Chapter 7: Overview – Plant Assets, Natural Resources, & Intangibles

The chapter begins with a spotlight on FedEx Corporation and the property and equipment the company uses to fulfill its delivery service. Three types of long-lived assets are introduced: plant assets, natural resources, and intangible assets. A discussion of the measurement and accounting for the cost of plant assets is shown. The major categories of plant assets include land, buildings, machinery, equipment, land improvements, and leasehold improvements. The treatment of lump-sum (or basket) purchases of assets is shown. The difference between a capital expenditure and an immediate expense is explained.

The concept of book value is reviewed, and a further explanation of depreciation is shown. The three items needed to depreciate an asset are detailed as: cost, estimated useful life, and estimated residual value. The straight-line, units-of-production, and double-declining balance methods are explained.

The second part of the chapter details the issues related to depreciation and taxes, depreciation for partial years, and changes in the useful like of a depreciable asset. Additionally, the presentation of fully depreciated assets on the financial statements is shown.

The effects of a plant asset disposal are explained. This can include disposing of a fully depreciated asset for no proceeds, selling a plant asset, and exchanging a plant asset.

Natural resources are introduced, and the process of depletion is explained. Natural resources may include iron ore, petroleum (oil), and timber.

Intangible assets are also defined, and the process of amortization is shown. Examples of intangible assets are patents, copyrights, trademarks and trade names, franchises and licenses, and goodwill. Research and development costs are also discussed.

The concept of asset impairment is explained, and return on assets is introduced. The chapter concludes with an analysis of the cash flow impact of long-lived asset transactions.

Chapter Opener Application

This chapter’s spotlight is on the FedEx Corporation. Discuss the types of assets that FedEx might use in their business. Ask the students to think about the different intangible assets that they might own. Challenge the students to think about how the cost of those assets might be allocated on FedEx’s books by using the process of depreciation and amortization.

Teaching Outline

I. Measure and Account for the Cost of Plant AssetsA. Types of Long-Lived Assets

1. Plant Assets2. Natural Resources3. Intangible Assets

B. Types of Plant Assets

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1. Land2. Buildings, Machinery, and Equipment3. Land Improvements and Leasehold Improvements

C. Lump-Sum (Basket) Purchases of AssetsII. Distinguish a Capital Expenditure from an Immediate ExpenseIII. Measure and Record Depreciation on Plant Assets

A. Book Value DefinedB. Depreciation DefinedC. Measuring Depreciation

1. Cost2. Estimated Useful Life3. Estimated Residual Value

D. Depreciation Methods1. Straight-Line Method2. Units-of-Production Method3. Double-Declining-Balance Method

E. Comparing Depreciation MethodsF. Other Issues in Accounting for Plant AssetsG. Depreciation for Tax PurposesH. Depreciation for Partial Years

IV. Analyze the Effect of a Plant Asset DisposalA. Disposing of a Fully Depreciated Asset for No ProceedsB. Selling a Plant AssetC. Exchanging a Plant Asset

V. Apply GAAP for Natural Resources and Intangible AssetsA. Accounting for Natural ResourcesB. Accounting for Intangible AssetsC. Accounting for Specific Intangibles

1. Patents2. Copyrights3. Trademarks and Trade Names4. Franchises and Licenses5. Goodwill

VI. Explain the Effect of an Asset Impairment on the Financial StatementsVII. Analyze Rate of Return on AssetsVIII. Analyze the Cash Flow Impact of Long-Lived Asset Transactions

A. AcquisitionsB. SalesC. Depreciation

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Chapter 7 Activity

Have the students list on the board the assets that they own personally (cars, computers, homes, etc.), along with the approximate costs of each. Then assign estimated lives to each of the assets and an estimated residual value. Then ask the students to calculate depreciation for each of these items using the three methods of depreciation. Once the students have this information, they can determine accumulated depreciation per year and book value.

Key Topics

Plant assets are long-lived assets that are tangible. The cost of this asset includes the purchase price, plus any taxes, commissions, and other amounts paid to make the asset ready for use. Land is not expensed over time, because its usefulness does not decrease. Land improvements, such as fencing, paving, security systems, and lighting, are subject to depreciation. Buildings, machinery, equipment, and leasehold improvements are all types of assets that are depreciated.

Lump-sum (or basket) purchases of assets occur when several assets are purchased as a group. Since each asset must be given a value, the total cost of the purchase is divided among the assets based on their relative sales (or market) values.

When a company spends money on a plant asset, it must determine if the cost is an asset or an expense. Expenditures that increase the asset’s capacity or extend its useful life are called capital expenditures. Costs that simply maintain the asset or restore it to working order are considered expenses.

Depreciation is the allocation of a plant asset’s cost over its useful life. In order to depreciate an asset, one must know the cost, estimated useful life (length of service expected from using the asset), and estimated residual value (expected cash value of an asset at the end of its useful life).

The three main methods of depreciation are straight-line, units-of-production, and double-declining-balance. The straight-line method assigns an equal amount of depreciation to each year that the asset is used. The depreciable cost (cost minus residual value) is divided by the useful life in years to determine the annual depreciation expense. The units-of-production method calculates a fixed amount that is assigned to each unit of output (or service) produced by the asset. This per-unit amount is then multiplied by the actual number of units produced each period to calculate depreciation. Finally, the double-declining-balance method writes off a larger amount of the asset’s cost at the beginning of its useful life than the straight-line method does. It computes annual depreciation by multiplying the asset’s declining book value by a constant percentage (two times the straight-line depreciation rate).

Plant assets are complex for several reasons. Companies may keep a separate set of depreciation records for tax purposes, so they may take advantage of accelerated depreciation methods. Additionally, companies may have to depreciate assets based on partial years, as they may purchase assets throughout the year. Companies may also make a change in an accounting estimate, whereby they change the useful life of an asset. Fully depreciated assets that are still owned must still be carried on the balance sheet, even if it has reached the end of its useful life.

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A plant asset may be disposed of or sold if it becomes obsolete, wears out, or is no longer useful. If this occurs, depreciation is recorded from the beginning of the period to the date of disposal. The remaining book value should be calculated. If the asset is not fully depreciated, a loss should be recorded equal to the remaining book value. An example of the associated journal entry:

Accumulated Depreciation XX (Accumulated Depreciation through date of disposal)

Loss on Disposal of Asset XX (Book Value of Asset)

Plant Asset XX (Original Cost of Asset)

If a disposed asset is fully depreciated, the journal entry is:

Accumulated Depreciation XX (Accumulated Depreciation)

Plant Asset XX (Original Cost of Asset)

If a company sells an asset for an amount greater than the remaining book value, a gain on the sale should be recorded as follows:

Accumulated Depreciation XX (Accumulated Depreciation through date of sale)

Gain on Sale of Asset XX (Cash Received - Book Value of Asset)

Plant Asset XX (Original Cost of Asset)

If a company sells an asset for an amount less than the remaining book value, a loss on the sale should be recorded as follows:

Accumulated Depreciation XX (Accumulated Depreciation through date of sale)

Loss on Sale of Asset XX (Book Value of Asset – Cash Received)

Plant Asset XX (Original Cost of Asset)

A business may also exchange or trade in an old asset for similar assets. If this occurs, the cost of an asset received is equal to the fair value of the assets given up (including the old asset and any cash paid). Any difference between the fair value of the old asset from its book value is recognized as a gain (fair value of old asset exceeds book value) or loss (book value of old asset exceeds fair value) on the exchange. An example of this type of entry is:

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Plant Asset XX (Fair Value of New Asset)

Accumulated Depreciation XX (Accumulated Depreciation through date of exchange)

Plant Asset XX (Original Cost of Old Asset)

Cash XX (Cash Paid)

Gain on Exchange of Plant Asset XX (Difference)

Natural resources are long-term assets, such as iron ore, petroleum (oil), and timber. The process of tracking the flow of a natural resource from its raw state to cost of goods sold or expense on the income statement is depletion. Depletion expense represents the portion of the cost of a natural resource that has been extracted during the period. The formula is similar to the units-of-production method of depreciation, and is shown as follows:

Depletion Expense = Cost – Residual Value X Units Extracted

Estimated Units of Resource

The entry to record depletion is:

Depletion Expense XXAccumulated Depletion XX

Intangible assets are long-lived assets that have no physical form. Examples of these include patents, copyrights, trademarks, franchises, and goodwill. Amortization of intangible assets is calculated using the straight-line method over the asset’s estimated useful life. This useful life cannot exceed its legal life. The entry to record amortization is as follows:

Amortization Expense XX

Intangible Asset XX

Generally accepted accounting principles require that companies test both tangible and intangible long-term assets for impairment each year. Impairment occurs when the expected future cash flows from a long-term asset fall below the asset’s net book value. If the asset is impaired, the company is required to adjust the carrying value downward to its fair value.

Company performance can be evaluated using the return on assets ratio. The formula is: return on assets = net income/average total assets.

When a plant asset is acquired, sold, or depreciated/amortized, it appears on the Statement of Cash Flows. Acquisitions and sales of long-term assets are investing activities. Depreciation and amortization are considered operating activities.

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Chapter 7 – Student Summary Handout

I. Measure and Account for the Cost of Plant AssetsA. Types of Long-Lived Assets

1. Plant Assets2. Natural Resources3. Intangible Assets

B. Types of Plant Assets1. Land – does not depreciate2. Buildings, Machinery, and Equipment3. Land Improvements and Leasehold Improvements

C. Lump-Sum (Basket) Purchases of AssetsII. Distinguish a Capital Expenditure from an Immediate ExpenseIII. Measure and Record Depreciation on Plant Assets

A. Book Value DefinedB. Depreciation DefinedC. Measuring Depreciation

1. Cost2. Estimated Useful Life3. Estimated Residual Value

D. Depreciation Methods1. Straight-Line Method

Cost – Residual ValueUseful Life in Years

2. Units-of-Production Method

Cost – Residual Value X Units Produced

Useful Life in Units3. Double-Declining-Balance Method

Step 1: Straight-Line Rate = 1 Useful Life in Years

Step 2: DDB Rate = 2 x Straight-Line RateStep 3: Depreciation = Book Value x DDB Rate

E. Comparing Depreciation MethodsF. Other Issues in Accounting for Plant AssetsG. Depreciation for Tax PurposesH. Depreciation for Partial Years

IV. Analyze the Effect of a Plant Asset DisposalA. Disposing of a Fully Depreciated Asset for No ProceedsB. Selling a Plant AssetC. Exchanging a Plant Asset

V. Apply GAAP for Natural Resources and Intangible Assets

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A. Accounting for Natural Resources - depletionB. Accounting for Intangible Assets - amortizationC. Accounting for Specific Intangibles

1. Patents2. Copyrights3. Trademarks and Trade Names4. Franchises and Licenses5. Goodwill

VI. Explain the Effect of an Asset Impairment on the Financial StatementsVII. Analyze Rate of Return on AssetsVIII. Analyze the Cash Flow Impact of Long-Lived Asset Transactions

A. AcquisitionsB. SalesC. Depreciation

Chapter 7: Assignment Grid

(Will have an X if available)

Assignment Topic(s) L.O. Estimated Time

(minutes)

Level of Difficulty

Excel Templates

General Ledger

Templates

S7-1 Measure the cost and book value of a company’s plant assets

1 5 Easy

S7-2 Measure and record the cost of individual assets in a lump-sum purchase of assets

1 5 Easy

S7-3 Distinguish a capital expenditure from an immediate expense

2 10-15 Medium

S7-4 Compute depreciation and book value by three methods – first year only

3 10 Easy

S7-5 Select the best depreciation method for income tax purposes

3 10 Easy

S7-6 Compute partial year depreciation and select the best depreciation method

2 5-10 Medium

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Assignment Topic(s) L.O. Estimated Time

(minutes)

Level of Difficulty

Excel Templates

General Ledger

Templates

S7-8 Compute depreciation; record a gain or loss on disposal

3,4 10 Medium

S7-9 Account for the depletion of a company’s natural resources

5 5-10 Easy

S7-10 Measure and record goodwill

5 5-10 Medium

S7-11 Calculate return on assets 7 5-10 EasyS7-12 Calculate return on assets 7 10-15 MediumS7-13 Analyze the cash flow

impact of investing activities on the statement of cash flows

7 10-15 Medium

S7-14 Explain the effect of asset impairment on financial statements

6 10-15 Medium

E7-15A Measure the cost of plant assets

1 10-15 Medium

E7-16A Allocate costs to assets acquired in a lump-sum purchase; dispose of a plant asset

1,4 10-15 Medium X

E7-17A Distinguish capital expenditures from expenses

2 10-15 Easy

E7-18A Measure, depreciate, and report plant assets

1,3 15 Medium X

E7-19A Determine depreciation amounts by three methods

3 15-20 Medium X

E7-20A Report plant assets, depreciation, and investing cash flows

1,3,8 15 Easy

E7-21A Change a plant asset’s useful life

3 10-15 Medium

E7-22A Measure DDB depreciation; analyze the effect of a sale of a plant asset

3,4 10-15 Medium X

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Assignment Topic(s) L.O. Estimated Time

(minutes)

Level of Difficulty

Excel Templates

General Ledger

Templates

E7-23A Measure a plant asset’s cost; calculate UOP depreciation; analyze the effect of a used asset trade-in

1,3,4 10-15 Medium

E7-24A Record natural resource assets and depletion

5 10-15 Medium

E7-25A Record intangibles, amortization, and impairment

5,6 10-15 Medium

E7-26A Compute and account for goodwill; explain the effect of asset impairment

5,6 10-15 Medium

E7-27A Calculate return on assets 7 10-15 MediumE7-28A Report cash flows for

plant assets8 20-30 Medium

E7-29B Measure the cost of plant assets

1 10-15 Medium

E7-30B Allocate costs to assets acquired in a lump-sum purchase; dispose of a plant asset

1,4 15-25 Difficult

E7-31B Distinguish capital expenditures from expenses

2 20-30 Difficult

E7-32B Measure, depreciate, and report plant assets

1,3 15-25 Difficult X

E7-33B Determine depreciation amounts by three methods

3 15-20 Difficult

E7-34B Report plant assets, depreciation, and investing cash flows

1,3,8 20-30 Difficult

E7-35B Change a plant asset’s useful life

3 15-20 Medium

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Assignment Topic(s) L.O. Estimated Time

(minutes)

Level of Difficulty

Excel Template

s

General Ledger

Templates

E7-36B Measure DDB depreciation; analyze the effect of a sale on a plant asset

3,4 15-20 Difficult

E7-37B Measure a plant asset’s cost; calculate UOP depreciation; analyze the effect of a used asset trade-in

1,3,4 20-30 Difficult

E7-38B Record natural resource assets and depletion

5 15-20 Medium

E7-39B Record intangibles, amortization, and impairment

5,6 15-20 Medium

E7-40B Compute and account for goodwill and impairment

5,6 10-20 Medium

E7-41B Calculate return on assets 7 10-15 MediumE7-42B Report cash flows for

plant assets8 10-20 Medium

Q7-43 to Q7-57

Practice Quiz All 30-40 Medium

P7-58A Measure and account for plant assets; distinguish a capital expenditure from an expense; measure and record depreciation

1,2,3 20-30 Medium X

P7-59A Measure and account for the cost of plant assets; record depreciation under DDB

1,3 15 Medium

P7-60A Measure and account for the cost of plant assets and depreciation; analyze and record a plant asset disposal

1,3,4 25-35 Medium X X

P7-61A Measure and account for the cost of a plant asset; measure depreciation by three methods; identify the cash flow advantage of accelerated depreciation for tax purposes

1,3,8 30-40 Medium

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Assignment Topic(s) L.O. Estimated Time

(minutes)

Level of Difficulty

Excel Templates

General Ledger

Templates

P7-63A Account for natural resources

5 30-40 Medium

P7-64A Analyze the effect of a plant asset addition and disposal; report plant asset transactions on the financial statements

1,4,8 30-40 Medium

P7-65A Calculate return on assets 7 20-30 MediumP7-66B Measure and account for

plant assets; distinguish a capital expenditure from an expense, measure and record

1,2,3 20-30 Medium

P7-67B Measure and account for the cost of plant assets; measure and record depreciation under DDB

1,3 15 Medium

P7-68B Measure and account for the cost of plant assets and depreciation; analyze and record a plant asset disposal

1,3,4 25-35 Medium

P7-69B Measure and account for the cost of a plant asset; measure depreciation by three methods; identify the cash flow advantage of accelerated depreciation for tax purposes

1,3,8 30-40 Medium

P7-70B Analyze plant asset transactions from a company’s financial statements

1,3,4,6,8

30-40 Medium

P7-71B Account for natural resources

5 30-40 Medium

P7-72B Analyze the effect of a plant asset addition and disposal; report plant asset transactions on the financial statements

1,4,8 30-40 Medium

P7-73B Calculate return on assets 7 20-30 MediumE7-74 Account for goodwill and

impairment5,6 30-45 Difficult

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Assignment Topic(s) L.O. Estimated Time

(minutes)

Level of Difficulty

Excel Templates

General Ledger

Templates

E7-76 Distinguish a capital expenditure from an expense and measure financial statement effect of an expensing error

2 20-30 Difficult

E7-77 Determine plant and equipment transactions for an actual company

4 30-45 Difficult

Decision Case 1

Measure profitability based on different inventory and depreciation methods

3 30-45 Difficult

Decision Case 2

Distinguish between capital expenditures and expense; account for plant assets and intangible assets

2,5 30-40 Medium

Ethical Issue United Jersey Bank All 30-40 DifficultFocus on Financials: Amazon.com

Analyze plant assets 2,3,6 30-40 Difficult

Focus on Analysis: RadioShack Corporation

Distinguish capital expenditure from an immediate expense; explain plant asset activity; analyze rate of return on assets

2,4,7 35-45 Difficult

Group Project

Visit a local business All 90+ Difficult

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Answer Key to Chapter 7 Quiz (Quiz on following pages.)

1. d 6. d2. a 7. c3. c 8. b4. a 9. c5. b 10. d

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Name____________________________________ Date_________________ Section_______________

CHAPTER 710-MINUTE QUIZ

Circle the letter of the best response.

Case 7-1: Use the information below to answer Questions 1 – 7.A business purchased an asset that had a total cost of $125,000 and a residual value of $5,000. The asset is expected to service the business for a period of 5 years or produce a total of 500,000 units. The machine was purchased January 1st of the current year and has been in service one complete year.

1. Refer to Case 7-1. What is the depreciable cost of the asset?a. $125,000b. $100,000c. $130,000d. $120,000

2. Refer to Case 7-1. What is the amount of depreciation in Year two of the asset’s life using the straight-line method?a. $24,000b. $25,000c. $20,000d. $28,000

3. Refer to Case 7-1. If the asset produces 150,000 units in Year 1 and 125,000 units in Year two, what is the amount of depreciation for Year two if the units-of-production method is used?a. $24,000b. $36,000c. $30,000d. $20,000

4. Refer to Case 7-1 and Question 3. What is the book value of the asset at the end of Year two using the units-of-production method?a. $59,000b. $66,000c. $95,000c. $90,000

5. Refer to Case 7-1. In preparing to calculate depreciation using the double-declining-balance method, what is the straight-line rate?a. 25%b. 20%c. 50%d. 40%

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6. Refer to Case 7-1. What is the depreciation expense in Year one if the double-declining-balance method is used?a. $40,000b. $52,000c. $45,000d. $50,000

7. The entry to record the annual depreciation includes:a. a debit to Accumulated Depreciation. b. a credit to Depreciation Expense.c. a credit to Accumulated Depreciation. d. none of the above

8. In calculating the total cost of a plant asset, all costs are included except:a. purchase price.b. routine repairs after purchase. c. commission.d. taxes.

9. If an asset is sold and a loss is incurred, the entry to record the sale would include a credit to:a. Accumulated Depreciation. b. Loss on Sale of Asset.c. Plant Asset.d. Cash.

10. Which of the following statements is TRUE?a. Allocating the cost of a plant asset over its useful life is called depreciation.b. Allocating the cost of a natural resource to an expense is called depletion. c. Intangible assets are amortized.d. All of the above are true.

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