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Fundamentals of Intermediate Accounting

Weygandt, Kieso and Warfield

Chapter 9:
Accounting
for
Property, Plant, and Equipment
Prepared by
Bonnie Harrison, College of Southern Maryland
LaPlata, Maryland

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Chapter 9
Accounting for Property, Plant
and Equipment
After studying this chapter, you should be able to:
1 Describe property, plant and equipment and costs
included in its initial valuation,
2 Describe the accounting problems associated with
self-constructed assets.
3 Understand accounting issues related to acquiring
and valuing plant assets.
4 Describe the accounting treatment for costs
subsequent to acquisition.

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Chapter 9
Accounting for Property Plant and
Equipment
After studying this chapter, you should be able to :
5 Explain the concept of depreciation.
6 Identify the factors involved in the depreciation
process.
7 Compare activity, straight line, and decreasing charge
methods of depreciation.
8 Describe the accounting treatment for the disposal of
property, plant and equipment.
9 Explain how property, plant and equipment are
reported and analyzed.
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Property, Plant, and Equipment (PP&E)

Includes land, building, structures and


equipment
They are not held for resale
They are long term and are subject to
depreciation (except land)
They are tangible

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Acquisition Cost
 Historical cost is the basis for determining cost.
 Historical cost includes:
 the asset’s cash or cash equivalent price, and
 the cost of readying the asset for use
 Costs incurred after acquisition are:
 added to asset’s cost, if they provide future
service potential,
- or -
 expensed, if they do not add to service potential
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Cost of Land, Building, and Equipment

 Land costs include:


 purchase price
 closing costs, attorney fees, and recording fees

 costs of getting land ready for use (clearing etc)

 special assessments for local improvements

 assumption of liens or encumbrances, and

 additional improvements with an indefinite life

 Sale of salvaged materials reduces cost


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Land Improvements, Building, and Plant
 Improvements with limited lives are recorded as
Land Improvements (and not as Land)
 Building cost includes:
 costs of materials and labor, and overhead

 professional fees and building permits

 Cost of equipment includes:


 purchase price

 freight and handling charges

 insurance on equipment while in transit

 costs of special foundation, and trial runs

 assembling, installation, and trial run costs


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Self-Constructed Assets
These are assets constructed by the business for
use in operations
The cost of self-constructed assets includes:
cost of direct materials,
cost of direct labor,
variable manufacturing overhead,
a pro rata portion of the fixed overhead,
- and -
actual interest costs incurred during
construction (with modification)
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Interest Capitalization: Rationale

• When under construction:


– asset does not produce revenue, so
capitalize interest cost
• When construction is complete:
– asset produces revenue, so expense
interest cost

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Valuation Issues
• A cash discount, whether taken or not, reduces
purchase price of asset. (This is the preferred
approach)

• Cost of assets, acquired in a basket purchase, are


allocated on the basis of their relative fair market
values

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Issuance of Stock for Assets
If stock is traded:

 basis for recording is the market value of the


stock issued.

If the market value of stock is not determinable:

 basis for recording is market value of asset.

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Contributions
Contributions received:
Recognized in period received as revenue
Recorded at fair value of assets received

Contributions given:
Recognized as expense in period donated
Recorded at fair value of asset donated
Difference between fair value and book value
recorded as gain or loss.

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Costs subsequent to Acquisition
• If costs incurred increase future benefits,
capitalize costs
• If costs maintain a given level of services, expense
costs
• Costs incurred after acquisition can be:
 additions
 improvements and replacements
 rearrangements and reinstallation
 repairs

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Improvements and Replacements
Capitalize costs, if

They increase future service potential

Improvements or Replacements

Substitution of Substitution of
a better asset a similar asset
for present for present
asset asset

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Capitalization Approaches

• Carrying value of • Substitution approach


asset is known

• Carrying value of the • Capitalize the new asset


(without removing the old
asset is unknown
asset from the pool), OR
• Debit accumulated
depreciation (when
expenditures extend useful
life of asset)
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Depreciation - Concept

* Depreciation is a means of cost allocation.


* It is not a method of valuation.
* Depreciation involves:
allocating the cost of tangible assets to an
expense in a systematic and rational manner to
periods expected to benefit from use of assets

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Factors in the Depreciation Process

Questions to be answered:

 What is the depreciable base of the asset?

 What is the asset’s useful life?

 What method of cost apportionment is best for


the asset in question?

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Depreciable Base
Depreciable base is the amount subject to
depreciation.

It is determined by taking:
 Originalcost of the asset less
 Estimated salvage or disposal value

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Estimated Service Lives
An asset’s service life and physical life are not the
same.
Assets are retired (from productive life) due to:
physical factors (such as casualty), or
economic factors (such as obsolescence)
Economic factors in turn include
Inadequacy (asset can not meet current demand)
Supercession (by a better asset)
Obsolescence (other factors)
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Depreciation Methods
Depreciation methods can be classified as follows:
Tax depreciation methods
Financial accounting depreciation methods
Financial accounting methods are:
activity method
straight-line method
accelerated method

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Depreciation Methods: Overview
Depreciation
Methods

Financial Accounting Tax


Depreciation Methods Depreciation

Activity Straight-line Accelerated


method method methods

1. Declining Balance
2. Sum-of-the-years’ digits
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Depreciation Methods: Example
Amber Corporation buys a truck on January 1, 2003.
Information relating to the truck is as follows:
 Cost, $34,000
 Estimated service life, 5 years (or 60,000 miles)
 Salvage value end of five years or use, $4,000
 Actual miles driven:
 20,000 miles (in 2003); 15,000 miles (in 2004)

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Straight-line method
1. Depreciable base = $34,000 less $4,000 = $30,000

2. Annual depreciation = $30,000 / 5 years = $6,000

3. Depreciation Schedule: (years 1 and 2)


Year Book Depreciation Accumulated Book value**
(beg) Depreciation end of year
1 $34,000 $6,000 $6,000 $28,000
2 $28,000 $6,000 $12,000 $22,000

** Book Value = Cost - Accumulated Depreciation


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Activity method (unit = mile)
1. Depreciable base = $34,000 less $4,000 = $30,000

2. Depreciation per mile = $30,000 / 60,000 = $0.50

3. Depreciation (2003) = $0.50 * 20,000 miles = $10,000


Depreciation (2004) = $0.50 * 15,000 miles = $ 7,500
4. Depreciation Schedule: (years 1 and 2)
Year Book Depreciation Accumulated Book value
(beg) Depreciation end of year
1 $34,000 $10,000 $10,000 $24,000
2 $24,000 $ 7,500 $17,500 $16,500

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Sum-of-the-years’-digits (SYD) method

1. Depreciable base = $34,000 less $4,000 = $30,000

2. SYD fraction = (1+2+3+4+5) = 15

3. Depreciation (2003) = $30,000 * (5/15) = $10,000


Depreciation (2004) = $30,000 * (4/15) = $ 8,000
Depreciation (2005) = $30,000 * (3/15) = $ 6,000
Depreciation (2006) = $30,000 * (2/15) = $ 4,000
Depreciation (2007) = $30,000 * (1/15) = $ 2,000

Decreasing Fractions
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Sum-of-the-years’-digits (SYD) method

4. Depreciation Schedule

Year Book Depreciation Accumulated Book value


(beg) Depreciation end of year

1 $34,000 $10,000 $10,000 $24,000


2 $24,000 $ 8,000 $18,000 $16,000
3 $16,000 $ 6,000 $ 24,000 $10,000
4 $10,000 $ 4,000 $ 28,000 $ 6,000
5 $ 6,000 $ 2,000 $ 30,000 $ 4,000

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Double Declining balance method

1. Rate of depreciation = 2 * (1/5) = 0.40

2. Depreciation (2003) = $34,000 * 0.40 = $ 13,600


Depreciation (2004) = $20,400 * 0.40 = $ 8,160
Depreciation (2005) = $12,240 * 0.40 = $ 4,896
Depreciation (2006) = $ 7,344 * 0.40 = $ 2,938
Depreciation (2007) = ($34,000–$4000) – 29,594 = $406

Total depreciation taken = $ 30,000

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Double declining balance method

3. Depreciation Schedule

Year Book Depreciation Accumulated Book value


(beg) Depreciation end of year

1 $34,000 $13,600 $13,600 $20,400


2 $20,400 $ 8,160 $21,760 $12,240
3 $12,240 $ 4,896 $ 26,656 $ 7,344
4 $ 7,344 $ 2938 $ 30,000 $ 4,406
5 $ 4,000 $ 406 $ 30,000 $ 4,000

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Partial year depreciation
 When an asset is bought sometime during
the year, a partial depreciation charge is
required.
 The procedure is:

 Determine depreciation for a full year, and


 allocate the amount between the two
periods affected (see example ==> )

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Partial year depreciation: Example
Amber Corporation buys a truck on July 1, 2003.
Information relating to the truck is as follows:
 Cost, $10,000
 Estimated service life, 5 years
 Salvage value end of five years, none.

Determine depreciation expense under the double


declining balance method.

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Partial year depreciation: Example

 Determine depreciation as follows:


 First year (2003) ==>
$10,000 X 40% = $4,000 X 6/12 =
$2,000
 Second full year (2004) ==>
($10,000 - $2,000) X 40% = $3,200
 And so on for the remaining years

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Revision of Depreciation Estimates
 Determination of depreciation involves
initial estimates (life, salvage value.)
 Whenthese estimates are revised, we re-
compute depreciation.
 Theserevised depreciation expenses apply
prospectively to the remaining life of asset.
 These changes do not affect prior periods.

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Revision of Depreciation Estimates:
Example
Amber Corporation buys a depreciable asset on
January 1, 2003 for $95,000.
Estimated life was 20 years.
Estimated salvage value was $5,000.
On January 1, 2009, estimates were revised as
follows:
 salvage value, $2,000
 estimated life : 24 years (years 2003 through 2032)
Determine depreciation for 2009 based on straight
line method of depreciation.
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Revision of Depreciation Estimates:
Example
 Accumulated depreciation to date of
revision of estimates:
 ($95,000 - $5,000) / 20 years = $4,500 dep
 $4,500 * 6 years = $27,000 accumulated depr.
 Amount to be depreciated (years 2009 through
2032 = 18 years)
 ($95,000 - $27,000 - $2,000) / 18 years
 = $3,667 (rounded) annual depreciation

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Dispositions of PP&E
• Plant assets may be:
– retired voluntarily, or
– disposed of by sale, exchange, involuntary
conversion

• Depreciation is recorded up to the date of disposal


before determining gain or loss

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Accounting for Exchanges
Types of Accounting Rationale
Exchange Guidance

Dissimilar Recognize gain Earnings process


assets and losses is complete

Similar Recognize loss; Earnings process


assets (cash Gain up to boot is partially
received) (partial gain) complete

Similar Recognize loss; Earnings process


assets (No Defer gain is not complete
cash received)
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Dissimilar Assets
• Amber Company exchanges a number of trucks
for land from Becktel Company.
• Fair value of trucks: $ 49,000.
• Book value of trucks: $ 42,000
(Cost, $64,000; Accu. Depr, $ 22,000)
• Cash paid to Becktel: $ 17,000
• Record the purchase in Amber’s books.

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Dissimilar Assets

Land,
Amber
FMV= $66,000
Becktel

Cash, $17,000
plus
Trucks,
FMV= $49,000

Amber recognizes gain= FMV less Book value = $7,000


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Dissimilar Assets
Land Dr. $ 66,000
Accu. Dep (Trucks) Dr. $ 22,000
Trucks $ 64,000
Cash $ 17,000
Gain on disposal $ 7,000

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Similar Assets (loss)
• Amber Company exchanges a used machine for a
similar machine from Becktel Company.
• Fair value of used machine: $ 6,000.
• Book value of used machine: $ 8,000
(Cost, $12,000; Accu. Depr, $ 4,000)
• Cash paid to Becktel: $ 7,000
• Record the purchase in Amber’s books.

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Similar Assets (Loss)

New machine,
Amber
FMV= $13,000
Becktel

Cash, $ 7,000
plus
used machine,
FMV= $ 6,000

Amber recognizes loss ==> Book value less FMV = $2,000


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Similar Assets (Loss)
New Machine Dr. $ 13,000
Accu. Dep (Old) Dr. $ 4,000
Loss on disposal Dr. $ 2,000
Machine (old) $ 12,000
Cash $ 7,000

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Similar Assets (Deferred gain)
• Davis Company exchanges Ford cars for GM cars
from Nertz Company.
• Fair value of Ford cars: $ 160,000.
• Book value of Ford cars: $ 135,000
(Cost, $150,000; Accu. Depr, $ 15,000)
• Cash paid to Nertz: $ 10,000
• Fair value of GM cars: ($160,000 + $ 10,000)
$ 170,000
• Record the purchase in Davis’ books.
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Similar Assets (Deferred Gain)

GM cars,
Davis
FMV= $170,000
Nertz

Cash, $ 10,000
plus
Ford cars,
FMV= $ 160,000

Davis defers gain ==> FMV less book value = $25,000


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Similar Assets (Deferred Gain)
GM cars Dr. $ 145,000 (see below)
Accu. Dep (Ford) Dr. $ 15,000
Ford cars (old) $ 150,000
Cash $ 10,000

Fair value of GM cars $170,000


Gain deferred ($ 25,000)
GM cars (basis) $145,000
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Similar Assets (Partial gain)
• Davis Company exchanges Ford cars for GM cars
from Nertz Company.
• Fair value of Ford cars: $ 160,000.
• Cash paid to Nertz: $ 10,000
• Fair value of GM cars: ($160,000 + $ 10,000)
$ 170,000
• Book value of GM cars: $ 136,000
(Cost, $200,000; Accu. Depr, $ 64,000)
• Record the purchase in Nertz’s books.
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Similar Assets (Partial Gain)
GM cars,
Davis
FMV= $170,000
Nertz

Cash, $ 10,000
plus
Ford cars,
FMV= $ 160,000

Nertz: Gain realized: FMV less book value = $34,000


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Similar Assets (Partial gain)
• Since Nertz receives cash (boot) as part of
the exchange, Nertz recognizes partial gain
as follows:
FMV less Book value = Realized gain
$170,000 less $136,000 = $ 34,000
• Recognized gain: (next slide)

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Similar Assets (Partial gain)
• Nertz recognizes partial gain as follows:
(boot / total consideration) * Realized gain
($10,000 / $ 170,000) * $34,000
= $ 2,000.
Total gain less gain recognized = deferred gain
$34,000 less $2,000 = $32,000

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Nertz Company (Partial Gain)
Ford cars Dr. $ 128,000 (see below)
Accu. Dep (GM) Dr. $ 64,000
Cash Dr. $ 10,000
GM cars (old) $ 200,000
Gain on disposal $ 2,000
Fair value of Ford cars $160,000
Gain deferred ($ 32,000)
Ford cars (basis) $128,000
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Copyright

Copyright © 2003 John Wiley & Sons, Inc. All rights


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