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PLANT ASSETS, NATURIAL RESOURCES

AND INTANGIBLES

Student: Copy

Reference: Wild, et al, Chapter 10

COVERAGE:
Nature of Fixed Assets and Depreciation (Costs and classification)
Accounting for Depreciation
Methods: Straight-Line Method, Units-of-Production Method,
declining-Balance Method (double or 150%)
Revising Depreciation Estimates
Capital and Revenue Expenditures
Disposal of Fixed Assets
Natural Resources
Intangible Assets ~

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ACCOUNTING FOR FIXED ASSETS

(Also called Plant Assets or Property, Plant & Equipment)

I. Definition:
FIXED ASSETS OR PLANT ASSETS: long-lived assets used in the
operation of the business, have a useful life of more than one accounting period, and
not held for resale. Consist of tangible (Land, building, equipment) and intangible
(patent, copyrights, trademark, franchise, and goodwill) assets as well as natural
resources (site acquired for the purpose of extracting some valuable resources such as
oil, gas, minerals, or timber).

II. Accounting Events in the Lives of Fixed Assets

1. Acquisition cost = price + other expenditures to prepare asset for its intended use.
a) Land: (price + broker’s commission + survey fees + legal fees + taxes + escrow
+landscaping+ grading + draining + clearing + demolition of old bldg. + street &
water line assessment) minus proceeds from sale of salvaged materials. Land is
not depreciated in the financial books.
b) Land Improvements – Paving, parking, fencing, and other improvements in the
land that have limited life are recorded separately in this account, and subject to
depreciation.
c) Building if purchased, cost includes the purchase price, titling, legal & broker’s
fees, improvements, repairs, repainting, and other modifications and
improvements to make the building ready for its intended use. Subsequent
ordinary repairs and maintenance are expense.
d) Land and Building if purchased for a lump sum price, a competent appraisal must
be made to properly allocate the cost between the assets.
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Lump sum purchase: get appraisal for Market Value & apply ratio
i.e.. Paid Land & bldg. P 8.0M  land 8,000,000 80% = 6,400,000
Bldg.2,000,000 20% = 1,600,000
10,000,000 8,000,000
Land 6,400,000
Building 1,600,000
Cash 8,000,000 (or Mortgage/Note Payable)

e) Leasehold improvements – if the building or a space in a building is just being

rented the improvements on the building or space to make it ready for use are
recorded as leasehold improvements.

f) Equipment, Machinery, furniture, and fixtures = price + freight + insurance +

taxes + installation costs + testing fees to make it ready for use.
(if damaged when unpacking, charge to expense)

Entry: Debit: The fixed asset

Credit: Cash (or Notes Payable/Mortgage Payable)

g) Intangible Assets – consist of goodwill, trademark, patents, copyrights, and

franchise. They are recorded at the cost of acquisition and amortized over their
useful life. The values of these assets come about because of management or
personnel know how, known company name, of distinct product/service
advantage that produces earnings that are above the normal return.
Entry: Debit: The intangible asset
Credit: Cash (or Notes Payable/Mortgage Payable)

h) Natural Resources – recorded at acquisition cost-plus development cost and

allocated over its estimated useful life thru depletion process.

2. Subsequent Expenditures:
Expenditures on fixed assets after they have been acquired may be either
capitalized (recorded in the asset account as additional cost) or recorded as a debit to
an expense account.
a) Extraordinary repairs, which are material in amount and extending the asset’s
useful life, are capitalized by debiting the related accumulated depreciation
account (effectively increasing the book value). The new book value amount
less the salvage value will then be the basis for determining the depreciation
amount for the remaining extended life of the asset. Ordinary repairs and
maintenance are debited to expense (revenue expenditures).
b) Betterments, improvements, additions, or expansions are capitalized by
debiting the asset account. The new book value (less salvage value) is then
depreciated over the asset’s remaining useful life.

Change in cost ( betterment or improvements):

(cost of Betterment + orig. cost of asset) – Accum. Dep. – Residual value
remaining life

Revenue expenditures Capital expenditures:

--- recorded as expenses -- added to cost of plant assets
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--- does not increase (materially) life -- benefits extend beyond 1 period
--- supplies, fuel, lubricants -- roofing, expansion, overhauls, annex
--- Ordinary repairs: -- Extraordinary repairs:
i.e. cleaning, small parts extends life
-- Betterment
3. Fixed assets and Depreciation
As the fixed assets are used in the operation of the business to produce certain
product for sale, or to render service to customers, or to process certain operations,
and to house to transport the employees of the company, they become subject to wear
and tear (exposure to the elements, friction, use) and obsolescence (out of date due to
development of better technology), or they simply become inadequate. Their cost
must be allocated methodically to the periods in which they were used (matching
principle). The means of allocating to expense the cost of the fixed asset over its
estimated economic life is called depreciation (depletion for natural resources).

Depreciation expense: to allocate cost of asset to expense over its useful life due to
wear & tear or obsolescence; useful > 1 accounting period
a) cost
b) estimated residual value (RV) (*or salvage value or scrap value or t-in value)
c) estimated useful life
d) pattern of use: regular or varying revenues

Entry: Debit: Depreciation Expense,* (identify fixed asset)

Credit: Accumulated Depreciation,** (identify fixed asset)
* Depreciation expense is shown in the Income Statement.
** Accumulated depreciation is a contra account of the fixed asset. It is shown as
a deduction to the fixed asset in the balance sheet. As the term implies, it is an
accumulation of all depreciation expense of the fixed asset.

Terms to consider:
Book value = cost – accumulated depreciation
Depreciable cost = cost – salvage value (or residual value, etc.)

Methods of depreciation: time factor or use factor methods

1. Straight-line method = Formula: cost – residual value = depreciation
estimated life

i.e. cost of equipment = P100,000; salvage value is P5,000; estimated life = 5

years or estimated life is 20 % (1/5)
Depreciation expense: 100,000 – 5,000 = 19,500 per year
5 years
or 95,000 X .2 = 19,500

2. Declining balance method: accelerated method –> larger expense in beginning

** assumes rapid reduction in output in later years; the last year’s depreciation
expense should not result in Book Value lower than residual value or salvage
value.. The residual value is not included in the computation.
Formula: Book value x rate
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a) Double declining (two times the straight-line rate) or 1/life x 2 = % apply

to book value of the asset.
i.e. Life is 10 years: 1/10 x 2 = 20%
20% x beginning period Book value = dep. Expense (for the year)

b) 150% declining method = (1/life) x 1.5% apply to book value of asset.

i.e. Life is 10 years: 1/10 x 1.5 = 15%
15% x beginning period Book Value = dep. Expense (for the year)

Partial year depreciation: first 15 days, count the month; next 15 days, start
next month for straight-line and declining balance, compute for full year
depreciation, then get x/12 for pro-rata.

3. Units of production method

Formula: cost – Residual value = depreciation per units (or hours, etc)
life in units or hours*

*use factor – when usage varies; this is also called estimated capacity
i.e. Truck – kilometers; machinery – hours used, or units produced

i.e. cost of equipment = P100,000; salvage value is P5,000;

estimated life = 5 years
Estimated capacity in service hours = 20,000 hrs.; in number of units =
25,000
Depreciation expense:
a) P100,000 – 5,000/ 20,000 hours = P4.75 per hour
if the equipment was used for 1,000 hours during the year
Depreciation expense = 1,000 hours x 4.75 = P4,750
b) P100,000 – 5,000/25,000 units = P3.80 per unit
if the equipment was able to produce 1,000 units
depreciation expense = 1,000 units x P3.80 = P3,800

4. Change in useful life, residual value or costs (major renovation):

a) Change in Life:
New Dep. Exp = Remaining Book Value – Residual Value
remaining new life

i.e. Cost P500,000, life 10 yrs., no Residual Value;

After 4 years of depreciation (P200,000), new life is 5 years instead of 6 yrs.
New Depreciation expense: 500,000 – 200,000 = 300,000 book value
300,000 / 5 years = 60,000 per year.
b) Change in Residual Value:
New depreciation expense: Book Value – new residual value
remaining life

i.e. Cost P500,000, life 10 yrs., no Residual Value;

After 4 years of depreciation (200,000), residual value P60,000
New depreciation expense: 500,000 – 200,000 = 300,000 book value
= 300,000 – 60,000 = 240,000/6 = 40,000
6 years
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3. Disposal of Plant Assets:

Update depreciation expense & Accumulated Depreciation account

**Close asset and its accumulated depreciation account
**Record any cash (or asset) received or paid
**Record gain or loss

A. Retirement or discarding of plant asset when it is no longer useful to the

company
1) Fully depreciated, no market value
Debit: Accumulated Depreciation, (identify asset)
Credit: Fixed asset (identify asset)

2) If not fully depreciated:

Accum. Depreciation, (identify asset)
Loss on disposal of fixed asset
Fixed asset, identify asset (at cost)

B. Sale: if cash is more than book value recognize gain; if cash is less than
Book Value recognize loss.
i.e. cost of equipment is P5,000 ; BV is P1,000; sold for P1,500

Cash 1,500
Accum. Depreciation, Equipment 4,000
Equipment 5,000
Gain on sale of Equipment 500

i.e. sold for 800: Cash 800

Accum. Depreciation, Equipment 4,000
Loss on Sale of Equipment 200
Equipment 5,000

Trade-in of asset = exchange old asset for new asset

** Update depreciation expense and accumulated depreciation
** Close the balances of old asset and its accumulated depreciation
** Get price of new asset vs. cash out: price – Trade in allowance

1. if trade-in allowance = Book Value, no gain or loss is recognized

2. if trade-in allowance < BV, recognize loss
3. if trade-in allowance > BV, no gain is recognized if same kind of asset
instead cost of new asset is reduced.

eg.1. Old asset P10,000, acc. dep = 9,000, new asset P11,000, if T-in allowance is
P1,000
Equipment(new) 11,000
Accum. Depreciation, equipment 9,000
Equipment (old) 10,000
Cash 10,000
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i.e. 2. If T-in is P 500:

Equipment (new) 11,000
Accum. Depreciation, Equipment 9,000
Loss on Exchange of Equipment 500
Equipment (old) 10,000
Cash 10,500

i.e. 3. T-in is P 1,200:

Equipment (new) 10,800
Accum. Depreciation, Equipment 9,000
Equipment (old) 10,000
Cash 9,800

NATURAL RESOURCES are assets that are physically consumed when used. They
are recorded at cost plus other costs necessary to acquire the resource and prepare it
for intended use. i.e. iron ore, petroleum, natural gas, timber, mineral deposits.

Depletion is the process of allocating the cost of the natural resources to the period
when it is consumed. Use units-of- production method to record depletion. It is
reported in the balance at cost less accumulated depletion.

Formula: cost – residual value = depletion per kilos, lbs. etc.

estimated capacity in units

Entry: Debit: Depletion expense

Credit: Accum. Depletion

Property, plant, and equipment used in extracting are depreciated using the units-of-
production in proportion to the depletion of the natural resources.

INTANGIBLE ASSETS are nonphysical assets used in the operation, that confers
to their owner’s long-term rights, privileges, competitive advantages i.e. patents,
copyrights, franchises, goodwill, trademarks. They are recorded at cost. Intangibles
are divided between those with limited life or indefinite life.
a. Limited life – the cost is systematically amortized to expense over its
useful life; straight line method is used, i.e. patients, copyrights
b. Unlimited life – no legal, regulatory, contractual, economic, or other
factors limits its useful life; no amortization is recorded; i. e. goodwill,
trademarks, trade names. An intangible asset that is not amortized is
tested annually for impairment; an impairment loss is recorded.

Intangible Assets with limited life: The cost is amortized over the periods expected to
benefit by its use, but in no case can this period be longer than the asset’s legal
existence as follows.
1. Patents: exclusive right to produce or sell an invention, 20 years.
2. Copyright: exclusive right to reproduce or sell a book, musical composition,
film or other works of art, computer software; legal life is author’s life + 70
years.
3. Franchises & licenses: privilege to sell a product or service in accordance with
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specified conditions; amortized over the life of the agreement.

4. Trademark & trade name: unique symbol, name, phrase, jingle identified with
a company, product, or servIce; amortized over its expected life, if any.
5. Goodwill is the amount by which the company’s value exceeds the value of it
assets and liabilities. It is not amortized but subject to impairment; if the
carrying amount does not exceed its recoverable amount, goodwill is not
impaired. If the carrying amount of goodwill exceed its recoverable amount, an
impairment loss is recorded equal to that excess.

SHORT PROBLEMS (Meeting 1) CLASS WORK

1. In the first week of July 2018, South Company acquired a machine by paying
the following costs:
Invoice price 5,000,000
Shipping 50,000
Installation 150,000

The estimated life of the machine is 8 years or a total of 100,000 working hours
with no residual value. The operating hours of the machine totaled: 2019, 5,000
hours; 2020, 12,000 hours. The company follows the working-hours method of
depreciation.

As of December 31, 2020, how much is the carrying value of the machine?
Ans: _________________

Review: Cost
Less Accum. Depreciation
= Carrying value or book value

Cost – residual value (scrap value) = depreciable value

2. Denise Company. purchased a P200,000 tract of land for a factory site.

Denise razed an old building on the property and sold the materials it salvaged
from the demolition. Denise incurred additional costs and realized salvage
proceeds as follows:

Demolition of building …………………………… P 25,000

Legal fees for purchase contract and recording ownership …...5,000
Title guarantee insurance ……………………………………..6,000
Proceeds from sale of salvaged materials …………………….4,000

3. Abring Services acquired equipment on July 10, 2020. It has an estimated

useful life of 10 years and estimated scrap value of P5,000, which is 6.25% of
acquisition price. Using the straight-line method, how much depreciation
should be recorded for the year ended, December 31, 2020?

4. Beck Company purchased land, building and equipment from Josefina Group
of Companies for a lump sum cash payment of P306,000. The estimated fair
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values of the assets at the time of purchase were land P60,000; building
P220,000; and equipment P80,000.

At what amounts should each of the assets be recorded?

Land____________
Building____________
Equipment_____________

Solution:

5. Fear Factory purchased equipment which was installed and put into service on
January 1, 2021 at a total cost of P500,000. The equipment has an estimated 5-
year service life with no salvage value. It is the company’s policy for 5-year
service life assets to use the double declining balance method for the first two
years of the assets’ life and then switch to the straight-line depreciation basis.

In its December 31, 2023 balance sheet, what amount should Fear Factory report as
accumulated depreciation for the equipment? Ans: ________________

Given: January 1, 2021 at a total cost of P500,000.

Life 5 years, no salvage value, life 5years
Policy: first 2 years use double declining
3rd to 5th year use straight line
Required; On Dec. 31,2023 compute for

a. the accum. Depreciation

b. carrying value

Sol.guide 5 yrs = 20% x 2 = 40%.

Compute for depreciation 2 years
Formula for CV:
Cost - Accum. Depreciaton

Grouop
Work TO BE GIVEN LATER