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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


reserved. Reproduction or translation of this work
beyond that named in Section 117 of the 1976 United
States Copyright Act without the express written
consent of the copyright owner is unlawful. Request
for further information should be addressed to the
Permissions Department, John Wiley & Sons, Inc.
The purchaser may make back-up copies for his/her
own use only and not for distribution or resale. The
Publisher assumes no responsibility for errors,
omissions, or damages, caused by the use of these
programs or from the use of the information
contained herein.

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