CHAPTER 10
Plant Assets and Intangible Assets
Chapter Outline
Objective 3: Select the best depreciation method for income tax purposes
A. Depreciation methods for financial statement presentation and income tax reporting may vary.
1. The straight-line method is most often used for financial statement purposes.
2. An accelerated method is most often used for tax purposes.
c. The Modified Accelerated Cost Recovery System (MACRS) is a special depreciation method created by the 1986 Tax Reform Act solely for income tax purposes. It requires strict adherence to many guidelines.
d. Exhibit 10-12 presents the various assets, classes, and lives for the depreciation methods prescribed by MACRS.
B. Partial-year depreciation calculations are required for assets that are purchased and/or disposed of on a date other than the start of the fiscal year. (Refer to Exhibit 10-13 for an illustration of DDB depreciation for partial years.)
1. In the first and last years of the asset’s life, it may be necessary to calculate partial-year depreciation expense.
2. Compute the entire year’s depreciation expense first, then calculate the partial-year amount based on the number of months the item was actually held that year.
C. Changing the estimated useful life or estimated residual value requires a revised depreciation schedule.
1. The formula for revised depreciation (SL) is:
Cost - Accumulated depreciation - New residual value = New annual depreciation expense
New estimated useful life remaining
2. This type of change, a change in accounting estimate, is often footnoted.
D. The business may continue to use a fully depreciated asset, but may not record additional depreciation expense.
Objective 4: Account for the disposal of a plant asset
A. A business disposes of plant assets when they wear out, become obsolete, or are no longer useful to the business.
B. Always record first a partial-year depreciation expense and then calculate the asset’s remaining book value.
C. If an asset is junked before it is fully depreciated, record a loss equal to the remaining book value.
D. The rules for the sale of a plant asset are:
1. Record gain on the sale if the cash received is greater than the remaining book value.
2. Record loss on the sale if the remaining book value is greater than the cash received.
3. The journal entry is:
Cash XX
Accumulated Depreciation XX
Loss on Sale of Asset XX
Asset XX
Or, Cash XX
Accumulated Depreciation XX
Gain on Sale of Asset XX
Asset XX
E. The rules for the exchange (trade-in) of a plant asset are:
1. Remove balances of old asset and accumulated depreciation.
2. The entry to record the trade-in is:
Equipment (new) XX
Accumulated Depreciation (old) XX
Equipment (old) XX
Cash XX
Objective 5: Account for natural resource assets and depletion
A. The process of allocating the cost of a natural resource to expense over its useful life is called depletion. Natural resources include timber, iron ore, and petroleum.
1. Depletion expense represents the portion of the cost of natural resources (iron ore, gas, oil, coal, timber) that is used up in a period.
2. Depletion is calculated the same way as units-of-production depreciation:
Cost - Residual value = Depletion expense/unit
Estimated units of resource
and, Depl/unit x Number of units extracted = Annual depletion expense
(current year) (current year)
B. Natural resources are reported at book value on the balance sheet. Accumulated Depletion is a contra-asset account similar to Accumulated Depreciation.
Objective 6: Account for intangible assets and amortization
A. The process of allocating the cost of an intangible asset to expense over its useful life is called amortization.
1. The calculation of amortization is based on the straight-line method and uses the estimated useful life of the intangible asset or its legal life, whichever is shorter.
2. Intangible assets represent rights to current and anticipated benefits. They have no physical characteristics.
a. The useful life of intangible assets varies, but GAAP limits it to a 40-year maximum.
b. Included in the intangible asset category are patents, copyrights, trademarks, franchises, and goodwill.
3. Patents grant the holder the exclusive right to produce and sell an invention for 20 years.
4. Copyrights grant exclusive rights to reproduce and sell a written or created work; copyrights extend for 50 years beyond the author’s life.
5. Trademarks, brand names represent distinctive identifications of products or services.
6. Franchises, licenses are privileges granted to sell a product or service under specified conditions.
7. Goodwill is the excess of the cost of an acquired company over the sum of the market values of its net assets; thus, is can only be recorded when a company is acquired. Internationally, some countries account for goodwill in a manner other than by amortization.
8. Even though research and development costs represent intangible assets, these costs are expensed when incurred rather than capitalized and amortized.
B. Ethical issues in accounting for plant assets mostly deal with whether to capitalize or expense particular costs.
C. Decision guidelines review questions related to accounting for plant assets and related expenses, including issues such as capitalizing or expensing.