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السبت، 16 أبريل 2016

Summarization chapter 10- PLANT ASSETS, NATURAL RESOURCES, AND INTANGIBLE ASSETS


Summarization chapter 10
PLANT ASSETS, NATURAL RESOURCES,
AND INTANGIBLE ASSETS

Plant assets 
Plant assets are resources that have three characteristics:-

1-They have a physical substance
2-used in the operations of a business
3- not intended for sale to customers

Determining the Cost of Plant Assets :
The historical cost principle requires that companies record plant assets at cost
Cost consists of all expenditures necessary to acquire the asset and make it ready for its intended use.
For example, the cost of factory machinery includes the purchase price, freight costs paid by the purchaser, and installation costs. Once cost is established, the company uses that amount as the basis of accounting for the plant asset over its useful life.

LAND
Companies often use land as a building site for a manufacturing plant or office building. The cost of land includes
(1) the cash purchase price
 (2) closing costs such as title and attorney’s fees,
(3) real estate brokers’ commissions,
(4) accrued property taxes and other liens assumed by the purchaser.


Companies record as debits (increases) to the Land account all necessary
costs incurred to make land ready for its intended use. When a company
acquires vacant land, these costs include expenditures for clearing, draining, filling,
and grading. Sometimes the land has a building on it that must be removed
before construction of a new building. In this case, the company debits to the
Land account all demolition and removal costs, less any proceeds from salvaged
materials.



LAND IMPROVEMENTS
Land improvements are structural additions made to land. Examples are driveways,
parking lots, fences, landscaping, and underground sprinklers.
The cost of land improvements includes all expenditures necessary to make the improvements
ready for their intended use.
Land improvements have limited useful lives, and their maintenance and
replacement are the responsibility of the company. As a result, companies expense
(depreciate) the cost of land improvements over their useful lives



BUILDINGS

Buildings are facilities used in operations, such as stores, offices, factories, warehouses, and airplane hangars.
When a building is purchased, such costs include the purchase price, closing costs
(attorney’s fees, title insurance, etc.), and real estate broker’s commission. Costs
to make the building ready for its intended use include expenditures for remodeling
and replacing or repairing the roof, fl oors, electrical wiring, and plumbing

When a new building is constructed, cost consists of the contract price plus payments
for architects’ fees, building permits, and excavation costs


In addition, companies charge certain interest costs to the Buildings account.
Interest costs incurred to finance the project are included in the cost of the building
when a significant period of time is required to get the building ready for use.
In these circumstances, interest costs are considered as necessary as materials
and labor. However, the inclusion of interest costs in the cost of a constructed
building is limited to the construction period. When construction has been
completed, the company records subsequent interest payments on funds borrowed
to finance the construction as debits (increases) to Interest Expense.


EQUIPMENT
Equipment includes assets used in operations, such as store check-out counters,
office furniture, factory machinery, delivery trucks, and airplanes

The cost of equipment,  consists of the cash purchase price  sales taxes, freight charges, and insurance during transit paid by the purchaser. It also includes expenditures required in assembling, installing, and testing the unit. However, Rent-A-Wreck does not include motor vehicle licenses and accident insurance on company vehicles in the cost of equipment. These costs represent
annual recurring expenditures and do not benefit future periods. Thus, they are treated as expenses as they are incurred.





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Depreciation

depreciation is the process of allocating to expense the cost of a plant asset over its useful (service) life in a rational and systematic manner Cost allocation enables companies to properly match expenses with revenues in accordance with the expense recognition principle


It is important to understand that depreciation is a process of cost allocation. It is not a process of asset valuation

the book value (cost less accumulated depreciation) of a plant asset may be quite different from its fair value. In fact, if an asset is fully depreciated, it can have a zero book value but still have
a significant fair value

Depreciation applies to three classes of plant assets: land improvements, buildings, and equipment.
Each asset in these classes is considered to be a depreciable asset. Why? Because the usefulness to the company and revenue-producing ability of each asset will decline over the asset’s useful life

Depreciation does not apply to land because its usefulness and revenue-producing ability generally remain intact over time

Recognizing depreciation on an asset does not result in an accumulation
of cash for replacement of the asset. The balance in Accumulated Depreciation
represents the total amount of the asset’s cost that the company has charged to
expense. It is not a cash fund.

The going-concern assumption states that the company will continue
in operation for the foreseeable future. If a company does not use a goingconcern
assumption, then plant assets should be stated at their fair value. In that
case, depreciation of these assets is not needed.


FACTORS IN COMPUTING DEPRECIATION

1. Cost. 
2. Useful life.is an estimate of the expected productive life .management considers
3. Salvage value is an estimate of the asset’s value at the end of its useful life.

DEPRECIATION METHODS

Depreciation is generally computed using one of the following methods:
1. Straight-line 
2. Units-of-activity
3. Declining-balance  
Each method is acceptable under generally accepted accounting principles
Once a company chooses a method, it should apply it consistently over the useful life of the asset. Consistency enhances the comparability of financial statements. Depreciation affects the balance sheet through accumulated depreciation and the income statement through depreciation expense.

STRAIGHT-LINE Under the straight-line method, companies expense the same
amount of depreciation for each year of the asset’s useful life







UNITS-OF-ACTIVITY Under the units-of-activity method, useful life is expressed in terms of the total units of production or use expected from the asset, rather than as a time period.



DECLINING-BALANCEThe declining-balance method produces a decreasing
annual depreciation expense over the asset’s useful life. The method is so named
because the periodic depreciation is based on a declining book value (cost less
accumulated depreciation) of the asset. With this method, companies compute
annual depreciation expense by multiplying the book value at the beginning of the
year by the declining-balance depreciation rate. The depreciation rate remains
constant from year to year, but the book value to which the rate is applied
declines each year.



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Expenditures During Useful Life

revenue expenditures
Companies record such repairs as debits to Maintenance and Repairs Expense
as they are incurred. Because they are immediately charged as an expense against revenues

capital expenditures.In contrast, additions and improvements are costs incurred to increase the
operating efficiency, productive capacity, or useful life of a plant asset

Companies must use good judgment in deciding between a revenue expenditure and capital expenditure 
The materiality concept states that if an item would not make a difference in decision-making






Plant Asset Disposals

Companies dispose of plant assets that are no longer useful to them



RETIREMENT OF PLANT ASSETS


What happens if a fully depreciated plant asset is still useful to the company?
In this case, the asset and its accumulated depreciation continue to be reported
on the balance sheet, without further depreciation adjustment, until the company
retires the asset. Reporting the asset and related accumulated depreciation
on the balance sheet informs the fi nancial statement reader that the asset is still
in use. Once fully depreciated, no additional depreciation should be taken, even
if an asset is still being used. In no situation can the accumulated depreciation on
a plant asset exceed its cost.


If a company retires a plant asset before it is fully depreciated and no cash is
received for scrap or salvage value, a loss on disposal occurs




SALE OF PLANT ASSETS





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Natural Resources

Natural resources consist of standing timber and underground deposits of oil, gas, and minerals. These long-lived productive assets have two distinguishing characteristics:
(1) They are physically extracted in operations (such as mining, cutting, or pumping).
 (2) They are replaceable only by an act of nature.
The acquisition cost of a natural resource is the price needed to acquire the resource and prepare it for its intended use. For an already-discovered resource, such as an existing coal mine, cost is the price paid for the property.

depletion
The allocation of the cost of natural resources to expense in a rational and systematic
manner over the resource’s useful life is called depletion. (That is, depletion
is to natural resources as depreciation is to plant assets.) Companies
generally use the units-of-activity method (learned earlier in the chapter) to
compute depletion. The reason is that depletion generally is a function of the
units extracted during the year.


Presentation
The company reports the account Depletion Expense as a part of the cost of producing
the product. Accumulated Depletion is a contra asset account, similar to
accumulated depreciation. It is deducted from the cost of the natural resource in the balance sheet,
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Intangible Assets

Intangible assets are rights, privileges, and competitive advantages that result
from the ownership of long-lived assets that do not possess physical substance.
Evidence of intangibles may exist in the form of contracts or licenses. Intangibles
may arise from the following sources:
1. Government grants, such as patents, copyrights, licenses, trademarks, and trade names.
2. Acquisition of another business, in which the purchase price includes a payment for goodwill.
3. Private monopolistic arrangements arising from contractual agreements, such as franchises and leases. Some widely known intangibles are Microsoft’s patents, McDonald’s franchises,
Apple’s trade name iPod, J.K. Rowling’s copyrights on the Harry Potter books, and
the trademark Rent-A-Wreck in the Feature Story.


Accounting for Intangible Assets
The process of allocating the cost of intangibles is referred to as amortization. The cost of intangible assets with indefinite lives should not be amortized.

Intangible assets are typically amortized on a straight-line basis. For example,
the legal life of a patent is 20 years. Companies amortize the cost of a patent
over its 20-year life or its useful life, whichever is shorter. To illustrate the
computation of patent amortization, assume that National Labs purchases a patent
at a cost of $60,000. If National estimates the useful life of the patent to be eight
years, the annual amortization expense is $7,500 ($60,000 4 8). National records
the annual amortization as follows.


PATENTS
A patent is an exclusive right issued by the U.S. Patent Offi ce that enables the
recipient to manufacture, sell, or otherwise control an invention for a period of
20 years from the date of the grant. A patent is nonrenewable. But, companies
can extend the legal life of a patent by obtaining new patents for improvements
or other changes in the basic design. The initial cost of a patent is the cash or
cash equivalent price paid to acquire the patent.
The saying, “A patent is only as good as the money you’re prepared to spend
defending it,” is very true. Many patents are subject to litigation by competitors.
Any legal costs an owner incurs in successfully defending a patent in an infringement
suit are considered necessary to establish the patent’s validity. The owner
adds those costs to the Patents account and amortizes them over the remaining
life of the patent.
The patent holder amortizes the cost of a patent over its 20-year legal
life or its useful life, whichever is shorter. Companies consider obsolescence
and inadequacy in determining useful life. These factors may cause a patent to
become economically ineffective before the end of its legal life.
COPYRIGHTS
The federal government grants copyrights, which give the owner the exclusive
right to reproduce and sell an artistic or published work. Copyrights extend for the
life of the creator plus 70 years. The cost of a copyright is the cost of acquiring
and defending it. The cost may be only the small fee paid to the U.S. Copyright
Office. Or, it may amount to much more if an infringement suit is involved.

The useful life of a copyright generally is significantly shorter than its legal life.
Therefore, copyrights usually are amortized over a relatively short period of time.
TRADEMARKS AND TRADE NAMES
A trademark or trade name is a word, phrase, jingle, or symbol that identifies a
particular enterprise or product. Trade names like Wheaties, Monopoly, Big Mac,
Kleenex, Coca-Cola, and Jeep create immediate product identification. They also
generally enhance the sale of the product. The creator or original user may obtain
exclusive legal right to the trademark or trade name by registering it with the U.S.
Patent Office. Such registration provides 20 years of protection. The registration
may be renewed indefinitely as long as the trademark or trade name is in use.
If a company purchases the trademark or trade name, its cost is the purchase
price. If a company develops and maintains the trademark or trade name, any
costs related to these activities are expensed as incurred. Because trademarks
and trade names have indefinite lives, they are not amortized.
FRANCHISES
When you fi ll up your tank at the corner Shell station, eat lunch at Subway, or rent
a car from Rent-A-Wreck, you are dealing with franchises. A franchise is a contractual
arrangement between a franchisor and a franchisee. The franchisorgrants the
franchisee the right to sell certain products, perform specific services, or use certain
trademarks or trade names, usually within a designated geographic area.
Another type of franchise is a license. A license granted by a governmental
body permits a company to use public property in performing its services. Examples
are the use of city streets for a bus line or taxi service, the use of public land
for telephone and electric lines, and the use of airwaves for radio or TV broadcasting.
In a recent license agreement, FOX, CBS, and NBC agreed to pay $27.9
billion for the right to broadcast NFL football games over an eight-year period.
Franchises and licenses may by granted for a definite period of time, an indefinite
period, or perpetually.
When a company can identify costs with the purchase of a franchise or
license, it should recognize an intangible asset. Companies should amortize
the cost of a limited-life franchise (or license) over its useful life. If the life is
indefinite, the cost is not amortized. Annual payments made under a franchise
agreement are recorded as operating expenses in the period in which they are incurred.
GOODWILL
Usually, the largest intangible asset that appears on a company’s balance sheet is
goodwill. Goodwill represents the value of all favorable attributes that relate to a
company that are not attributable to any other specifi c asset. These include
exceptional management, desirable location, good customer relations, skilled
employees, high-quality products, and harmonious relations with labor unions.
Goodwill is unique. Unlike assets such as investments and plant assets, which
can be sold individually in the marketplace, goodwill can be identifi ed only with
the business as a whole.
If goodwill can be identifi ed only with the business as a whole, how can its
amount be determined? One could try to put a dollar value on the factors listed
above (exceptional management, desirable location, and so on). But, the results
would be very subjective, and such subjective valuations would not contribute to
the reliability of fi nancial statements. Therefore, companies record goodwill
only when an entire business is purchased. In that case, goodwill is the excess
of cost over the fair value of the net assets (assets less liabilities) acquired.
In recording the purchase of a business, the company debits (increases) the
identifiable acquired assets, credits liabilities at their fair values, credits cash for
the purchase price, and records the difference as goodwill. Goodwill is not
amortized because it is considered to have an indefi nite life. Companies report
goodwill in the balance sheet under intangible assets.



Research and Development Costs

Research and development costs are expenditures that may lead to patents,
copyrights, new processes, and new products. Many companies spend considerable
sums of money on research and development (R&D).
Research and development costs present accounting problems. For one thing,
it is sometimes difficult to assign the costs to specific projects. Also, there are
uncertainties in identifying the extent and timing of future benefits. As a result,
companies usually record R&D costs as an expense when incurred, whether
the research and development is successful or not.
To illustrate, assume that Laser Scanner Company spent $3 million on R&D
that resulted in two highly successful patents. It spent $20,000 on legal fees for
the patents. The company would add the lawyers’ fees to the patent account. The
R&D costs, however, cannot be included in the cost of the patent. Instead, the
company would record the R&D costs as an expense when incurred.
Many disagree with this accounting approach. They argue that expensing
R&D costs leads to understated assets and net income. Others, however, argue
that capitalizing these costs will lead to highly speculative assets on the balance
sheet. Who is right is difficult to determine.

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Statement Presentation and Analysis

Presentation
Usually, companies combine plant assets and natural resources under “Property,
plant, and equipment” in the balance sheet. They show intangibles separately.
Companies disclose either in the balance sheet or the notes the balances of the
major classes of assets, such as land, buildings, and equipment, and accumulated
depreciation by major classes or in total. In addition, they should describe the
depreciation and amortization methods that were used, as well as disclose the
amount of depreciation and amortization expense for the period.



Analysis
Using ratios, we can analyze how effi ciently a company uses its assets to generate
sales. The asset turnover analyzes the productivity of a company’s assets. It
tells us how many dollars of sales a company generates for each dollar invested
in assets. This ratio is computed by dividing net sales by average total assets for
the period. Illustration 10-25 shows the computation of the asset turnover for
The Procter & Gamble Company. P&G’s net sales for 2011 were $82,559 million.
Its total ending assets were $138,354 million, and beginning assets were
$128,172 million.


Thus, each dollar invested in assets produced $0.62 in sales for P&G. If a
company is using its assets efficiently, each dollar of assets will create a high
amount of sales. This ratio varies greatly among different industries—from those
that are asset-intensive (utilities) to those that are not (services).

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Exchange of Plant Assets

Ordinarily, companies record a gain or loss on the exchange of plant assets. The
rationale for recognizing a gain or loss is that most exchanges have commercial
substance. An exchange has commercial substance if the future cash fl ows
change as a result of the exchange.
To illustrate, Ramos Co. exchanges some of its equipment for land held by
Brodhead Inc. It is likely that the timing and amount of the cash fl ows arising
from the land will differ signifi cantly from the cash fl ows arising from the equipment.
As a result, both Ramos and Brodhead are in different economic positions.
Therefore, the exchange has commercial substance, and the companies recognize
a gain or loss in the exchange. Because most exchanges have commercial
substance (even when similar assets are exchanged), we illustrate only this type
of situation, for both a loss and a gain.
Loss Treatment
To illustrate an exchange that results in a loss, assume that Roland Company
exchanged a set of used trucks plus cash for a new semi-truck. The used trucks
have a combined book value of $42,000 (cost $64,000 less $22,000 accumulated
depreciation). Roland’s purchasing agent, experienced in the second-hand
market, indicates that the used trucks have a fair value of $26,000. In addition to
the trucks, Roland must pay $17,000 for the semi-truck. Roland computes the
cost of the semi-truck as follows.

Roland incurs a loss on disposal of plant assets of $16,000 on this exchange.
The reason is that the book value of the used trucks is greater than the fair value
of these trucks. The computation is as follows.



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