense over its
expected useful life

Dr. Depreciation Expense XXX

Cr. Accumulated Depreciation XXX

• Accumulated Depreciation is the cumulative sum of all depreciation to date for an asset

• Book Value on the statement of financial position equals the cost of the asset less
accumulated depreciation; over time the book value of an asset decreases as it is depreciated
3. Depreciation Methods

• 3 main approaches:
1. Straight-line (Most often used for financial statements)
2. Declining-balance
3. Units-of-activity

• A firm can use different methods for different asset groups.

• Management selects the method that best measures an asset’s contribution to revenue over its useful
life.
• It should apply it consistently over the useful life.
3. Depreciation
Formulas for annual depreciation expense

(C − RV)
Straight-line =
N
Double-declining-balance =
2
× BV
N
(C − RV)
Units-of-Activity = [ ]× Units Used
U

C = Cost
RV = Residual value
C-RV = Depreciable cost
N = Useful life
BV = Book Value = C- Acc.Dep.
U = Total units
3. Depreciation
Example

• Assume that Home Depot purchases a truck on January 1 20XX, and that Home Depot’s
fiscal year ends on December 31

Cost of truck. $41,000

Less: Estimated residual value (1,000)
Depreciable value 40,000
Estimated useful life :
Years 5 years
Units 100,000 units (miles)
3-1. Depreciation
Straight-line method

Depreciation (C − RV) (41000 − 1000)

= = = 8000
Expense per year N 5

12/31/xx Dr. Depreciation Expense 8000

Cr. Accumulated Depreciation 8000

An equal amount of depreciation is assigned to each year.

3-1. Depreciation
Straight-line method

Straight-Line Depreciation Schedule

for the Home Depot Truck

Date Depreciation Expense Accumulated Depreciation Acquisition Cost Book Value

1/1/20x0 41,000 41,000

12/31/20x0 8,000 8,000 41,000 33,000
12/31/20x1 8,000 16,000 41,000 25,000
12/31/20x2 8,000 24,000 41,000 17,000
12/31/20x3 8,000 32,000 41,000 9,000
12/31/20x4 8,000 40,000 41,000 1,000
3-1. Depreciation
Straight-line method

• Companies purchase plant assets as needed, so they develop policies to compute

depreciation for partial years

• Suppose a calendar-year business purchases a building on April 1 for $500,000 with an

estimated life of 20 years and an estimated residual value of $80,000. Assuming the
straight-line method, the first year’s depreciation is :

Full-year depreciation: (500,000 − 80,000)

= 21,000
20
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Partial year depreciation: 21,000 * = 15,750
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3-2. Depreciation
Double-declining balance method

• Accelerated depreciation method

• Depreciation is higher in the early years and lower in the later as compared to S-L
• Computes annual depreciation by multiplying the asset’s book value by a constant
percentage, which is 2 times the straight-line depreciation rate
• Ignores the residual value
• Switches to straight-line when the straight-line method applied to the book value gives
a greater depreciation expense
3-2. Depreciation
Double-declining balance method

2 2
DDB Rate = = ==40%per year
N 5

Depreciation (2 × BV ) (2 × 41,000)
= = = 16,400
Expense N 5

12/31/xx Dr. Depreciation Expense 16,400

Cr. Accumulated Depreciation 16,400

3-2. Depreciation
Double-declining balance method

Double Declining Balance Depreciation Schedule for the Home Depot Truck

Date DDB Depreciation Expense Accumulated Acquisition Cost Book Value

Rate Depreciation
1/1/20x0 41,000 41,000
12/31/20x0 0.4 16,400 16,400 41,000 24,600
12/31/20x1 0.4 9,840 26,240 41,000 14,760
12/31/20x2 0.4 5,904 32,144 41,000 8,856
12/31/20x3 3,928 36,072 41,000 4,928
12/31/20x4 3,928 40,000 41,000 1,000

Year 4 depreciation based on DDB = 0.4 * 8,856 = 3,542.

Based on S-L, (8,856-1,000)/2 = 3,928. So, Use S-L method for the next two
years.
3-3. Depreciation
Units-of-Activity method

Depreciation (C − RV) (41,000 − 1,000)

= = = 0.40 per mile
per unit of output U 100,000 miles

If the truck is expected to be driven 20,000 miles in the year 2016,

Depreciation (C − RV)
= [ ]× Units Used = 0.40 * 20,000 = 8,000
Expense U

12/31/xx Dr. Depreciation Expense 8,000

Cr. Accumulated Depreciation 8,000

Depreciation expense will vary with usage.

3-3. Depreciation
Units-of-Activity method

The truck is expected to be driven 20,000 miles in the 1st year and 30,000, 25,000, 15,000 and
10,000 during the 2nd, 3rd, 4th and 5th years respectively. The depreciation schedule for the
truck is:

Date Depreciation per unit Units used Depreciation Expense Accumulated Depreciation Acquisition Cost Book Value

1/1/20xx 41,000 41,000

12/31/20xx 0.4 20,000 8,000 8,000 41,000 33,000

12/31/20x1 0.4 30,000 12,000 20,000 41,000 21,000

12/31/20x2 0.4 25,000 10,000 30,000 41,000 11,000

12/31/20x3 0.4 15,000 6,000 36,000 41,000 5,000

12/31/20x4 0.4 10,000 4,000 40,000 41,000 1,000

Home Depot Accumulated Depreciation Using Different Methods
3. Depreciation
Different methods

o The straight-line method best meets the matching principle for a plant asset that
generates revenue evenly over time
o The units-of-activity method best fits those assets that wear out because of physical use
rather than obsolescence
o The accelerated method (such as the DDB) applies best to those assets that generate
greater revenue earlier in their useful lives

Managers are free to choose methods regardless of the physical characteristics of the
asset (as long as they are systematic and rational)
3. Depreciation
Accounting fraud at Waste Management

• WM is the leading provider of waste and environmental services in North America

• A Fixed-Asset intensive business – depreciation is one of the largest expenses
• Much of the scandal stemmed from the topics we’re currently studying in Ch 9.

o They inflated the useful lives of the garbage trucks and dumpsters. They estimated useful
lives of 12-14 years for garbage trucks and useful lives for dumpsters of 15-20 years, while
others in the industry estimated those to be 8-10 years and 12 years, respectively.
o They assigned a salvage value to dumpsters that all others in the industry assumed $0
residual value
o Didn’t depreciate their landfills as they filled them with waste

-> Resulted in a $1.7 billion restatement for 1991 - 1997

Part 2- Agenda
• Plant assets
• Disposal: What happens when we sell a fixed asset?
• Revaluation
• Ratios

• Intangible assets
• Amortization
• Impairment
• Goodwill
Disposal
What happens when we sell a fixed asset?

• A gain (credit account) or loss (debit account) typically occurs– unless the total proceeds
from the asset sale exactly equal the current book value of the asset sold

• Gain (or Loss) = Sale proceeds (e.g. cash received) less the BV of the asset sold

• Disposal requires the removal of its BV, which appears on both the asset account and its
accumulated depreciation account

3
Junking a fixed asset

• Suppose Wal-Mart store fixtures that cost $4,000 are thrown away because they can
no longer be used. Accumulated depreciation is $3,000 and Book Value is therefore
$1,000. Disposal of these store fixtures records a loss as follows:

4
Junking a fixed asset

• Suppose Wal-Mart store fixtures that cost $4,000 are thrown away because they can
no longer be used. Accumulated depreciation is $3,000 and Book Value is therefore
$1,000. Disposal of these store fixtures records a loss as follows:

5
Selling a fixed asset

• Suppose a business sells equipment for $5,000 cash that had a purchase price
of 10,000 and accumulated depreciation of 3,750. The gain or loss is
determined as follows:

6
Selling a fixed asset

• Suppose a business sells equipment for $5,000 cash that had a purchase price
of 10,000 and accumulated depreciation of 3,750. The gain or loss is
determined as follows:

7
Selling a fixed asset

The entry to record sale of the equipment for $5,000 cash is:

If the sale price had been $7,000:

8
Revaluation of plant assets

• IFRS allows companies to revalue plant assets to fair value at the reporting date.
• If revaluation is used,
• it must be applied to all assets in a class of assets.
• assets experiencing rapid price changes must be revalued on an annual basis.

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Revaluation of plant assets

• Pernice Company applies revaluation to equipment with a book (carrying) value of

HK$1,000,000, a useful life of 5 years, and no residual value. Pernice makes the
following journal entries in year 1, assuming straight-line depreciation

Dr. Depreciation expense 200,000

Cr. Accumulated Depreciation 200,000

At the end of year 1, independent appraisers determine that the asset has a fair value
of HK$850,000. The entry to record the revaluation is as follows.

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Revaluation of plant assets

• Pernice Company applies revaluation to equipment with a book (carrying) value of

HK$1,000,000, a useful life of 5 years, and no residual value. Pernice makes the
following journal entries in year 1, assuming straight-line depreciation

Dr. Depreciation expense 200,000

Cr. Accumulated Depreciation 200,000

At the end of year 1, independent appraisers determine that the asset has a fair value
of HK$850,000. The entry to record the revaluation is as follows.

Dr. Accumulated depreciation 200,000

Cr. Equipment 150,000
Cr. Revaluation surplus 50,000

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Revaluation of plant assets

• Instead, at the end of year 1, independent appraisers determine that the asset has a
recoverable amount (the higher of fair value less costs to sell or value-in-use) of
HK$750,000.

• When its recoverable amount is below the book value, we need to impair the asset

• Asset impairment leads to a write-down of assets to its recoverable amount

Dr. Loss on Impairment

XXX
(shows up on I/S)
Cr. Accumulated Depreciation
XXX
(reduces BV of the asset on B/S)

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Decision Making – Age of Fixed Assets

Accumulated Depreciation
Percent Depreciated =
Original Asset Cost

Accumulated Depreciation
Age of Asset =
Depreciation Expense

• Helps to project the future CAPEX (i.e., if high percent used up, company will need to replace assets
soon)

• Expect older assets to be less efficient and have higher maintenance costs

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Intangible Assets

• Long-lived assets that are not physical

• Patents & Copyrights
• Trademarks
• Franchises & Licenses
• Goodwill

• Generally recorded on the Statement of Financial Position only if purchased

from an external party (not developed internally)

• Research and development costs, employee training are NOT assets as

defined by IASB. They must be expensed immediately.

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Amortization of intangible assets

• Acquisition costs of intangibles are capitalized and then gradually expensed (“amortized”)
over the useful life of the asset (similar to depreciation for fixed assets)
• Assets with an indefinite useful life (trademarks and goodwill) are not amortized

• Often expensed directly against the asset account rather than held in an accumulated
amortization account

• Usually computed on a straight-line basis

• Patents – maximum 20 years

• Copyrights – maximum of life of creator or 70 years

• Franchises and licenses – useful life varies

15
Impairment of intangible assets

• Companies are required to evaluate both definite and indefinite life intangibles
at least annually to determine if they will provide future benefit to firm

– If the intangible has lost value, then the firm must record an impairment loss
– The firm would not record a gain if the intangible gained (or regained) value

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Intangible assets: goodwill

• Recorded only when the company purchases an entire business;

cannot buy a separate asset

• Goodwill
• Goodwill = Purchase price of company – Market value of identifiable Net assets
• Is not amortized– it’s tested for reasonableness each year and written down when it is
thought to be over-valued

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• Suppose Whole Foods acquires Bread & Circus for $10M cash. The sum of the market
values of B & C’s assets (cash, inventory, trademarks, etc.) is $12M and of its liabilities is
$4M.

• Goodwill is calculated as follows:

Purchase price paid for Bread & Circus $10 million

Sum of the market values of B & C assets 12 million

Less: B & C’s liabilities (4 million)

Market value of B & C NET assets

Excess is called Goodwill (long-lived intangible Asset)

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• Suppose Whole Foods acquires Bread & Circus for $10M cash. The sum of the market
values of B & C’s assets (cash, inventory, trademarks, etc.) is $12M and of its liabilities is
$4M.

• Goodwill is calculated as follows:

Purchase price paid for Bread & Circus $10 million

Sum of the market values of B & C assets 12 million

Less: B & C’s liabilities (4 million)

Market value of B & C NET assets 8 million

Excess is called Goodwill (long-lived intangible Asset) 2 million

Dr. Various Asset Accounts (cash, inventory, etc.) 12

Cr. Various Liability Accounts 4
Cr. Cash 10
Dr. Goodwill 2
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