Introduction to Accounting:

The Language of Business

Lesson 8: Long-Term Operating Assets
Supplemental Textbook

Business Learning Software, Inc

Chapter 8: Part 1

Property, plant, and equipment

Learning objectives
After studying this section, you should be able to:
• List the characteristics of plant assets and identify the costs of acquiring plant assets.
• List the four major factors affecting depreciation expense.
• Describe the various methods of calculating depreciation expense.
• Distinguish between capital and revenue expenditures for plant assets.
• Describe the subsidiary records used to control plant assets.
• Analyze and use the financial results—rate of return on operating assets.

A company accountant's role in managing plant assets

Property, plant, and equipment (fixed assets or operating assets) compose more than one-half of total assets in
many corporations. These resources are necessary for the companies to operate and ultimately make a profit. It is
the efficient use of these resources that in many cases determines the amount of profit corporations will earn.
Accountants employed by a company are deeply involved in nearly all decisions regarding the company's fixed
assets, from pre-acquisition planning to the ultimate disposal or sale of those assets. Companies do not view an
asset acquisition as merely a purchase, but as an investment. For example, should your company or client purchase
an airplane to visit clients? Accountants will investigate all the benefits, both financial and intangible, and compare
these benefits to the costs. By determining whether or not the airplane will be a good investment for the company,
the accountant can assist the company in making sound strategic business decisions.
Since these assets are so closely related to profits, good management is required. In accounting terms, a good
return on operating assets is crucial to the success of the corporation. Many corporations have a staff of accountants
whose primary task is to manage operating assets. This task involves making decisions concerning the purchase,
use, and disposal of said assets. Once an asset has been acquired, accountants are responsible for determining the
original value of the asset, the period over which it will extend benefits to the company, and its current market
value while owned by the entity. The accountant must ultimately determine when and how to dispose of such an
asset. The decision can range from trading the asset for a new asset to selling the asset to a salvage dealer.
Recently, The Williams Companies, Inc. had over USD 10 billion dollars in property, plant, and equipment. In
addition, the company also had approximately USD 530 million in commitments for construction and acquisition
of property, plant, and equipment. Managing a portfolio of assets of this magnitude takes both accounting
knowledge and analytical skills. Successful management of these assets can be financially rewarding to both the
company and the accountant.
On a classified balance sheet, the asset section contains: (1) current assets; (2) property, plant, and equipment;
and (3) other categories such as intangible assets and long-term investments. Previous chapters discussed current
assets. This chapter begins a discussion of property, plant, and equipment that is concluded in Chapter 8 Part 2
below. Property, plant, and equipment are often called plant and equipment or simply plant assets. Plant assets

Introduction to Accounting : The Language of Business – Supplemental Textbook 1

are long-lived assets because they are expected to last for more than one year. Long-lived assets consist of tangible
assets and intangible assets. Tangible assets have physical characteristics that we can see and touch; they include
plant assets such as buildings and furniture, and natural resources such as gas and oil. Intangible assets have no
physical characteristics that we can see and touch but represent exclusive privileges and rights to their owners.

Nature of plant assets

To be classified as a plant asset, an asset must: (1) be tangible, that is, capable of being seen and touched; (2)
have a useful service life of more than one year; and (3) be used in business operations rather than held for resale.
Common plant assets are buildings, machines, tools, and office equipment. On the balance sheet, these assets
appear under the heading "Property, plant, and equipment".
Plant assets include all long-lived tangible assets used to generate the principal revenues of the business.
Inventory is a tangible asset but not a plant asset because inventory is usually not long-lived and it is held for sale
rather than for use. What represents a plant asset to one company may be inventory to another. For example, a
business such as a retail appliance store may classify a delivery truck as a plant asset because the truck is used to
deliver merchandise. A business such as a truck dealership would classify the same delivery truck as inventory
because the truck is held for sale. Also, land held for speculation or not yet put into service is a long-term
investment rather than a plant asset because the land is not being used by the business. However, standby
equipment used only in peak or emergency periods is a plant asset because it is used in the operations of the
business.
Accountants view plant assets as a collection of service potentials that are consumed over a long time. For
example, over several years, a delivery truck may provide 100,000 miles of delivery services to an appliance
business. A new building may provide 40 years of shelter, while a machine may perform a particular operation on
400,000 parts. In each instance, purchase of the plant asset actually represents the advance payment or
prepayment for expected services. Plant asset costs are a form of prepaid expense. As with short-term prepayments,
the accountant must allocate the cost of these services to the accounting periods benefited.
Accounting for plant assets involves the following four steps:
• Record the acquisition cost of the asset.
• Record the allocation of the asset's original cost to periods of its useful life through depreciation.
• Record subsequent expenditures on the asset.
• Account for the disposal of the asset.
In Exhibit 1, note how the asset's life begins with its procurement and the recording of its acquisition cost, which
is usually in the form of a dollar purchase. Then, as the asset provides services through time, accountants record the
asset's depreciation and any subsequent expenditures related to the asset. Finally, accountants record the disposal
of the asset. We discuss the first three steps in this section and the disposal of an asset in Part 2 below. The last
section in this chapter explains how accountants use subsidiary ledgers to control assets.
Remember that in recording the life history of an asset, accountants match expenses related to the asset with the
revenues generated by it. Because measuring the periodic expense of plant assets affects net income, accounting for
property, plant, and equipment is important to financial statement users.

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 Initial recording of plant assets
When a company acquires a plant asset, accountants record the asset at the cost of acquisition (historical cost).
This cost is objective, verifiable, and the best measure of an asset's fair market value at the time of purchase. Fair
market value is the price received for an item sold in the normal course of business (not at a forced liquidation
sale). Even if the market value of the asset changes over time, accountants continue to report the acquisition cost in
the asset account in subsequent periods.
The acquisition cost of a plant asset is the amount of cash or cash equivalents given up to acquire and place
the asset in operating condition at its proper location. Thus, cost includes all normal, reasonable, and necessary
expenditures to obtain the asset and get it ready for use. Acquisition cost also includes the repair and
reconditioning costs for used or damaged assets. Unnecessary costs (such as traffic tickets or fines) that must be
paid as a result of hauling machinery to a new plant are not part of the acquisition cost of the asset.
The next sections discuss which costs are capitalized (debited to an asset account) for: (1) land and land
improvements; (2) buildings; (3) group purchases of assets; (4) machinery and other equipment; (5) self-
constructed assets; (6) noncash acquisitions; and (7) gifts of plant assets.
The cost of land includes its purchase price and other costs such as option cost, real estate commissions, title
search and title transfer fees, and title insurance premiums. Also included are an existing mortgage note or unpaid
taxes (back taxes) assumed by the purchaser; costs of surveying, clearing, and grading; and local assessments for
sidewalks, streets, sewers, and water mains. Sometimes land purchased as a building site contains an unusable
building that must be removed. Then, the accountant debits the entire purchase price to Land, including the cost of
removing the building less any cash received from the sale of salvaged items while the land is being readied for use.

Exhibit 1: Recording the life history of a depreciable asset

To illustrate, assume that Spivey Company purchased an old farm on the outskirts of San Diego, California,USA,
as a factory site. The company paid USD 225,000 for the property. In addition, the company agreed to pay unpaid
property taxes from previous periods (called back taxes) of USD 12,000. Attorneys' fees and other legal costs
relating to the purchase of the farm totaled USD 1,800. Spivey demolished (razed) the farm buildings at a cost of
USD 18,000. The company salvaged some of the structural pieces of the building and sold them for USD 3,000.

Introduction to Accounting : The Language of Business – Supplemental Textbook 3

Because the firm was constructing a new building at the site, the city assessed Spivey Company USD 9,000 for
water mains, sewers, and street paving. Spivey computed the cost of the land as follows:

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 Land
Cost of factory site $225,000
Back taxes 12,000
Attorneys' fees and other legal costs 1,800
Demolition 18,000
Sale of salvaged parts (3,000)
City assessment 9,000
$262,800

Accountants assigned all costs relating to the farm purchase and razing of the old buildings to the Land account
because the old buildings purchased with the land were not usable. The real goal was to purchase the land, but the
land was not available without the buildings.
Land is considered to have an unlimited life and is therefore not depreciable. However, land improvements,
including driveways, temporary landscaping, parking lots, fences, lighting systems, and sprinkler systems, are
attachments to the land. They have limited lives and therefore are depreciable. Owners record depreciable land
improvements in a separate account called Land Improvements. They record the cost of permanent landscaping,
including leveling and grading, in the Land account.
When a business buys a building, its cost includes the purchase price, repair and remodeling costs, unpaid taxes
assumed by the purchaser, legal costs, and real estate commissions paid.
Determining the cost of constructing a new building is often more difficult. Usually this cost includes architect's
fees; building permits; payments to contractors; and the cost of digging the foundation. Also included are labor and
materials to build the building; salaries of officers supervising the construction; and insurance, taxes, and interest
during the construction period. Any miscellaneous amounts earned from the building during construction reduce
the cost of the building. For example, an owner who could rent out a small completed portion during construction
of the remainder of the building, would credit the rental proceeds to the Buildings account rather than to a revenue
account.
Sometimes a company buys land and other assets for a lump sum. When land and buildings purchased together
are to be used, the firm divides the total cost and establishes separate ledger accounts for land and for buildings.
This division of cost establishes the proper balances in the appropriate accounts. This is especially important later
because the depreciation recorded on the buildings affects reported income, while no depreciation is taken on the
land.
Returning to our example of Spivey Company, suppose one of the farm buildings was going to be remodeled for
use by the company. Then, Spivey would determine what portion of the purchase price of the farm, back taxes, and
legal fees (USD 225,000 + USD 12,000 + USD 1,800 = USD 238,800) it could assign to the buildings and what
portion to the land. (The net cost of demolition would not be incurred, and the city assessment would be incurred at
a later time.) Spivey would assign the USD 238,800 to the land and the buildings on the basis of their appraised
values. For example, assume that the land was appraised at USD 162,000 and the buildings at USD 108,000. Spivey
would determine the cost assignable to each of these plant assets as follows:
Appraised Per cent of Total
Asset Value Value
Land $162,000 60% (162/270)
Buildings 108,000 40 (108/270)
$270,000 100% (270/270)
Per cent of X Purchase Cost
Total Value Price = Assigned
Land 60% X $238,800* = $ 143,280
Buildings 40 X $238,800 = 95,520
$ 238,800
*The purchase price is the sum of the cash price, back taxes, and legal fees.

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 The journal entry to record the purchase of the land and buildings would be:
Land (+A) 143,280
Buildings (+A) 95,520
Cash (-A) 238,800
To record the purchase of land and buildings.

When the city eventually assessed the charges for the water mains, sewers, and street paving, the company
would still debit these costs to the Land account as in the previous example.
Often companies purchase machinery or other equipment such as delivery or office equipment. Its cost includes
the seller's net invoice price (whether the discount is taken or not), transportation charges incurred, insurance in
transit, cost of installation, costs of accessories, and testing and break-in costs. Also included are other costs needed
to put the machine or equipment in operating condition in its intended location. The cost of machinery does not
include removing and disposing of a replaced, old machine that has been used in operations. Such costs are part of
the gain or loss on disposal of the old machine, as discussed in Chapter 8: Part 2 below.
To illustrate, assume that Clark Company purchased new equipment to replace equipment that it has used for
five years. The company paid a net purchase price of USD 150,000, brokerage fees of USD 5,000, legal fees of USD
2,000, and freight and insurance in transit of USD 3,000. In addition, the company paid USD 1,500 to remove old
equipment and USD 2,000 to install new equipment. Clark would compute the cost of new equipment as follows:
Net purchase price $150,000
Brokerage fees 5,000
Legal fees 2,000
Freight and insurance in transit 3,000
Installation costs 2,000
Total cost $162,000

If a company builds a plant asset for its own use, the cost includes all materials and labor directly traceable to
construction of the asset. Also included in the cost of the asset are interest costs related to the asset and amounts
paid for utilities (such as heat, light, and power) and for supplies used during construction. To determine how much
of these indirect costs to capitalize, the company compares utility and supply costs during the construction period
with those costs in a period when no construction occurred. The firm records the increase as part of the asset's cost.
For example, assume a company normally incurred a USD 600 utility bill for June. This year, the company
constructed a machine during June, and the utility bill was USD 975. Thus, it records the USD 375 increase as part
of the machine's cost.
To illustrate further, assume that Tanner Company needed a new die-casting machine and received a quote from
Smith Company for USD 23,000, plus USD 1,000 freight costs. Tanner decided to build the machine rather than
buy it. The company incurred the following costs to build the machine: materials, USD 4,000; labor, USD 13,000;
and indirect services of heat, power, and supplies, USD 3,000. Tanner would record the machine at its cost of USD
20,000 (USD 4,000 + USD 13,000 + USD 3,000) rather than USD 24,000, the purchase price of the machine. The
USD 20,000 is the cost of the resources given up to construct the machine. Also, recording the machine at USD
24,000 would require Tanner to recognize a gain on construction of the assets. Accountants do not subscribe to the
idea that a business can earn revenue (or realize a gain), and therefore net income, by dealing with itself.
You can apply the general guidelines we have just discussed to other plant assets, such as furniture and fixtures.
The accounting methods are the same.
When a plant asset is purchased for cash, its acquisition cost is simply the agreed on cash price. However, when
a business acquires plant assets in exchange for other noncash assets (shares of stock, a customer's note, or a tract
of land) or as gifts, it is more difficult to establish a cash price. This section discusses three possible asset valuation
bases.

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 The general rule on noncash exchanges is to value the noncash asset received at its fair market value or the fair
market value of what was given up, whichever is more clearly evident. The reason for not using the book value of
the old asset to value the new asset is that the asset being given up is often carried in the accounting records at
historical cost or book value. Neither amount may adequately represent the actual fair market value of either asset.
Therefore, if the fair market value of one asset is clearly evident, a firm should record this amount for the new asset
at the time of the exchange.
Appraised value Sometimes, neither of the items exchanged has a clearly determinable fair market value.
Then, accountants record exchanges of items at their appraised values as determined by a professional appraiser.
An appraised value is an expert's opinion of an item's fair market price if the item were sold. Appraisals are used
often to value works of art, rare books, and antiques.
Book value The book value of an asset is its recorded cost less accumulated depreciation. An old asset's book
value is usually not a valid indication of the new asset's fair market value. If a better basis is not available, however,
a firm could use the book value of the old asset.
Occasionally, a company receives an asset without giving up anything for it. For example, to attract industry to
an area and provide jobs for local residents, a city may give a company a tract of land on which to build a factory.
Although such a gift costs the recipient company nothing, it usually records the asset (Land) at its fair market value.
Accountants record gifts of plant assets at fair market value to provide information on all assets owned by the
company. Omitting some assets may make information provided misleading. They would credit assets received as
gifts to a stockholders' equity account titled Paid-in Capital—Donations.

An accounting perspective:

Use of technology

How can CPA firms sell services on the Web other than by advertising their services? Ernst &
Young has developed a website for nonaudit consulting clients in which they charge an annual
fixed fee for nonaudit clients to obtain advice from the firm's consultants. The site is secure in that
it can only be accessed by those who have paid the fee. The subscribers type in their questions on
any business topic and get a response from an expert within two working days. Another firm,
PricewaterhouseCoopers, has an on-line service for tax professionals to seek advice. The other
large accounting firms undoubtedly have developed or are developing secure websites for
providing similar types of services.

Depreciation of plant assets

Companies record depreciation on all plant assets except land. Since the amount of depreciation may be
relatively large, depreciation expense is often a significant factor in determining net income. For this reason, most
financial statement users are interested in the amount of, and the methods used to compute, a company's
depreciation expense.
Depreciation is the amount of plant asset cost allocated to each accounting period benefiting from the plant
asset's use. Depreciation is a process of allocation, not valuation. Eventually, all assets except land wear out or
become so inadequate or outmoded that they are sold or discarded; therefore, firms must record depreciation on

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every plant asset except land. They record depreciation even when the market value of a plant asset temporarily
rises above its original cost because eventually the asset is no longer useful to its current owner.

Exhibit 2: Factors affecting depreciation

Major causes of depreciation are (1) physical deterioration, (2) inadequacy for future needs, and (3)
obsolescence. Physical deterioration results from the use of the asset—wear and tear—and the action of the
elements. For example, an automobile may have to be replaced after a time because its body rusted out. The
inadequacy of a plant asset is its inability to produce enough products or provide enough services to meet current
demands. For example, an airline cannot provide air service for 125 passengers using a plane that seats 90. The
obsolescence of an asset is its decline in usefulness brought about by inventions and technological progress. For
example, the development of the xerographic process of reproducing printed matter rendered almost all previous
methods of duplication obsolete.
The use of a plant asset in business operations transforms a plant asset cost into an operating expense.
Depreciation, then, is an operating expense resulting from the use of a depreciable plant asset. Because
depreciation expense does not require a current cash outlay, it is often called a noncash expense. The purchaser
gave up cash in the period when the asset was acquired, not during the periods when depreciation expense is
recorded.
To compute depreciation expense, accountants consider four major factors:
• Cost of the asset.
• Estimated salvage value of the asset. Salvage value (or scrap value) is the amount of money the company
expects to recover, less disposal costs, on the date a plant asset is scrapped, sold, or traded in.
• Estimated useful life of the asset. Useful life refers to the time the company owning the asset intends to
use it; useful life is not necessarily the same as either economic life or physical life. The economic life of a car
may be 7 years and its physical life may be 10 years, but if a company has a policy of trading cars every 3 years,
the useful life for depreciation purposes is 3 years. Various firms express useful life in years, months, working
hours, or units of production. Obsolescence also affects useful life. For example, a machine capable of
producing units for 20 years, may be expected to be obsolete in 6 years. Thus, its estimated useful life is 6 years
—not 20. Another example, on TV you may have seen a demolition crew setting off explosives in a huge
building (e.g. The Dunes Hotel and Casino in Las Vegas, Nevada, USA) and wondering why the owners decided
to destroy what looked like a perfectly good building. The building was destroyed because it had reached the
end of its economic life. The land on which the building stood could be put to better use, possibly by
constructing a new building.

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 • Depreciation method used in depreciating the asset. We describe the four common depreciation methods in
the next section.

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 Number of Companies

Method 2003 2002 2001 2000

Straight-line 580 579 579 576
Declining Balance 22 22 22 22
Sum of year's digits 5 5 6 7
Accelerated method-not specified 41 44 49 53
Units of production 30 32 32 34
Other 4 7 9 10
Source: Based on American Institute of Certified Public Accountants, Accounting
Trends & Techniques
(New York: AICPA, 2004), p. 409.

Exhibit 3: Depreciation method used

In Exhibit 2, note the relationship among these factors. Assume Ace Company purchased an office building for
USD 100,000. The building has an estimated salvage value of USD 15,000 and a useful life of 20 years. The
depreciable cost of the building is USD 85,000 (cost less estimated salvage value). Ace would allocate this
depreciable base over the useful life of the building using the proper depreciation method under the circumstances.
Today, companies can use many different methods to calculate depreciation on assets. 1 This section discusses
and illustrates the most common methods—straight-line, units-of-production, and accelerated depreciation method
(double-declining-balance).
As is true for inventory methods, normally a company is free to adopt the most appropriate depreciation method
for its business operations. According to accounting theory, companies should use a depreciation method that
reflects most closely their underlying economic circumstances. Thus, companies should adopt the depreciation
method that allocates plant asset cost to accounting periods according to the benefits received from the use of the
asset. Exhibit 3 shows the frequency of use of these methods for 600 companies. You can see that most companies
use the straight-line method for financial reporting purposes. Note that some companies use one method for certain
assets and another method for other assets. In practice, measuring the benefits from the use of a plant asset is
impractical and often not possible. As a result, a depreciation method must meet only one standard: the
depreciation method must allocate plant asset cost to accounting periods in a systematic and rational manner. The
following four methods meet this requirement.

An accounting perspective:

Business insight

Regardless of the method or methods of depreciation chosen, companies must disclose their
depreciation methods in the footnotes to their financial statements. They include this information
in the first footnote, which summarizes significant accounting policies.
The disclosure is generally straightforward: Sears, Roebuck & Co. operates department stores,
paint and hardware stores, auto supply stores, and eye wear stores. Its annual report states
simply that "depreciation is provided principally by the straight-line method". Companies may
use different depreciation methods for different assets. General Electric Company is a highly
diversified multinational corporation that develops, manufactures, and markets aerospace

1 Because depreciation expense is an estimate, calculations may be rounded to the nearest dollar.

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 products, major appliances, industrial products, and high-performance engineered plastics. It
uses an accelerated method for most of its property, plant, and equipment; however, it
depreciates some assets on a straight-line basis, while the company's mining properties are
depreciated under the units-of-production method.

In the illustrations of the four depreciation methods that follow, we assume the following: On 2010 January 1, a
company purchased a machine for USD 54,000 with an estimated useful life of 10 years, or 50,000 units of output,
and an estimated salvage value of USD 4,000.
Straight-line method Straight-line depreciation has been the most widely used depreciation method in
the United States for many years . To apply the straight-line method, a firm charges an equal amount of plant asset
cost to each accounting period. The formula for calculating depreciation under the straight-line method is:
Asset cost – Estimated salvage value
Deprecation per period=
Number of accounting periods for estimated useful life
Using our example of a machine purchased for USD 54,000, the depreciation is:
$54,000−$ 4,000
=$5,000 per year
10 years
I n Exhibit 4, we present a schedule of annual depreciation entries, cumulative balances in the accumulated
depreciation account, and the book (or carrying) values of the USD 54,000 machine.
Using the straight-line method for assets is appropriate where (1) time rather than obsolescence is the major
factor limiting the asset's life and (2) the asset produces relatively constant amounts of periodic services. Assets that
possess these features include items such as pipelines, fencing, and storage tanks.
Units-of-production (output) method The units-of-production depreciation method assigns an equal
amount of depreciation to each unit of product manufactured or service rendered by an asset. Since this method of
depreciation is based on physical output, firms apply it in situations where usage rather than obsolescence leads to
the demise of the asset. Under this method, you would compute the depreciation charge per unit of output. Then,
multiply this figure by the number of units of goods or services produced during the accounting period to find the
period's depreciation expense. The formula is:
Asset cost – Estimated salvage value
Deprecation per unit =
Estimated total units of production service  during useful life of asset
Depreciation per period=Deprecation per unit ×Number of units of goods /services produced
You would determine the deprecation charge for the USD 54,000 machine as:
USD 54,000 – USD 4,000
=$1per unit
50,000 units

Introduction to Accounting : The Language of Business – Supplemental Textbook 11

End of Depreciation
Year Expense Dr.; Total
Accumulated Accumulated
Depreciation Cr. Depreciation Book Value
$54,000
1 $ 5,000 $ 5,000 49,000
2 5,000 10,000 44,000
3 5,000 15,000 39,000
4 5,000 20,000 34,000
5 5,000 25,000 29,000
6 5,000 30,000 24,000
7 5,000 35,000 19,000
8 5,000 40,000 14,000
9 5,000 45,000 9,000
10 5,000 50,000 4,000*
$50,000
* Estimated salvage value.

Exhibit 4: Straight-line depreciation schedule

If the machine produced 1,000 units in 2010 and 2,500 units in 2011, depreciation expense for those years
would be USD 1,000 and USD 2,500, respectively.
Accelerated depreciation methods record higher amounts of depreciation during the early years of an
asset's life and lower amounts in the asset's later years. A business might choose an accelerated depreciation
method for the following reasons:
• The value of the benefits received from the asset decline with age (for example, office buildings).
• The asset is a high-technology asset subject to rapid obsolescence (for example, computers).
• Repairs increase substantially in the asset's later years; under this method, the depreciation and repairs
together remain fairly constant over the asset's life (for example, automobiles).
The most common accelerated method of depreciation is the double-declining-balance (DDB) method.

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 Depreciation
Expense Dr.; Total
Accumulated Accumulated
End of Year Depreciation Cr. Depreciation Book Value
$54,000
1. (20% of $54,000) $10,800 $10,800 43,200
2. (20% of $43,200) 8,640 19,440 34,560
3. (20% of $34,560) 6,912 26,352 27,648
4. (20% of $27,648) 5,530 31,882 22,118
5. (20% of $22,118) 4,424 36,306 17,694
6. (20% of $17,694) 3,539 39,845 14,155
7. (20% of $14,155) 2,831 42,676 11,324
8. (20% of $11,324) 2,265 44,941 9,059
9. (20% of $9,059) 1,812 46,753 7,247
10. (20% of $7,247) 1,449* 48,202 5,798
* This amount could be $3,247 to reduce the book value to the estimated salvage value of
$4,000. Then, accumulated depreciation would be $50,000.

Exhibit 5: Double-declining-balance (DDB) depreciation schedule

Double-declining-balance method T o a p p l y t h e double-declining-balance (DDB) method of
computing periodic depreciation charges you begin by calculating the straight-line depreciation rate. To do this,
divide 100 per cent by the number of years of useful life of the asset. Then, multiply this rate by 2. Next, apply the
resulting double-declining rate to the declining book value of the asset. Ignore salvage value in making the
calculations. At the point where book value is equal to the salvage value, no more depreciation is taken. The formula
for DDB depreciation is:
Deprecation per period=2×Straight−line rate×Asset cost – Accumulated depreciation 

Introduction to Accounting : The Language of Business – Supplemental Textbook 13

Method Base Calculation
Asset Estimated Cost - Number of accounting periods in Base estimated
Straight-line
salvage value useful life
Double-declining balance Asset - Accumulated% Base X (2 X Straight-line rate)
%Cost - Depreciation

Exhibit 6: Summary of depreciation methods

Look at the calculations for the USD 54,000 machine using the DDB method in Exhibit 5. The straight-line rate
is 10 per cent (100 per cent/10 years), which, when doubled, yields a DDB rate of 20 per cent. (Expressed as
fractions, the straight-line rate is 1/10, and the DDB rate is 2/10.) Since at the beginning of year 1 no accumulated
depreciation has been recorded, cost is the basis of the calculation. In each of the following years, book value is the
basis of the calculation at the beginning of the year.
In the 10th year, you could increase depreciation to USD 3,247 if the asset is to be retired and its salvage value is
still USD 4,000. This higher depreciation amount for the last year (USD 3,247) would reduce the book value of USD
7,247 down to the salvage value of USD 4,000. If an asset is continued in service, depreciation should only be
recorded until the asset's book value equals its estimated salvage value.
For a summary of the three depreciation methods, see Exhibit 6.
I n Exhibit 7, we compare two of the depreciation methods just discussed—straight line and double-declining
balance—using the same example of a machine purchased on 2010 January 1, for USD 54,000. The machine has an
estimated useful life of 10 years and an estimated salvage value of USD 4,000.

An accounting perspective:

Uses of technology

Corporations are subject to corporate income taxes. Also, CPA firms hire many tax professionals to
address the tax matters of their clients. If you have an interest in taxes, you may want to visit the
following website to learn more about taxes:
http://webcast.ey.com/thoughtcenter/default.aspx
This site was created by the CPA firm, Ernst & Young, and has many interesting features. For
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So far we have assumed that the assets were put into service at the beginning of an accounting period and
ignored the fact that often assets are put into service during an accounting period. When assets are acquired during
an accounting period, the first recording of depreciation is for a partial year. Normally, firms calculate the
depreciation for the partial year to the nearest full month the asset was in service. For example, they treat an asset
purchased on or before the 15th day of the month as if it were purchased on the 1st day of the month. And they treat
an asset purchased after the 15th of the month as if it were acquired on the 1st day of the following month.
To compare the calculation of partial-year depreciation, we use a machine purchased for USD 7,600 on 2010
September 1, with an estimated salvage value of USD 400, an estimated useful life of five years, and an estimated
total units of production of 25,000 units.

14
 Exhibit 7: Comparison of straight-line and double-declining-balance depreciation methods

Straight-line method Partial-year depreciation calculations for the straight-line depreciation method are
relatively easy. Begin by finding the 12-month charge by the normal computation explained earlier. Then, multiply
this annual amount by the fraction of the year for which the asset was in use. For example, for the USD 7,600
machine purchased 2010 September 1 (estimated salvage value, USD 400; and estimated useful life, five years), the
annual straight-line depreciation is [(USD 7,600 - USD 400)/5 years] = USD 1,440. The machine would operate for
four months prior to the end of the accounting year, December 31, or one-third of a year. The 2010 depreciation is
(USD 1,440 X 1/3) = USD 480.
Units-of-production method The units-of-production method requires no unusual computations to record
depreciation for a partial year. To compute the partial-year depreciation, multiply the depreciation charge per unit
by the units produced. The charge for a partial year would be less than for a full year because fewer units of goods or
services are produced.
Double-declining-balance method Under the double-declining-balance method, it is relatively easy to
determine depreciation for a partial year and then for subsequent full years. For the partial year, simply multiply
the fixed rate times the cost of the asset times the fraction of the partial year. For example, DDB depreciation on the
USD 7,600 asset for 2010 is (USD 7,600 X 0.4 X 1/3) = USD 1,013. For subsequent years, compute the depreciation
using the regular procedure of multiplying the book value at the beginning of the period by the fixed rate. The 2011
depreciation would be [(USD 7,600 - USD 1,013) X 0.4] = USD 2,635.

An accounting perspective:

Uses of technology

Most companies report property, plant, and equipment as one amount in the balance sheet in their
annual report; however, that account is made up of many items. Computers and accounting
software have simplified record keeping for all of a company's depreciable assets. When
depreciable plant assets are purchased, employees enter in the computer the cost, estimated useful
life, and estimated salvage value of the assets. In addition, they enter the method of depreciation

Introduction to Accounting : The Language of Business – Supplemental Textbook 15

 that the company decides to use on the assets. After processing this information, the computer
calculates the company's depreciation expense and accumulates depreciation for each type of asset
and each individual asset (e.g. a machine).

After depreciating an asset down to its estimated salvage value, a firm records no more depreciation on the asset
even if continuing to use it. At times, a firm finds the estimated useful life of an asset or its estimated salvage value
is incorrect before the asset is depreciated down to its estimated salvage value; then, it computes revised
depreciation charges for the remaining useful life. These revised charges do not correct past depreciation taken;
they merely compensate for past incorrect charges through changed expense amounts in current and future
periods. To compute the new depreciation charge per period, divide the book value less the newly estimated salvage
value by the estimated periods of useful life remaining.
For example, assume that a machine cost USD 30,000, has an estimated salvage value of USD 3,000, and
originally had an estimated useful life of eight years. At the end of the fourth year of the machine's life, the balance
in its accumulated depreciation account (assuming use of the straight-line method) was (USD 30,000 - USD 3,000)
X 4/8 = USD 13,500. At the beginning of the fifth year, a manager estimates that the asset will last six more years.
The newly estimated salvage value is USD 2,700. To determine the revised depreciation per period:
Original cost $ 30,000
Less: Accumulated deprecation at end of 4th year 13,500
Book value at the beginning of 5 th year 16,500
Less: Revised salvage value 2,700
Remaining depreciable cost $13,800
Revised deprecation per period $ 13,000/6 = $2,300

Had this company used the units-of-production method, its revision of the life estimate would have been in
units. Thus, to determine depreciation expense, compute a new per-unit depreciation charge by dividing book value
less revised salvage value by the estimated remaining units of production. Multiply this per unit charge by the
periodic production to determine depreciation expense.
Using the double-declining-balance method, the book value at the beginning of year 5 would be USD 9,492.19
(cost of USD 30,000 less accumulated depreciation of USD 20,507.81). Depreciation expense for year 5 would be
twice the new straight-line rate times book value. The straight-line rate is 100 per cent/6 = 16.67 per cent. So twice
the straight-line rate is 33.33 per cent, or 1/3. Thus, 1/3 X USD 9,492.19 = USD 3,164.06.
APB Opinion No. 12 requires that companies separately disclose the methods of depreciation they use and the
amount of depreciation expense for the period in the body of the income statement or in the notes to the financial
statements. Major classes of plant assets and their related accumulated depreciation amounts are reported as
shown in Exhibit 8.
Showing cost less accumulated depreciation in the balance sheet gives statement users a better understanding of
the percentages of a company's plant assets that have been used up than reporting only the book value (remaining
undepreciated cost) of the assets. For example, reporting buildings at USD 75,000 less USD 45,000 of accumulated
depreciation, resulting in a net amount of USD 30,000, is quite different from merely reporting buildings at USD
30,000. In the first case, the statement user can see that the assets are about 60 per cent used up. In the latter case,
the statement user has no way of knowing whether the assets are new or old.

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 Reed Company
Partial Balance Sheet
2010 June 30
Property, plant, and equipment
Land $ 30,000
Buildings $ 75,000
Less: Accumulated depreciation 45,000 30,000
Equipment $ 9,000
Less: Accumulated depreciation 1,500 7,500
Total property, plant, and equipment $ 67,500

Exhibit 8: Partial balance sheet

An accounting perspective:

Business insight

In their financial statements, companies often provide one amount for property, plant, and
equipment that is net of accumulated depreciation. Nonetheless, notes (footnotes) actually provide
the additional information regarding the separate types of assets. The Limited, Inc. is a world
leader in the design and distribution of numerous lines of women's and men's clothing. For
instance, its 2001 Feb 3, balance sheet showed property, plant, and equipment, net, equal to USD
1,394,619. In a note to the financial statements (slightly modified to clarify), management
explained this amount as follows:
(Dollar amounts in thousands)

Property and Equipment, Net

Property and Equipment, at cost 2000 1999
Land, buildings and improvements $ 362,997 $ 390,121
Furniture, fixtures and equipment 2,079,567 2,020,651
Leaseholds and improvements 655,736 498,232
Construction in progress 46,748 35,823
Total $3,145,048 $2,944,827
Less: accumulated depreciation and amortization 1,750,429 1,715,215
Property and equipment, net $1,394,619 $1,229,612

A misconception Some mistaken financial statement users believe that accumulated depreciation represents
cash available for replacing old plant assets with new assets. However, the accumulated depreciation account
balance does not represent cash; accumulated depreciation simply shows how much of an asset's cost has been
charged to expense. Companies use the plant asset and its contra account, accumulated depreciation, so that data
on the total original acquisition cost and accumulated depreciation are readily available to meet reporting
requirements.
Costs or market values in the balance sheet In the balance sheet, firms report plant assets at original cost
less accumulated depreciation. One of the justifications for reporting the remaining undepreciated costs of the asset
rather than market values is the going-concern concept. The going-concern concept assumes that the company will
remain in business indefinitely, which implies the company will use its plant assets rather than sell them. Generally,
analysts do not consider market values relevant for plant assets in primary financial statements, although they may
be reported in supplemental statements.

17
 A broader perspective:

Wolverine World Wide, Inc.

Introduction to Accounting : The Language of Business – Supplemental Textbook 18

(Dollars in Thousands) 2002 2001
Total current assets $ 349,301 $ 340,978
Property, Plant and Equipment
Land 1,177 1,177
Buildings and improvements 64,848 63,006
Machinery and equipment 117,524 108,094
Software 29,217 22,097
$212,766 $194,374
Less accumulated depreciation 96,483 83,239
Total plant assets $ 116,283 $ 111,135
Other Assets
Goodwill and other intangibles,
less accumulated amortization
(2002-$3,565; 2001-$2,447) 16,178 19,931
Cash value of life insurance 16,443 14,725
Prepaid pension costs 19,099 15,242
Assets held for exchange 7,706 7,942
Notes receivable 4,736 4,921
Other 4,649 6,604
Total other assets $ 68,811 $ 69,365
Total Assets $534,395 $521,478

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1 (In Part): Summary of Significant Accounting Policies
Property, Plant and Equipment
Property, plant and equipment are stated on the basis of cost and include expenditures for new
facilities, major renewals, betterments and software. Normal repairs and maintenance are
expensed as incurred.
Depreciation of plant, equipment and software is computed using the straight-line method. The
depreciable lives for buildings and improvements range from five to forty years; from three to ten
years for machinery and equipment; and from three to ten years for software.
As required, the Company adopted the American Institute of Certified Public Accountants
Statement of Position (SoP) 98-1, Accounting for the Costs of Computer Software Developed and
Obtained for Internal Use, in 1999. The SOP provides guidelines for determining whether costs
should be expensed or capitalized for computer software developed or purchased for internal use.
The Company's accounting policies for such items were already in substantial compliance with SOP
98-1 and, therefore, the adoption did not have a material effect on its 1999 consolidated financial
position or results of operations.

Subsequent expenditures (capital and revenue) on assets

Companies often spend additional funds on plant assets that have been in use for some time. They debit these
expenditures to: (1) an asset account; (2) an accumulated depreciation account; or (3) an expense account.
Expenditures debited to an asset account or to an accumulated depreciation account are capital
expenditures. Capital expenditures increase the book value of plant assets. Revenue expenditures, on the
other hand, do not qualify as capital expenditures because they help to generate the current period's revenues
rather than future periods' revenues. As a result, companies expense these revenue expenditures immediately and
report them in the income statement as expenses.
Betterments or improvements to existing plant assets are capital expenditures because they increase the
quality of services obtained from the asset. Because betterments or improvements add to the service-rendering

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ability of assets, firms charge them to the asset accounts. For example, installing an air conditioner in an
automobile that did not previously have one is a betterment. The debit for such an expenditure is to the asset
account, Automobiles.
Occasionally, expenditures made on plant assets extend the quantity of services beyond the original estimate but
do not improve the quality of the services. Since these expenditures benefit an increased number of future periods,
accountants capitalize rather than expense them. However, since there is no visible, tangible addition to, or
improvement in, the quality of services, they charge the expenditures to the accumulated depreciation account, thus
reducing the credit balance in that account. Such expenditures cancel a part of the existing accumulated
depreciation; firms often call them extraordinary repairs.
To illustrate, assume that after operating a press for four years, a company spent USD 5,000 to recondition the
press. The reconditioning increased the machine's life to 14 years instead of the original estimate of 10 years. The
journal entry to record the extraordinary repair is:
Accumulated Depreciation-Machinery (+A) 5,000
Cash (for Accounts Payable) (-A) 5,000
To record the cost of reconditioning a press.

Originally, the press cost USD 40,000, had an estimated useful life of 10 years, and had no estimated salvage
value. At the end of the fourth year, the balance in its accumulated depreciation account under the straight-line
method is [(USD 40,000/10) X 4] = USD 16,000. After debiting the USD 5,000 spent to recondition the press to
the accumulated depreciation account, the balances in the asset account and its related accumulated depreciation
account are as shown in the last column:
Before After
Extraordinary Extraordinary
Repair Repair
Press $40,000 $40,000
Accumulated depreciation 16,000 11,000
Book value
(end of four years) $24,000 $29,000

In effect, the expenditure increases the carrying amount (book value) of the asset by reducing its contra account,
accumulated depreciation. Under the straight-line method, we would divide the new book value of the press, USD
29,000, equally among the 10 remaining years in amounts of USD 2,900 per year (assuming that the estimated
salvage value is still zero).
As a practical matter, expenditures for major repairs not extending the asset's life are sometimes charged to
accumulated depreciation. This avoids distorting net income by expensing these expenditures in the year incurred.
Then, firms calculate a revised depreciation expense, and spread the cost of major repairs over a number of years.
This treatment is not theoretically correct.
To illustrate, assume the same facts as in the previous example except that the USD 5,000 expenditure did not
extend the life of the asset. Because of the size of this expenditure, the company still charges it to accumulated
depreciation. Now, it would spread the USD 29,000 remaining book value over the remaining six years of the life of
the press. Under the straight-line method, annual depreciation would then be (USD 29,000/6) = USD 4,833.

Introduction to Accounting : The Language of Business – Supplemental Textbook 20

 Exhibit 9: Expenditures on plant assets after acquisition

Accountants treat as expenses those recurring and/or minor expenditures that neither add to the asset's service-
rendering quality nor extend its quantity of services beyond its original estimated useful life. Thus, firms
immediately expense regular maintenance (lubricating a machine) and ordinary repairs (replacing a broken fan belt
on an automobile) as revenue expenditures. For example, a company that spends USD 190 to repair a machine after
using it for some time, debits Maintenance Expense or Repairs Expense.
Low-cost items Most businesses purchase low-cost items that provide years of service, such as
paperweights, hammers, wrenches, and drills. Because of the small dollar amounts involved, it is impractical to use
the ordinary depreciation methods for such assets, and it is often costly to maintain records of individual items.
Also, the effect of low-cost items on the financial statements is not significant. Accordingly, it is more efficient to
record the items as expenses when they are purchased. For instance, many companies charge any expenditure less
than an arbitrary minimum, say, USD 100, to expense regardless of its impact on the asset's useful life. This
practice of accounting for such low unit cost items as expenses is an example of the modifying convention of
materiality. In Exhibit 9, we summarize expenditures on plant assets after acquisition.
In practice, it is difficult to decide whether to debit an expenditure to the asset account or to the accumulated
depreciation account. For example, some expenditures seem to affect both the quality and quantity of services.
Even if the wrong account were debited for the expenditure, the book value of the plant asset at that point would be
the same amount it would have been if the correct account had been debited. However, both the asset and
accumulated depreciation accounts would be misstated.
As an example of the effect of misstated asset and accumulated depreciation accounts, assume Watson Company
had an asset that had originally cost USD 15,000 and had been depreciated to a book value of USD 6,000 at the
beginning of 2010. At that time, Watson estimated the equipment had a remaining useful life of two years. The
company spent USD 4,000 in early January 2010 to install a new motor in the equipment. This motor extended the
useful life of the asset four years beyond the original estimate. Since the expenditure extended the life, the firm
should capitalize it by a debit to the accumulated depreciation account. We show the calculations for depreciation

21
expense if the entry was made correctly and if the expenditure had been improperly charged (debited) to the asset
account in Exhibit 10.
After Expenditure Entry
2010 Jan 1 Correct Incorrect
Cost $15,000 $15,000 $19,000T
Accumulated depreciation 9,000 5,000* 9,000
Book value $ 6,000 $10,000 $10,000
Remaining life 2 years 6 years 6 years
Depreciation expense per year $ 3,000 $ 1,667 $1,667
* ($9,000 - $4,000)
T ($15,000 + $4,000)

Exhibit 10: Expenditure extending plant asset life

If an expenditure that should be expensed is capitalized, the effects are more significant. Assume now that USD
6,000 in repairs expense is incurred for a plant asset that originally cost USD 40,000 and had a useful life of four
years and no estimated salvage value. This asset had been depreciated using the straight-line method for one year
and had a book value of USD 30,000 (USD 40,000 cost—USD 10,000 first-year depreciation) at the beginning of
2010. The company capitalized the USD 6,000 that should have been charged to repairs expense in 2010. The
charge for depreciation should have remained at USD 10,000 for each of the next three years. With the incorrect
entry, however, depreciation increases.
Regardless of whether the repair was debited to the asset account or the accumulated depreciation account, the
firm would change the depreciation expense amount to USD 12,000 for each of the next three years [(USD 30,000
book value + USD 6,000 repairs expense)/3 more years of useful life]. These errors would cause net income for the
year 2010 to be overstated USD 4,000: (1) repairs expense is understated by USD 6,000, causing income to be
overstated by USD 6,000; and (2) depreciation expense is overstated by USD 2,000, causing income to be
understated by USD 2,000. In 2011, the overstatement of depreciation by USD 2,000 would cause 2011 income to
be understated by USD 2,000.
Note that the USD 6,000 recording error affects more than just the expense accounts and net income. Plant
asset and Retained Earnings accounts on the balance sheet also reflect the impact of this error. To see the effect of
incorrectly capitalizing the USD 6,000 to the asset account rather than correctly expensing it, look at Exhibit 11.

Subsidiary records used to control plant assets

Most companies maintain formal records (ranging from handwritten documents to computer tapes) to ensure
control over their plant assets. These records include an asset account and a related accumulated depreciation
account in the general ledger for each major class of depreciable plant assets, such as buildings, factory machinery,
office equipment, delivery equipment, and store equipment.
Because the general ledger account has no room for detailed information about each item in a major class of
depreciable plant assets, many companies use plant asset subsidiary ledgers. Subsidiary ledgers for Accounts
Receivable and Accounts Payable were explained briefly in An accounting perspective in Chapter 4. A company
may also use subsidiary ledgers for plant assets. For instance, assume a company has a general ledger account for
office furniture. The subsidiary ledger for office furniture might contain four separate accounts entitled: Desks,
Chairs, File Cabinets and Bookshelves. Alternatively, a company could even have a separate subsidiary account for
each piece of furniture. The total of all the subsidiary account balances must equal the total of the general ledger
"control" account for Office Furniture at the end of the accounting period. Each general ledger account for each
class of depreciable asset, such as Buildings, Delivery Equipment, and so on, could have a subsidiary ledger backing

Introduction to Accounting : The Language of Business – Supplemental Textbook 22

it up and showing information such as the description, cost, and purchase date for each asset. These subsidiary
ledgers and detailed records provide more information and allow the company to maintain better control over plant
and equipment.
2010
Correctly Incorrectly
Expensing Expensing
Depreciation expense $10,000 $12,000
Repair Expense 6,000 -0-
Net in come overstated by $4,000, which $16,000 $12,000
affects retained earnings
Asset cost $40,000 $46,000
Accumulated depreciation 20,000 22,000
Book value $20,000 $24,000
2011
Correctly Incorrectly
Expensing Expensing
Depreciation expense $10,000 $12,000
Repair Expense -0- -0-
Net in come understated by $2,000, which $10,000 $12,000
affects retained earnings
Asset cost $40,000 $46,000
Accumulated depreciation 30,000 34,000
Book value $10,000 $12,000

Exhibit 11: Effect of revenue expenditure treated as capital expenditure

When they are kept for each major class of plant and equipment, a company may have subsidiary ledgers for
factory machinery, office equipment, and other classes of depreciable plant assets. Then there may be an additional
subsidiary ledger for each type of asset within each category. For example, the subsidiary office equipment ledger
may contain accounts for microcomputers, printers, fax machines, copying machines, and so on. Companies also
keep a detailed record for each item represented in a subsidiary ledger account. For example, there may be a
separate detailed record for each microcomputer represented in the Microcomputer subsidiary ledger account.
Each detailed record should include a description of the asset, identification or serial number, location of the asset,
date of acquisition, cost, estimated salvage value, estimated useful life, annual depreciation, accumulated
depreciation, insurance coverage, repairs, date of disposal, and gain or loss on final disposal of the asset. Note the
detailed record for one particular microcomputer as of 2010 December 31, in Exhibit 12.
To enhance control over plant and equipment, companies stencil on or attach the identification or serial number
to each asset. Periodically, firms must take a physical inventory to determine whether all items in the accounting
records actually exist, whether they are located where they should be, and whether they are still being used. A
company that does not use detailed records and identification numbers or take physical inventories finds it difficult
to determine whether assets have been discarded or stolen.
The general ledger control account balance for each major class of plant and equipment should equal the total of
the amounts in the subsidiary ledger accounts for that class of plant assets. Also, the totals in the detailed records
for a specific subsidiary ledger account (such as Microcomputers) should equal the balance of that account. Each
time a plant asset is acquired, exchanged, or disposed of, the firm posts an entry to both a general ledger control
account and the appropriate subsidiary ledger account. It also updates the detailed record for the items affected.

23
Item Dell Precision M40 Insurance coverage:
Id. No. Z-43806 United Ins. Co.
Location Rm. 403, Adm. bldg. Pol. No. 0052-61481-24
Date acquired 2009 Jan. 1 Amt. $3,000
Cost $3,000 Repairs:
Estimated salvage value $200 2010/6/13 $140
Estimated useful life 4 yrs.
Deprecation per year $700
Accumulated depreciation: ' Disposal date
2009/12/31 $ 700 Gain or loss
2010/12/31 1,400
2011/12/31
2012/12/31

Exhibit 12: Detailed record of a specific plant asset

DEMENT & PEERY, INC.
Consolidated Balance Sheets
2010 December 31 and 2009 (Dollars in millions)
2010 2009
ASSETS
Current Assets:
Cash $ 121 $ 192
Accounts receivable, net of allowance for doubtful accounts of $15 in both 2010 and 2009 379 491
Inventories 247 175
Deposits, prepaid expenses and other 120 58
Total Current Assets $ 867 $ 916
Investments
Equity affiliates 170 277
Other assets 87 63
Property and Equipment - Net 4,153 3,919
Deferred Charges 164 154
Total Assets $5,441 $5,329
Net Operating Earnings $ 560 $ 433

Exhibit 13: Consolidated balance sheets

Analyzing and using the financial results—Rate of return on operating assets

Analyzing the ratios of income statement and balance sheet items from one year to the next can reveal important
trends. Management uses these ratios to measure performance by establishing targets and evaluating results. As an
example, look at Exhibit 13. Analysts use these figures to calculate the ratios and to explain the importance of this
information to management and investors.
To determine the rate of return on operating assets for Dement & Peery for 2009 and 2010, use the
following formula:
Net operating income
Rate of return on operating assets=
Operating assets
2009: USD 433,000/USD 5,329,000 = 8.13 per cent
2010: USD 560,000/USD 5,441,000 = 10.29 per cent
Net operating income is also called net operating earnings or income before interest and taxes. In calculating
Dement & Peery's ratio, we have assumed that all assets are operating assets used in producing operating revenues.
This ratio measures the profitability of the company in carrying out its primary business function. For Dement &
Peery, these figures indicate a slight increase in the earning power of the company in 2010. Net operating income
increased more than proportionately compared to the increase in operating assets. Perhaps this performance
justifies the increase in operating assets.

Introduction to Accounting : The Language of Business – Supplemental Textbook 24

 In this section, you learned how to account for the acquisition of plant assets and depreciation. The next section
(Part 2 below) discusses how to record the disposal of plant assets and how to account for natural resources and
intangible assets.
Understanding the learning objectives
• To be classified as a plant asset, an asset must: (1) be tangible; (2) have a useful service life of more than
one year; and (3) be used in business operations rather than held for resale.
• In accounting for plant assets, accountants must:
(a) Record the acquisition cost of the asset.
(b) Record the allocation of the asset's original cost to periods of its useful life through depreciation.
(c) Record subsequent expenditures on the asset.
(d)Account for the disposal of the asset.
• Accountants consider four major factors in computing depreciation: (1) cost of the asset; (2) estimated
salvage value of the asset; (3) estimated useful life of the asset; and (4) depreciation method to use in
depreciating the asset.
• Straight-line method: Assigns an equal amount of depreciation to each period. The formula for
calculating straight-line depreciation is:
Asset cost – Estimated salvage value
Depreciation per period=
Number of accounting periods∈estimated useful life
• Units-of-production method: Assigns an equal amount of depreciation to each unit of product
manufactured by an asset. The units-of-production depreciation formulas are:
Asset cost – Estimated salvage value
Deprecation per period=
Estimated total units of production service during useful life of asset
Depreciation per period=Depreciation per unit× Number of units of goods / services produced
• Double-declining-balance method: DDB is an accelerated deprecation method. Salvage value is
ignored in making annual calculations. The formula for DDB deprecation is:
Deprecation per period=2×straight−line rate×Asset cost – Accumulated deprecation 
• Capital expenditures are debited to an asset account or an accumulated depreciation account and increase
the book value of plant assets. Expenditures that increase the quality of services or extend the quantity of
services beyond the original estimate are capital expenditures.
• Revenue expenditures are expensed immediately and reported in the income statement as expenses.
Recurring and or minor expenditures that neither add to the asset's quality of service-rendering abilities nor
extend its quantity of services beyond the asset's original estimated useful life are expenses.
• Plant asset subsidiary ledgers contain detailed information that cannot be maintained in the general ledger
account about each item in a major class of depreciable plant assets.
• Control over plant and equipment is enhanced by plant asset subsidiary ledgers and other detailed records.
Information in a detailed record may include a description of the asset, identification or serial number,
location of the asset, date of acquisition, cost, estimated salvage value, estimated useful life, annual
depreciation, accumulated depreciation, insurance coverage, repairs, date of disposal, and gain or loss on final
disposal of the asset. A periodic physical inventory should be taken to determine whether items in accounting
records actually exist and are still being used at the proper location.

25
 • To calculate the rate of return on operating assets, divide net operating income by operating assets. This
ratio helps management determine how effectively it used assets to produce a profit.
Demonstration problem
Demonstration problem A Cleveland Company purchased a 2-square-mile farm under the following terms:
cash paid, USD 486,000; mortgage note assumed, USD 240,000; and accrued interest on mortgage note assumed,
USD 6,000. The company paid USD 55,200 for brokerage and legal services to acquire the property and secure
clear title. Cleveland planned to subdivide the property into residential lots and to construct homes on these lots.
Clearing and leveling costs of USD 21,600 were paid. Crops on the land were sold for USD 14,400. A house on the
land, to be moved by the buyer of the house, was sold for USD 5,040. The other buildings were torn down at a cost
of USD 9,600, and salvaged material was sold for USD 10,080.
Approximately 6 acres of the land were deeded to the township for roads, and another 10 acres was deeded to
the local school district as the site for a future school. After the subdivision was completed, this land would have an
approximate value of USD 7,680 per acre. The company secured a total of 1,200 salable lots from the remaining
land.
Present a schedule showing in detail the composition of the cost of the 1,200 salable lots.
Demonstration problem B Calvin Company acquired and put into use a machine on 2010 January 1, at a
total cost of USD 45,000. The machine was estimated to have a useful life of 10 years and a salvage value of USD
5,000. It was also estimated that the machine would produce one million units of product during its life. The
machine produced 90,000 units in 2010 and 125,000 units in 2011.
Compute the amounts of depreciation to be recorded in 2010 and 2011 under each of the following:
a. Straight-line method.
b. Units-of-production method.
c. Double-declining-balance method.
d. Assume 30,000 units were produced in the first quarter of 2010. Compute depreciation for this quarter under
each of the three methods.
Solution to demonstration problem
Solution to demonstration problem A
CLEVELAND COMPANY
Schedule of Cost of 1,200 Residential Lots
Costs incurred:
Cash paid $486,000
Mortgage note assumed 240,000
Interest accrued on mortgage note
assumed 6,000
Broker and legal services 55,200
Clearing and leveling costs incurred 21,600
Tearing down costs 9,600 $818,400
Less proceeds from sale of:
Crops $ 14,400
House 5,040
Salvaged materials 10,080 29,520
Net cost of land to be subdivided into
1,200 lots $788,880

Solution to demonstration problem B

a. Straight-line method:

Introduction to Accounting : The Language of Business – Supplemental Textbook 26

 USD 45,000 – USD 5,000
2010: =USD 4,000
10
USD 45,000 – USD 5,000
2011: =USD 4,000
10
b. Units-of-production method:
USD 45,000 – USD 5,000
2010: ×90,000=USD 3,600
1,000,000
USD 45,000 – USD 5,000
2011: ×125,000= USD 5,000
1,000,000
c. Double-declining-balance method:
2010: USD 45,000×20 per cent=USD 9,000
2011: USD 45,000 – USD 9,000×20 per cent= USD 7,200
USD 45,000 – USD 5,000  1
d. Straight-line: × =USD 1,000
10 4
Units-of-production: (USD 30,000 – USD 0.04) = USD 1,200
1
Double-declining-balance: USD 45,000 – USD 9,000 – USD 7,000×0.2× =USD 1,440
4

Key terms
Accelerated depreciation methods Record higher amounts of depreciation during the early years of an
asset's life and lower amounts in later years.
Acquisition cost Amount of cash and/or cash equivalents given up to acquire a plant asset and place it in
operating condition at its proper location.
Appraised value An expert's opinion as to what an item's market price would be if the item were sold.
Betterments (improvements) Capital expenditures that are properly charged to asset accounts because
they add to the service-rendering ability of the assets; they increase the quality of services obtained from an
asset.
Book value An asset's recorded cost less its accumulated depreciation.
Capital expenditures Expenditures debited to an asset account or to an accumulated depreciation
account.
Depreciation The amount of plant asset cost allocated to each accounting period benefiting from the plant
asset's use. The straight-line depreciation method charges an equal amount of plant asset cost to each
period. The units-of-production depreciation method assigns an equal amount of depreciation for each
unit of product manufactured or service rendered by an asset. The double-declining-balance (DDB)
method assigns decreasing amounts of depreciation to successive periods of time.
Double-declining-balance (DDB) depreciation See depreciation.
Extraordinary repairs Expenditures that cancel a part of the existing accumulated depreciation because
they increase the quantity of services expected from an asset.
Fair market value The price that would be received for an item being sold in the normal course of business
(not at a forced liquidation sale).
Inadequacy The inability of a plant asset to produce enough products or provide enough services to meet
current demands.
Land improvements Attachments to land, such as driveways, landscaping, parking lots, fences, lighting
systems, and sprinkler systems, that have limited lives and therefore are depreciable.
Low-cost items Items that provide years of service at a relatively low unit cost, such as hammers,
paperweights, and drills.
Obsolescence Decline in usefulness of an asset brought about by inventions and technological progress.
Physical deterioration Results from use of the asset—wear and tear—and the action of the elements.
Plant and equipment A shorter title for property, plant, and equipment; also called plant assets. Included
are land and manufactured or constructed assets such as buildings, machinery, vehicles, and furniture.

27
 Rate of return on operating assets Net operating income/Operating assets. This ratio helps
management determine how effectively it used assets to produce a profit.
Revenue expenditures Expenditures (on a plant asset) that are immediately expensed.
Salvage value The amount of money the company expects to recover, less disposal costs, on the date a plant
asset is scrapped, sold, or traded in. Also called scrap value or residual value.
Straight-line depreciation See depreciation.
Tangible assets Assets that we can see and touch such as land, buildings, and equipment.
Units-of-production depreciation See depreciation.
Useful life Refers to the length of time the company owning the asset intends to use it.
Self-test
True-false
Indicate whether each of the following statements is true or false.
The cost of land includes its purchase price and other related costs, including the cost of removing an old
unusable building that is on the land.
Depreciation is the process of valuation of an asset to arrive at its market value.
The purpose of depreciation accounting is to provide the cash required to replace plant assets.
Expenditures made on plant assets that increase the quality of services are debited to the accumulated
depreciation account.
Plant asset subsidiary ledgers are used to increase control over plant assets.
Multiple-choice
Select the best answer for each of the following questions.
O n 2010 January 1, Jackson Company purchased equipment for USD 400,000, and installation and testing
costs totaled USD 40,000. The equipment has an estimated useful life of 10 years and an estimated salvage value of
USD 40,000. If Jackson uses the straight-line depreciation method, the depreciation expense for 2010 is:
a. USD 36,000.
b. USD 40,000.
c. USD 44,000.
d. USD 80,000.
e. USD 88,000.
In Question 1, if the equipment were purchased on 2010 July 1, and Jackson used the double-declining-balance
method, the depreciation expense for 2010 would be:
a. USD 88,000.
b. USD 72,000.
c. USD 36,000.
d. USD 44,000.
e. USD 40,000.
Hatfield Company purchased a computer on 2008 January 2, for USD 10,000. The computer had an estimated
salvage value of USD 3,000 and an estimated useful life of five years. At the beginning of 2010, the estimated
salvage value changed to USD 1,000, and the computer is expected to have a remaining useful life of two years.
Using the straight-line method, the depreciation expense for 2010 is:
a. USD 1,400.

Introduction to Accounting : The Language of Business – Supplemental Textbook 28

b. USD 1,750.
c. USD 2,250.
d. USD 1,800.
e. USD 3,100.
The result of recording a capital expenditure as a revenue expenditure is an:
a. Overstatement of current year's expense.
b. Understatement of current year's expense.
c. Understatement of subsequent year's net income.
d. Overstatement of current year's net income.
e. None of the above.
Now turn to “Answers to self-test” at the end of the chapter to check your answers.

Questions
➢ What is the main distinction between inventory and a plant asset?
➢ Which of the following items are properly classifiable as plant assets on the balance sheet?
➢ Advertising that will appear in the future to inform the public about new energy-saving programs
at a manufacturing plant.
➢ A truck acquired by a manufacturing company to be used to deliver the company's products to
wholesalers.
➢ An automobile acquired by an insurance company to be used by one of its salespersons.
➢ Adding machines acquired by an office supply company to be sold to customers.
➢ The cost of constructing and paving a driveway that has an estimated useful life of 10 years.
➢ In general terms, what does the cost of a plant asset include?
➢ In what way does the purchase of a plant asset resemble the prepayment of an expense?
➢ Brown Company purchased an old farm with a vacant building as a factory site for USD 1,040,000.
Brown decided to use the building in its operations. How should Brown allocate the purchase price
between the land and the building? How should this purchase be handled if the building is to be torn
down?
➢ Describe how a company may determine the cost of a self-constructed asset.
➢ In any exchange of noncash assets, the accountant's task is to find the most appropriate valuation for
the asset received. What is the general rule for determining the most appropriate valuation in such a
situation?
➢ Why should periodic depreciation be recorded on all plant assets except land?
➢ Define the terms inadequacy and obsolescence as used in accounting for depreciable plant assets.
➢ What four factors must be known to compute depreciation on a plant asset? How objective is the
calculation of depreciation?
➢ A friend, Mindy Jacobs, tells you her car depreciated USD 5,000 last year. Explain whether her
concept of depreciation is the same as the accountant's concept.
➢ What does the term accelerated depreciation mean? Give an example showing how depreciation is
accelerated.

29
 ➢ Provide a theoretical reason to support using an accelerated depreciation method.
➢ Nancy Company purchased a machine that originally had an estimated eight years of useful life. At
the end of the third year, Nancy determined that the machine would last only three more years. Does
this revision affect past depreciation taken?
➢ What does the balance in the accumulated depreciation account represent? Does this balance
represent cash that can be used to replace the related plant asset when it is completely depreciated?
➢ What is the justification for reporting plant assets on the balance sheet at undepreciated cost (book
value) rather than market value?
➢ Distinguish between capital expenditures and revenue expenditures.
➢ For each of the following, state whether the expenditure made should be charged to an expense, an
asset, or an accumulated depreciation account:
➢ Cost of installing air-conditioning equipment in a building that was not air-conditioned.
➢ Painting of an owned factory building every other year.
➢ Cost of replacing the roof on a 10-year-old building that was purchased new and has an
estimated total life of 40 years. The expenditure did not extend the life of the asset beyond the
original estimate.
➢ Cost of repairing an electric motor. The expenditure extended the estimated useful life beyond
the original estimate.
➢ Indicate which type of account (asset, accumulated depreciation, or expense) would be debited for
each of the following expenditures:
➢ Painting an office building at a cost of USD 1,000. The building is painted every year.
➢ Adding on a new plant wing at a cost of USD 24,000,000.
➢ Expanding a paved parking lot at a cost of USD 144,000.
➢ Replacing a stairway with an escalator at a cost of USD 20,000.
➢ Replacing the transmission in an automobile at a cost of USD 1,600, thus extending its useful life
two years beyond the original estimate.
➢ Replacing a broken fan belt at a cost of USD 600.
➢ How do subsidiary records provide control over a company's plant assets?
➢ What advantages can accrue to a company that maintains plant asset subsidiary records?
➢ Real world question Based on the financial statements and the notes to those statements of The
Limited, Inc., contained in the Annual report appendix, what was the 2000 ending net property and
equipment balance? Did the company acquire any of these assets in 2000? What depreciation
method did the company use?
Exercises
Exercise A Stephon Company paid USD 640,000 cash for a tract of land on which it plans to erect a new
warehouse, and paid USD 8,000 in legal fees related to the purchase. Stephon also agreed to assume responsibility
for USD 25,600 of unpaid taxes on the property. The company incurred a cost of USD 28,800 to remove an old
apartment building from the land. Prepare a schedule showing the cost of the land acquired.

Introduction to Accounting : The Language of Business – Supplemental Textbook 30

 Exercise B Laural Company paid USD 840,000 cash for real property consisting of a tract of land and a
building. The company intended to remodel and use the old building. To allocate the cost of the property acquired,
Laural had the property appraised. The appraised values were as follows: land, USD 576,000, and office building,
USD 384,000. The cost of clearing the land was USD 18,000. The building was remodeled at a cost of USD 76,800.
The cost of a new identical office building was estimated to be USD 432,000. Prepare a schedule showing the cost of
the assets acquired.
Exercise C Fine Company purchased a heavy machine to be used in its factory for USD 720,000, less a 2 per
cent cash discount. The company paid a fine of USD 3,600 because an employee hauled the machine over city
streets without securing the required permits. The machine was installed at a cost of USD 21,600, and testing costs
of USD 7,200 were incurred to place the machine in operation. Prepare a schedule showing the recorded cost of the
machine.
Exercise D A machine is acquired in exchange for 50 shares of Marley Corporation capital stock. The stock
recently traded at USD 400 per share. The machine cost USD 30,000 three years ago. At what amount should the
machine be recorded?
Exercise E Keely Company purchased some office furniture for USD 29,760 cash on 2009 March 1. It also paid
USD 480 cash for freight costs incurred. The furniture is being depreciated over four years under the straight-line
method, assuming a salvage value of USD 1,440. The company employs a calendar-year accounting period. On 2010
July 1, it spent USD 192 to refinish the furniture. Prepare journal entries for the Keely Company to record all of the
data, including the annual depreciation adjustments through 2010.
Exercise F On 2009 January 2, a new machine was acquired for USD 900,000. The machine has an estimated
salvage value of USD 100,000 and an estimated useful life of 10 years. The machine is expected to produce a total of
500,000 units of product throughout its useful life. Compute depreciation for 2009 and 2010 using each of the
following methods:
a. Straight line.
b. Units of production (assume 30,000 and 60,000 units were produced in 2009 and 2010, respectively).
c. Double-declining balance.
Exercise G Terrill Company finds its records are incomplete concerning a piece of machinery used in its plant.
According to the company records, the machinery has an estimated useful life of 10 years and an estimated salvage
value of USD 24,000. It has recorded USD 12,000 in depreciation each year using the straight-line method. If the
accumulated depreciation account shows a balance of USD 72,000, what is the original cost of the machinery and
how many years remain to be depreciated?
Exercise H Katherine Company purchased a machine on 2009 April 1, for USD 72,000. The machine has an
estimated useful life of five years with no expected salvage value. The company's accounting year ends on December
31.
Compute the depreciation expense for 2009 and 2010 under the double-declining-balance method.
Exercise I Australia Company purchased a machine for USD 3,200 and incurred installation costs of USD 800.
The estimated salvage value of the machine is USD 200. The machine has an estimated useful life of four years.
Compute the annual depreciation charges for this machine under the double-declining-balance method.
Exercise J Regal Company acquired a delivery truck on 2009 January 2, for USD 107,200. The truck had an
estimated salvage value of USD 4,800 and an estimated useful life of eight years. At the beginning of 2009, a

31
revised estimate shows that the truck has a remaining useful life of six years. The estimated salvage value changed
to USD 1,600.
Compute the depreciation charge for 2009 and the revised depreciation charge for 2009 using the straight-line
method.
Exercise K Assume that the truck described in the previous exercise was used 40 per cent of the time in 2010
to haul materials used in the construction of a building by Regal Company for its own use. (Remember that 2010 is
before the revision was made on estimated life.) During the remaining time, Regal used the truck to deliver
merchandise to its customers.
Prepare the journal entry to record straight-line depreciation on the truck for 2010.
Exercise L Vineland Company purchased a computer for USD 60,000 and placed it in operation on 2008
January 2. Depreciation was recorded for 2008 and 2009 using the straight-line method, a six-year life, and an
expected salvage value of USD 2,400. The introduction of a new model of this computer in 2010 caused the
company to revise its estimate of useful life to a total of four years and to reduce the estimated salvage value to zero.
Compute the depreciation expense on the computer for 2010.
Exercise M On 2009 January 2, a company purchased and placed in operation a new machine at a total cost of
USD 60,000. Depreciation was recorded on the machine for 2009 and 2010 under the straight-line method using
an estimated useful life of five years and no expected salvage value. Early in 2011, the machine was overhauled at a
cost of USD 20,000. The estimated useful life of the machine was revised upward to a total of seven years.
Compute the depreciation expense on the machine for 2011.
Exercise N Lasky Company purchased a machine on 2009 January 3, at a cost of USD 50,000. It debited
freight and installation charges of USD 10,000 to Repairs Expense. It recorded straight-line depreciation on the
machine in 2009 and 2010 using an estimated life of 10 years and no expected salvage value.
Compute the amount of the error in net income for 2009 and 2010, and state whether net income is understated
or overstated.
Exercise O Bragg Company owns a plant asset that originally cost USD 240,000 in 2006 The asset has been
depreciated for three years assuming an eight-year useful life and no salvage value. During 2009, Bragg incorrectly
capitalized USD 120,000 in repairs on the plant asset rather than expensing them. Describe the impact of this error
on the asset's cost and Bragg's net income over the next five years.
Problems
Problem A Bolt Company purchased a machine for use in its operations that had an invoice price of USD
80,000 excluding sales tax. A 4 per cent sales tax was levied on the sale. Terms were net 30. The company
estimated the total cost of hauling the machine from the dealer's warehouse to the company's plant at USD 5,600,
which did not include a fine of USD 1,600 for failure to secure the necessary permits to use city streets in
transporting the machine. In delivering the machine to its plant, a Bolt employee damaged the truck used; repairs
cost USD 3,600. The machine was also slightly damaged with repair costs amounting to USD 1,600.
Bolt incurred installation costs of USD 32,000 that included the USD 4,000 cost of shoring up the floor under
the machine. Testing costs amounted to USD 2,400. Safety guards were installed on the machine at a cost of USD
640, and the machine was placed in operation.
Prepare a schedule showing the amount at which the machine should be recorded in Bolt's accounts.

Introduction to Accounting : The Language of Business – Supplemental Textbook 32

 Problem B Pressler Company planned to erect a new factory building and a new office building in Atlanta,
Georgia, USA. A report on a suitable site showed an appraised value of USD 180,000 for land and orchard and USD
120,000 for a building.
After considerable negotiation, the company and the owner reached the following agreement: Pressler Company
was to pay USD 216,000 in cash, assume a USD 90,000 mortgage note on the property, assume the interest of USD
1,920 accrued on the mortgage note, and assume unpaid property taxes of USD 13,200. Pressler Company paid
USD 18,000 cash for brokerage and legal services in acquiring the property.
Shortly after acquisition of the property, Pressler Company sold the fruit on the trees for USD 2,640, remodeled
the building into an office building at a cost of USD 38,400, and removed the trees from the land at a cost of USD
9,000. Construction of the factory building was to begin in a week.
Prepare schedules showing the proper valuation of the assets acquired by Pressler Company.
Problem C Timothy Company acquired and placed into use a heavy factory machine on 2009 October 1. The
machine had an invoice price of USD 360,000, but the company received a 3 per cent cash discount by paying the
bill on the date of acquisition. An employee of Timothy Company hauled the machine down a city street without a
permit. As a result, the company had to pay a USD 1,500 fine. Installation and testing costs totaled USD 35,800.
The machine is estimated to have a USD 35,000 salvage value and a seven-year useful life. (A fraction should be
used for the DDB calculation rather than a percentage.)
a. Prepare the journal entry to record the acquisition of the machine.
b. Prepare the journal entry to record depreciation for 2009 under the double-declining balance method.
c. Assume Timothy Company used the straight-line depreciation method. At the beginning of 2009, it estimated
the machine will last another six years. Prepare the journal entry to record depreciation for 2009. The estimated
salvage value would not change.
Problem D Peach Company has the following entries in its Building account:

33
 Debits
2009
May 5 Cost of land and building purchased $200,000
5 Broker fees incident to purchase of land and building 12,000
2010
Jan. 3 Contract price of new wing added to south end 84,000
15 Cost of new machinery, estimated life 10 years 160,000
June 10 Real estate taxes for six months ended 2010/6/30 3,600
Aug. 10 Cost of building parking lot for employees in back of building 4,960
Sept. 6 Replacement of windows broken in August 160
Oct. 10 Repairs due to regular usage 2,240
Credits
2009
May 24 Transfer to Land account, per allocation of purchase cost
authorized in minutes of board of directors 32,000
2010
Jan. 5 Proceeds from leases of second floor for six months ended
2009/12/31 8,000

Peach acquired the original property on 2009 May 5. Orange immediately engaged a contractor to construct a
new wing on the south end of the building. While the new wing was being constructed, the company leased the
second floor as temporary warehouse space to Kellett Company. During this period (July 1 to 2009 December 31),
the company installed new machinery costing USD 160,000 on the first floor of the building. Regular operations
began on 2010 January 2.
a. Compute the correct balance for the Buildings account as of 2010 December 31. The company employs a
calendar-year accounting period.
b. Prepare the necessary journal entries to correct the records of Peach Company at 2010 December 31. No
depreciation entries are required.
Problem E Cardine Company acquired and placed into use equipment on 2009 January 2, at a cash cost of
USD 935,000. Transportation charges amounted to USD 7,500, and installation and testing costs totaled USD
55,000.
The equipment was estimated to have a useful life of nine years and a salvage value of USD 37,500 at the end of
its life. It was further estimated that the equipment would be used in the production of 1,920,000 units of product
during its life. During 2009, 426,000 units of product were produced.
Compute the depreciation to the nearest dollar for the year ended December 31, using:
a. Straight-line method.
b. Units-of-production method.
c. Double-declining-balance method (use a fraction rather than a percentage).
Problem F Goodrich Company purchased a machine on 2009 October 1 for USD 100,000. The machine has an
estimated salvage value of USD 30,000 and an estimated useful life of eight years.
Compute to the nearest dollar the amount of depreciation Goodrich should record on the machine for the years
ending 2009 December 31, and 2010, under each of the following methods:

Introduction to Accounting : The Language of Business – Supplemental Textbook 34

 a. Straight-line.
b. Double-declining-balance.
Alternate problems
Alternate problem A Brite Company purchased a machine that had an invoice price of USD 400,000
excluding sales tax. Terms were net 30. A 4 per cent sales tax was levied on the sale. The company incurred and
paid freight costs of USD 10,000. Special electrical connections were run to the machine at a cost of USD 14,000
and a special reinforced base for the machine was built at a cost of USD 18,000. The machine was dropped and
damaged while being mounted on this base. Repairs cost USD 4,000. Raw materials with a cost of USD 1,000 were
consumed in testing the machine. Safety guards were installed on the machine at a cost of USD 1,400, and the
machine was placed in operation. In addition, USD 500 of costs were incurred in removing an old machine.
Prepare a schedule showing the amount at which the machine should be recorded in Brite Company's account.
Alternate problem B Maxwell Company purchased 2 square miles of farmland under the following terms:
USD 968,000 cash; and liability assumed on mortgage note of USD 320,000 and interest accrued on mortgage note
assumed, USD 12,800. The company paid USD 67,200 of legal and brokerage fees and also paid USD 3,200 for a
title search on the property.
The company planned to use the land as a site for a new office building and a new factory. Maxwell paid clearing
and leveling costs of USD 28,800. It sold crops on the land for USD 7,360 and sold one of the houses on the
property for USD 19,200. The other buildings were torn down at a cost of USD 14,400; sale of salvaged materials
yielded cash proceeds of USD 13,600. Approximately 1 per cent of the land acquired was deeded to the county for
roads. The cost of excavating a basement for the office building amounted to USD 9,120.
Prepare a schedule showing the amount at which the land should be carried on Maxwell Company's books.
Alternate problem C Dawson Towing Company purchased a used panel truck for USD 28,800 cash. The next
day the company's name and business were painted on the truck at a total cost of USD 1,488. The truck was then
given a minor overhaul at a cost of USD 192, and new "super" tires were mounted on the truck at a cost of USD
1,920, less a trade-in allowance of USD 240 for the old tires. The truck was placed in service on 2009 April 1, at
which time it had an estimated useful life of five years and a salvage value of USD 3,360.
a. Prepare a schedule showing the cost to be recorded for the truck.
b. Prepare the journal entry to record depreciation at the end of the calendar-year accounting period, 2009
December 31. Use the double-declining-balance method.
c. Assume that the straight-line depreciation method has been used. At the beginning of 2009 it is estimated the
truck will last another four years. The estimated salvage value changed to USD 1,920. Prepare the entry to record
depreciation for 2012.
Alternate problem D You are the new controller for Jayson Company, which began operations on 2009
October 1, after a start-up period that ran from the middle of 2008. While reviewing the accounts, you find an
account entitled "Fixed Assets", which contains the following items:
Cash paid to previous owner of land and old buildings $ 192,000
Cash given to construction company as partial payment for the new building 72,000
Legal and title search fees 2,400
Real estate commission 14,400
Cost of demolishing old building 16,800
Cost of leveling and grading 9,600
Architect's fee (90% of building and 10% improvements) 6,000
Cost of excavating (digging) basement for new building 21,600

35
Cash paid to construction company for new building 288,000
Repair damage done by vandals 7,200
Sprinkler system for lawn 31,200
Lighting system for parking lot 40,800
Paving of parking lot 60,000
Net invoice price of machinery 1,152,000
Freight cost incurred on machinery 50,400
Installation and testing of machinery 19,200
Medical bill paid for employee injured in installing machinery 3,600
Landscaping (permanent) 38,400
Repair damage to building in installation of machinery 4,800
Special assessment paid to city for water mains and sewer line 45,600
Account balance $2,106,000

In addition, you discover that cash receipts of USD 1,200 from selling materials salvaged from the old building
were credited to Miscellaneous Revenues in 2009. Digging deeper, you find that the plant manager spent all of his
time for the first nine months of 2009 supervising installation of land improvements (10 per cent), building
construction (40 per cent), and installation of machinery (50 per cent). The plant manager's nine-month salary of
USD 108,000 was debited to Officers' Salaries Expense.
a. List all items on a form containing columns for Land, Land Improvements, Building, and Machinery. Sort the
items into the appropriate columns, omitting those items not properly included as an element of asset cost. Show
negative amounts in parentheses. Total your columns.
b. Prepare one compound journal entry to reclassify and adjust the accounts and to eliminate the Fixed Assets
account. Do not attempt to record depreciation for the partial year.
Alternate problem E Land Company acquired and put into use a machine on 2009 January 1, at a cash cost of
USD 120,000 and immediately spent USD 5,000 to install it. The machine had an estimated useful life of eight
years and an estimated salvage value of USD 15,000 at the end of this time. It was further estimated that the
machine would produce 500,000 units of product during its life. In the first year, the machine produced 100,000
units.
Prepare journal entries to record depreciation to the nearest dollar for 2009, using:
a. Straight-line method.
b. Units-of-production method.
c. Double-declining-balance method.
Alternate problem F Crawford Company paid USD 60,000 for a machine on 2009 April 1, and placed it in
use on that same date. The machine has an estimated life of 10 years and an estimated salvage value of USD 10,000.
Compute the amount of depreciation to the nearest dollar the company should record on this asset for the years
ending 2009 December 31, and 2010, under each of the following methods:
a. Straight-line.
b. Double-declining-balance.
Beyond the numbers—Critical thinking
Business decision case A You are a new staff auditor assigned to audit Cray Company's Buildings account.
You determine that Cray Company made the following entries in its Buildings account in 2009:
Debits
2009
Jan. 2 Cost of land and old buildings purchased $ 720,000
2 Legal fees incident to purchase 9,600
2 Fee for title search 1,200
12 Cost of demolishing old buildings on land 19,200
June 16 Cost of insurance during construction of new building 4,800

Introduction to Accounting : The Language of Business – Supplemental Textbook 36

July 30 Payment to contractor on completion of new building 1,080,000
Aug. 5 Architect's fees for design of new building 48,000
Sept. 15 City assessment for sewers and sidewalks (considered permanent) 16,800
Oct. 6 Cost of landscaping (considered permanent) 9,600
Nov. 1 Cost of driveways and parking lots 60,000
Credits
Jan. 15 Proceeds received upon sale of salvaged materials from old
buildings 4,800

In addition to the entries in the account, you obtained the following information in your interview with the
accountant in charge of the Buildings account:
The company began using the new building on 2009 September 1. The building is estimated to have a 40-year
useful life and no salvage value.
The company began using the driveways and parking lots on 2009 November 1. The driveways and parking lots
have an estimated 10-year useful life and no salvage value.
The company uses the straight-line depreciation method to depreciate all of its plant assets.
Using all of this information, do the following:
a. Prepare a schedule that shows the separate cost of land, buildings, and land improvements.
b. Compute the amount of depreciation expense for 2009.
c. Complete the journal entries required to correct the accounts at 2009 December 31. Assume that closing
entries have not been made.
d. Write a brief statement describing to management why depreciation must be recorded and how recording
depreciation affects net income.
Business decision case B On 2010 October 1, Besler Company acquired and placed into use new equipment
costing USD 504,000. The equipment has an estimated useful life of five years and an estimated salvage value of
USD 24,000. Besler estimates that the equipment will produce 2 million units of product during its life. In the last
quarter of 2010, the equipment produced 120,000 units of product. As the company's accountant, management has
asked you to do the following:
a. Compute the depreciation for the last quarter of 2010, using each of the following methods:
Straight-line.
Units-of-production.
Double-declining-balance.
b. Prepare a written report describing the conditions in which each of these four methods would be most
appropriate.
Business decision case C The notes to the financial statements of Wolverine World Wide, Inc., in "A Broader
Perspective", stated that substantially all fixed assets are depreciated using the straight-line method. Explain why
the straight-line method of depreciation may be appropriate for this company.
Business decision case D Discuss the meaning of rate of return on operating assets, its elements, and what it
means to investors and management.
Calculate the rate of return on operating assets for The Limited in the Annual report appendix for the two most
recent years. Assume all assets are operating assets. Comment on the results.
Annual report analysis E The following footnote excerpted from a recent annual report of Kerr-McGee
Corporation describes the company's accounting policies for property, plant, and equipment:

37
 Property, plant, and equipment is depreciated over its estimated life by the unit-of-production or the straight-
line-method.
a. How many different depreciation methods are used by Kerr-McGee Corporation? Does this practice conform
with generally accepted accounting principles?
b. Discuss why management might select each of these methods to depreciate plant assets.
Group project F In a group of two or three students, visit a large company in your community and inquire
about the subsidiary records it maintains to establish accounting control over its plant assets. Also inquire about
physical controls used to protect its equipment that is movable, such as computers, copy machines, and so on.
Write a report to your instructor summarizing your findings and be prepared to give a short report to your class.
Group project G With a team of two or three students, visit two companies in your community to inquire
about why they use certain depreciation methods. Try to locate companies that use several depreciation methods in
accounting for various depreciable fixed assets. Interview those who made the decision as to methods to use to find
out the reasons for their choices. Write a report to your instructor summarizing your findings.
Group project H In a small group of students, visit a large company in your community to determine how it
decides to account for expenditures on fixed assets made after the assets have been in use for some time. In other
words, how does it decide whether to debit the asset account, the accumulated depreciation account, or an expense
account? What role does materiality play in the decision? Evaluate the reasonableness of the decision model used.
Write a report to your instructor summarizing your findings and be prepared to make a short presentation to your
class.
Using the Internet—A view of the real world
Visit the CPA Review site at:
http://www.beckerconviser.com
Investigate this site. Identify the major types of employers. Make note of any interesting information at this site.
Write a report to your instructor summarizing your findings. Be prepared to make a short presentation to the class.
Visit the Best Software website at:
http://www.bestsoftware.com
What types of software does the company sell? Why might a company buy a software package from Best
Software? Study any other aspect of the information that looks interesting. Write a report to your instructor
summarizing your findings.
Answers to self-test
True-false
True. The cost of land includes all normal, reasonable, and necessary expenditures to obtain the land and get it
ready for use.
False. Depreciation is a process of allocation, not valuation, and the book value of an asset has little to do with
its market value.
False. Depreciation accounting does not provide funds required to replace plant assets. Instead, accumulated
depreciation simply shows how much of an asset's cost has been charged to expense since the asset was acquired.
False. Expenditures that improve the quality of services are charged to the asset account.

Introduction to Accounting : The Language of Business – Supplemental Textbook 38

 True. Plant asset subsidiary ledgers provide detailed information that the general ledger account cannot
provide and thus give better control over plant assets.
Multiple-choice
b. The depreciation expense for 2010 using the straight-line method is computed as follows:
USD 440,000− USD 40,000
=USD 40,000
10
100 per cent
d. Double-declining balance rate = 2× =20 per cent
10
6
Depreciation expense for 2010 = 2 per cent×USD 440,000× =USD 44,000
12
e. At the beginning of 2010, the balance of accumulated depreciation is USD 2,800 (annual depreciation of USD
1,400 X 2) and book value is USD 7,200, or (USD 10,000 - USD 2,800). The revised annual depreciation expense is
USD 7,200−USD 1,000
USD 3,100, or [ ¿ .
2
a. The error in recording a capital expenditure as a revenue expenditure results in an overstatement of current
year's expense, as well as an understatement of current year's net income.

39
Chapter 8: Part 2

Plant asset disposals, natural resources, and intangible assets

Learning objectives
After studying this section, you should be able to:
• Calculate and prepare entries for the sale, retirement, and destruction of plant assets.
• Describe and record exchanges of nonmonetary assets.
• Determine the periodic depletion cost of a natural resource and calculate depreciation of plant assets located
on extractive industry property.
• Prepare entries for the acquisition and amortization of intangible assets.
• Analyze and use the financial results-total assets turnover.

A company accountant's role in measuring intangibles

Many assets have no physical substance. These assets are referred to as intangible. Even though these assets
have no substance, the accountant still must spend time measuring the value of these assets to corporation and how
these assets contribute to the cash flow of the entity.
The accountant must first place a value on something that cannot be seen by the naked eye. Then the accountant
must determine if the asset is making a contribution toward cash flow of the entity (if so and how long) and finally,
the accountant must determine if and when this benefit has indeed expired.
As we move ever more toward an information based economy, the per cent of intangible assets to total assets
also increases. In many cases, intangible assets compose a significant majority of total assets. Thus, the earning
power of such companies is primarily based on the valuation of assets that cannot be seen or touched. Some
intangible assets, such as human assets and internally generated intangibles, are not even recorded on the
company's books. This makes it even more difficult to value the assets and determine their contribution to earnings.
Investors and analysts often compare book value per share with the market price per share for a corporation.
This ratio is referred to as the price to book ratio (PB). It measures the market's beliefs about the value of net assets
as compared to the recorded amount of net assets. In 1998 Tootsie Roll had a PB ratio of approximately 5.2. The
recorded net assets were approximately USD 400 million, yet the market perceived Tootsie Roll to have net assets
worth over USD 2,000 million. What is the nature of those unrecorded (intangible) assets? In 1998, Microsoft had a
PB ratio of approximately 12.4. The real value of Microsoft's net assets exceeded those reported in the accounting
records by a factor of 12.4. It is reasonable to assume that a large portion of the unrecorded assets of Microsoft must
be intangible. How does the accountant value something that has no physical substance and in many cases has not
been recorded? It is similar to walking around in a dark closet wearing a blindfold.
This function is closely related to the work of the plant asset accountant. Many of the same questions must be
addressed when accounting for intangible assets. The question still remains, how can you measure something you
cannot see?
Your study of long-term assets—plant assets, natural resources, and intangible assets—began in Chapter 10,
which focused on determining plant asset cost, computing depreciation, and distinguishing between capital and

Introduction to Accounting : The Language of Business – Supplemental Textbook 40

revenue expenditures. This chapter begins by discussing the disposal of plant assets. The next topic is accounting
for natural resources such as ores, minerals, oil and gas, and timber. The final topic is accounting for intangible
assets such as patents, copyrights, franchises, trademarks and trade names, leases, and goodwill.
Note that accounting for all the long-term assets discussed in these chapters is basically the same. A company
that purchases a long-term asset records it at cost. As the company receives benefits from the asset and its future
service potential decreases, the accountant transfers the cost from an asset account to an expense account. Finally,
the asset is sold, retired, or traded in on a new asset. Because the lives of long-term assets can extend for many
years, the methods accountants use in reporting such assets can have a dramatic effect on the financial statements
of many accounting periods.

Disposal of plant assets

All plant assets except land eventually wear out or become inadequate or obsolete and must be sold, retired, or
traded for new assets. When disposing of a plant asset, a company must remove both the asset's cost and
accumulated depreciation from the accounts. Overall, then, all plant asset disposals have the following steps in
common:
• Bring the asset's depreciation up to date.
• Record the disposal by:
(a) Writing off the asset's cost.
(b) Writing off the accumulated depreciation.
(c) Recording any consideration (usually cash) received or paid or to be received or paid.
(d)Recording the gain or loss, if any.
As you study this section, remember these common procedures accountants use to record the disposal of plant
assets. In the paragraphs that follow, we discuss accounting for the (1) sale of plant assets, (2) retirement of plant
assets without sale, (3) destruction of plant assets, (4) exchange of plant assets, and (5) cost of dismantling and
removing plant assets.

Sale of plant assets

Companies frequently dispose of plant assets by selling them. By comparing an asset's book value (cost less
accumulated depreciation) with its selling price (or net amount realized if there are selling expenses), the company
may show either a gain or loss. If the sales price is greater than the asset's book value, the company shows a gain. If
the sales price is less than the asset's book value, the company shows a loss. Of course, when the sales price equals
the asset's book value, no gain or loss occurs.
To illustrate accounting for the sale of a plant asset, assume that a company sells equipment costing USD 45,000
with accumulated depreciation of USD 14,000 for USD 35,000. The firm realizes a gain of USD 4,000:
Equipment cost $ 45,000
Accumulated depreciation 14,000
Book value $ 31,000
Sales price 35,000
Gain realized $ 4,000
The journal entry to record the sale is:
Cash (+A) 35,000
Accumulated Depreciation—Equipment (+A) 14,000
Equipment (-A) 45,000

41
Gain on Disposal of Plant Assets (+SE) 4,000
To record sale of equipment at a price greater than
book value.
If on the other hand, the company sells the equipment for USD 28,000, it realizes a loss of USD 3,000 (USD
31,000 book value—USD 28,000 sales price). The journal entry to record the sale is:
Cash (+A) 28,000
Accumulated Depreciation—Equipment (+A) 14,000
Loss from Disposal of Plant Asset (-SE) 3,000
Equipment (-A) 45,000
To record the sale of equipment at a price less than
book value.
If a firm sells the equipment for USD 31,000, no gain or loss occurs. The journal entry to record the sale is:
Cash (+A) 31,000
Accumulated Depreciation—Equipment (+A) 14,000
Equipment (-A) 45,000
To record sale of equipment at a price equal to
book
value.
Accounting for depreciation to date of disposal When selling or otherwise disposing of a plant asset, a
firm must record the depreciation up to the date of sale or disposal. For example, if it sold an asset on April 1 and
last recorded depreciation on December 31, the company should record depreciation for three months (January 1-
April 1). When depreciation is not recorded for the three months, operating expenses for that period are
understated, and the gain on the sale of the asset is understated or the loss overstated.
To illustrate, assume that on 2011 August 1, Ray Company sold a machine for USD 1,500. When purchased on
2003 January 2, the machine cost USD 12,000; Ray was depreciating it at the straight-line rate of 10 per cent per
year. As of 2010 December 31, after closing entries were made, the machine's accumulated depreciation account
had a balance of USD 9,600. Before determining a gain or loss and before making an entry to record the sale, the
firm must make the following entry to record depreciation for the seven months ended 2011 July 31:
July 31 Depreciation Expense—Machinery (-SE) 700
Accumulated Depreciation—Machinery (-A) 700
To record depreciation for seven months
[$12,000 X 0.10 X (7/12)]

An accountant would compute the USD 200 loss on the sale as follows:
Machine cost $ 12,00
0
Accumulated depreciation ($9,600 + 10,30
$700) 0
Book value $ 1,700
Sales price 1,500
Loss realized $ 200
The journal entry to record the sale is:
Cash (+A) 1,500
Accumulated Depreciation—Machinery (+A) 10,300
Loss from Disposal of Plant Assets (-SE) 200
Machinery(-A) 12,000

Introduction to Accounting : The Language of Business – Supplemental Textbook 42

To record the sale of machinery at a price less than book value.

When retiring a plant asset from service, a company removes the asset's cost and accumulated depreciation from
its plant asset accounts. For example, Hayes Company would make the following journal entry when it retired a
fully depreciated machine that cost USD 15,000 and had no salvage value:
Accumulated Depreciation—Machinery (+A) 15,000
Machinery (-A) 15,000
To record the retirement of a fully depreciated machine.
Occasionally, a company continues to use a plant asset after it has been fully depreciated. In such a case, the
firm should not remove the asset's cost and accumulated depreciation from the accounts until the asset is sold,
traded, or retired from service. Of course, the company cannot record more depreciation on a fully depreciated
asset because total depreciation expense taken on an asset may not exceed its cost.
Sometimes a business retires or discards a plant asset before fully depreciating it. When selling the asset as
scrap (even if not immediately), the firm removes its cost and accumulated depreciation from the asset and
accumulated depreciation accounts. In addition, the accountant records its estimated salvage value in a Salvaged
Materials account and recognizes a gain or loss on disposal. To illustrate, assume that a firm retires a machine with
a USD 10,000 original cost and USD 7,500 of accumulated depreciation. If the machine's estimated salvage value is
USD 500, the following entry is required:
Salvaged materials (+A) 500
Accumulated Depreciation—Machinery (+A) 7,500
Loss from Disposal of Plant Assets (-SE) 2,000
Machinery (-A) 10,000
To record the retirement of machinery, which will
be
sold for scrap at a later time.

An accounting perspective:

Uses of technology

The main advantages that companies give for having a home page on the Internet are (1) increased
efficiency in the work environment, (2) increased revenue, and (3) faster customer access. A home
page can be developed for a small company for a few hundred dollars and can be maintained for a
fairly low monthly fee. The Small Business Administration has a website at http://www.sba.gov
that provides helpful information to small businesses. One concern that companies have regarding
Internet use by their employees is that they might visit interesting nonbusiness related sites on
company time.

Sometimes accidents, fires, floods, and storms wreck or destroy plant assets, causing companies to incur losses.
For example, assume that fire completely destroyed an uninsured building costing USD 40,000 with up-to-date
accumulated depreciation of USD 12,000. The journal entry is:
Fire Loss (-SE) 28,000
Accumulated Depreciation—Buildings (+A) 12,000

43
Buildings (-A) 40,000
To record fire loss.
If the building was insured, the company would debit only the amount of the fire loss exceeding the amount to
be recovered from the insurance company to the Fire Loss account. To illustrate, assume the company partially
insured the building and will recover USD 22,000 from the insurance company. The journal entry is:
Receivable from Insurance Company (+A) 22,000
Fire Loss (-SE) 6,000
Accumulated Depreciation—Buildings (+A) 12,000
Buildings (-A) 40,000
To record fire loss and amount recoverable from
insurance company.
Exchanges of nonmonetary assets Until late 2004, the rules according to APB Opinion No. 29 for recording
exchanges of nonmonetary assets depended on whether they were exchanges of dissimilar assets such as a truck for
a machine or were similar assets such as a truck for a truck 2. If the exchange classified as an exchange of dissimilar
assets, the acquired asset would be recorded at its fair value and any gain or loss would be recognized. In late 2004,
the FASB issued a new standard, Statement of Financial Accounting Standards No. 153, "Exchanges of
Nonoperating Assets: an amendment of APB Opinion No. 29" 3. This new standard was issued to bring about greater
agreement between US Generally Accepted Accounting Principles and International Financial Reporting Standards
and is effective for exchanges occurring during fiscal periods beginning after 2005 June 15.
This change allows the financial statements of US companies to be more comparable to the financial statements
of companies utilizing International Financial Reporting Standards.
The new FASB standard no longer distinguishes between dissimilar and similar asset exchanges. Instead it
differentiates between exchanges that have commercial substance and those that do not have commercial
substance. An exchange has commercial substance if, as a result of the exchange, future cash flows are expected
to change significantly. For instance, if a company exchanges a building for land (a dissimilar exchange), the timing
and the future cash flows are likely to be different than if the exchange had not occurred. Most exchanges qualify as
having commercial substance. However, if the exchange is not expected to create a significant change in future cash
flows, the exchange does not result in commercial substance. For example, if a company exchanges one truck for
another truck (a similar exchange) that will perform the same function as the old truck and for the same time
period so that the future cash flows are not significantly different, then the exchange does not result in commercial
substance. However, if the future cash flows are likely to be significantly different, then the exchange of similar
assets has commercial substance.
Exchanges of nonmonetary assets having commercial substance For exchanges of nonmonetary assets
that have commercial substance, accountants record the new asset at the fair market value of the asset received or
the asset(s) given up, whichever is more clearly evident. When the cash price of the new asset is stated, they use the
cash price to record the new asset. If the cash price is not stated, they assume that the fair market value of the old
asset plus any cash paid would equate to the cash price of the new asset and use that value to record the new asset.

2 APB, APB Opinion No. 29, "Accounting for Nonmonetary Transactions" (New York: AICPA, May 1973).
3 FASB, FASB Statement No. 153, "Exchanges of Nonmonetary Assets: an amendment of APB Opinion No. 29"
(Norwalk, CT: FASB Board, December 2004).

Introduction to Accounting : The Language of Business – Supplemental Textbook 44

Thus, accountants would normally record the asset received at either (1) the stated cash price of the new asset or (2)
a known fair market value of the asset given up plus any cash paid.
Debiting accumulated depreciation and crediting the old asset removes the book value of the old asset from the
accounts. The firm credits the Cash account for any amount paid. If the amount at which the new asset is recorded
exceeds the book value of the old asset plus any cash paid, a company records a gain to balance the journal entry. If
the situation is reversed, it records a loss to balance the journal entry. To illustrate such an exchange having
commercial substance, assume a company exchanges an old machine for a new delivery truck. The future cash flows
from the exchange are expected to be significantly different and, therefore, the exchange has commercial substance.
The machine cost USD 45,000 and had an up-to-date accumulated depreciation balance of USD 38,000. The truck
had a USD 55,000 cash price and was acquired by trading in the machine with a fair value of USD 3,000 and paying
USD 52,000 cash. The journal entry to record the exchange is:
Trucks (+A) 55,000
Accumulated Depreciation—Machinery (+A) 38,000
Loss from Disposal of Plant Assets (-SE) 4,000
Machinery (-A) 45,000
Cash (-A) 52,000
To record loss on exchange of dissimilar plant
assets.
Another way to compute the USD 4,000 loss on the exchange is to use the book value of the old asset less the fair
market value of the old asset. The calculation is as follows:
Machine cost $ 45,000
Accumulated depreciation 38,000
Book value $ 7,000
Fair market value of old asset
(trade-in allowance) 3,000
Loss realized $ 4,000
To illustrate the recognition of a gain from such an exchange having commercial substance, assume that the fair
market value of the machine was USD 9,000 instead of USD 3,000, and that only USD 46,000 was paid in cash.
The journal entry to record the exchange would be:
Trucks (+A) 55,000
Accumulated Depreciation—Machinery (+A) 38,000
Machinery (-A) 45,000
Cash (-A) 46,000
Gain on Disposal of Plant Assets(+SE) 2,000
To record gain on exchange of dissimilar assets.
Another way to compute the gain of USD 2,000 on the exchange is to use the fair market value of the old asset
less the book value of the old asset. The calculation is as follows:
Machine cost $ 45,000
Accumulated depreciation 38,000
Book value $ 7,000
Fair market value of old asset
(trade-in allowance) 9,000
Gain realized $ 2,000

45
 Remember, when the book value and the market value of the old asset are different, companies always recognize
a gain or a loss on an exchange of nonmonetary assets having commercial substance. As discussed earlier, they do
not recognize a gain or loss on an exchange of nonmonetary assets not having commercial substance.
Exchanges of nonmonetary assets not having commercial substance Often firms exchange plant
assets such as automobiles, trucks, and office equipment by trading the old asset for a similar new one. Once in a
while, such an exchange does not result in an expected change in future cash flows and therefore lacks commercial
substance. When such an exchange occurs, the company receives a trade-in allowance for the old asset, and pays
the balance in cash.4 Usually, the cash price of the new asset is stated. If not, accountants assume the cash price of
the new asset is the fair market value of the old asset plus the cash paid.
When such assets are exchanged, we must modify the general rule that new assets are recorded at the fair
market value of what is given up or received, whichever is clearer. Thus, companies record the new asset at the book
value of the old asset plus the cash paid. When applying this rule to exchanges of assets where no commercial
substance results, firms recognize no losses or gains.
To illustrate the accounting for exchanges of nonmonetary assets that do not have commercial substance,
assume that a delivery service exchanged USD 50,000 cash and truck No. 1—which cost USD 45,000, had USD
38,000 of up-to-date accumulated depreciation, and had a USD 5,000 fair market value—for truck No. 2. The new
truck has a cash price (fair market value) of USD 55,000. The delivery service realized a loss of USD 2,000 on the
exchange which cannot be recorded. The loss is calculated as follows:
The journal entry to record the exchange is:
Cost of trunk No. 1 $ 45,000
Accumulated depreciation 38,000
Book value $ 7,000
Fair market value of old asset
(trade-in allowance) 5,000
Loss indicated (but not recorded) $ 2,000
However, if a loss is indicated and is added to the recorded value of the new asset, the asset may later be written
down because of rules of impairment (as required by FASB Standard No. 144), a topic left to Intermediate
Accounting texts.

4 Trade-in allowance is sometimes expressed as the difference between list price and cash paid, but we choose to
define it as the difference between cash price and cash paid because this latter definition seems to agree with
current practice for exchange transactions.

Introduction to Accounting : The Language of Business – Supplemental Textbook 46

Truck (cost of No. 2) (+A) 57,000
Accumulated Depreciation—Trucks (+A) 38,000
Trucks (cost of No. 1) (-A) 45,000
Cash (-A) 50,000
To record the exchange of non-monetary assets
with no
commercial substance (no loss recorded).
Accounting for any gain resulting from exchanges of nonmonetary assets having no commercial substance is
similar to the case where a loss is present but unrecorded. To illustrate, assume that in the preceding example, the
delivery service gave truck No. 1 (now with a fair market value of USD 9,000) and USD 46,000 cash in exchange for
truck No. 2. The gain on the exchange is USD 2,000, but would be unrecorded.
Book value of old truck (No. 1) $ 7,000 1
Cash paid 46,000
Cost of new truck (No. 2) $ 53,000
Fair market value of new truck (No. 2) $ 55,000 1
Less: Gain indicated 2,000 (equal)
Cost of new truck (No. 2) $ 53,000 1
The company would record the new asset at the book value of the old asset (USD 7,000) plus cash paid (USD
46,000). The company deducts the gain from the cost of the new asset (USD 55,000). Thus, the cost basis of the
new delivery truck is equal to USD 55,000 less than the USD 2,000 gain, or USD 53,000. The delivery service uses
this USD 53,000 cost basis in recording depreciation on the truck and determining any gain or loss on its disposal.
The journal entry to record the exchange is:
Cost of trunk No. 1 $ 45,000
Accumulated depreciation 38,000
Book value $ 7,000
Fair market value of old asset
(trade-in allowance) 5,000
Loss indicated (but not recorded) $ 2,000
Firms would realize the gain on an exchange of nonmonetary assets not having commercial substance in future
accounting periods as increased net income resulting from smaller depreciation charges on the newly acquired
asset. In the preceding example, annual depreciation expense is less if it is based on the truck's USD 53,000 cost
basis than if it is based on the truck's USD 55,000 cash price. Thus, future net income per year will be larger.
Trucks (cost of No. 2) (+A) 53,000
Accumulated Depreciation—Trucks (+A) 38,000
Trucks (cost of No. 1) (-A) 45,000
Cash (-A) 46,000
To record exchange of nonmonetary assets with no
commercial substance (no gain recorded).

In Exhibit 14, we summarize the rules for recording nonmonetary asset exchanges.

An accounting perspective:

Uses of technology

Although sophisticated computer systems automatically compute the gain or loss on the disposal of
assets, such programs depend on human input. If an error was made in inputting the type of

Introduction to Accounting : The Language of Business – Supplemental Textbook 47

disposal or exchange, or if the life of the asset was estimated inaccurately, the calculated gain or
loss would be incorrect.

48
 Exchanges Having Exchanges NOT Having
Commercial Substance Commercial Substance
Recognize Gains? Yes No
Recognize Losses? Yes No
Record Fair market value of asset Book value of old asset plus
New Asset At: received (new asset) or fair cash paid
market value of asset given up
(old asset), whichever is more
clearly evident
Exhibit 14: Summary of rules for recording exchanges of plant assets
Companies incur removal costs when dismantling and removing old plant assets. They deduct these costs from
salvage proceeds to determine the asset's net salvage value. (The removal costs could be greater than the salvage
proceeds.) Accountants associate removal costs with the old asset, not the new asset acquired as a replacement.
The next section discusses natural resources. Note the underlying accounting principle of matching the expenses
with the revenues earned in that same accounting period.

Natural resources
Resources supplied by nature, such as ore deposits, mineral deposits, oil reserves, gas deposits, and timber
stands, are natural resources or wasting assets. Natural resources represent inventories of raw materials that
can be consumed (exhausted) through extraction or removal from their natural setting (e.g. removing oil from the
ground).
On the balance sheet, we classify natural resources as a separate group among noncurrent assets under headings
such as "Timber stands" and "Oil reserves". Typically, we record natural resources at their cost of acquisition plus
exploration and development costs; on the balance sheet, we report them at total cost less accumulated depletion.
(Accumulated depletion is similar to the accumulated depreciation used for plant assets.) When analyzing the
financial condition of companies owning natural resources, exercise caution because the historical costs reported
for the natural resources may be only a small fraction of their current value.

An accounting perspective:

Business insight

Kerr-McGee Corporation is a global energy and chemical company engaged in oil and gas
exploration and production, and the production and marketing of titanium dioxide pigment. In
notes to its financial statements, Kerr-McGee states that the company's geologists and engineers in
accordance with the Securities and Exchange Commission definitions have prepared estimates of
proved reserves. These estimates include reserves that may be obtained in the future by improved
recovery methods now in operation or for which successful testing has been exhibited.

Depletion is the exhaustion that results from the physical removal of a part of a natural resource. In each
accounting period, the depletion recognized is an estimate of the cost of the natural resource that was removed
from its natural setting during the period. To record depletion, debit a Depletion account and credit an
Accumulated Depletion account, which is a contra account to the natural resource asset account.

Introduction to Accounting : The Language of Business – Supplemental Textbook 49

 By crediting the Accumulated Depletion account instead of the asset account, we continue to report the original
cost of the entire natural resource on the financial statements. Thus, statement users can see the percentage of the
resource that has been removed. To determine the total cost of the resource available, we combine this depletion
cost with other extraction, mining, or removal costs. We can assign this total cost to either the cost of natural
resources sold or the inventory of the natural resource still on hand. Thus, we could expense all, some, or none of
the depletion and removal costs recognized in an accounting period, depending on the portion sold. If all of the
resource is sold, we expense all of the depletion and removal costs. The cost of any portion not yet sold is part of the
cost of inventory.
Computing periodic depletion cost To compute depletion charges, companies usually use the units-of-
production method. They divide total cost by the estimated number of units—tons, barrels, or board feet—that can
be economically extracted from the property. This calculation provides a per-unit depletion cost. For example,
assume that in 2010 a company paid USD 650,000 for a tract of land containing ore deposits. The company spent
USD 100,000 in exploration costs. The results indicated that approximately 900,000 tons of ore can be removed
economically from the land, after which the land will be worth USD 50,000. The company incurred costs of USD
200,000 to develop the site, including the cost of running power lines and building roads. Total cost subject to
depletion is the net cost assignable to the natural resource plus the exploration and development costs. When the
property is purchased, a journal entry assigns the purchase price to the two assets purchased—the natural resource
and the land. The entry would be:
Land (+A) 50,000
Ore Deposits (+A) 600,000
Cash (-A) 650,000
To record purchase of land and mine.
After the purchase, an entry debits all costs to develop the site (including exploration) to the natural resource
account. The entry would be:
Ore Deposits ($100,000 + $200,000) (+A) 300,000
Cash (-A) 300,000
To record costs of exploration and development.
The formula for finding depletion cost per unit is:
Cost of site – Residual valueof land if owned Costs develop site
Depletion cost per unit =
Estimated number of units that can be economically extracted
In some instances, companies buy only the right to extract the natural resource from someone else's land. When
the land is not purchased, its residual value is irrelevant and should be ignored. If there is an obligation to restore
the land to a usable condition, the firm adds these estimated restoration costs to the costs to develop the site.
In the example where the land was purchased, the total costs of the mineral deposits equal the cost of the site
(USD 650,000) minus the residual value of land (USD 50,000) plus costs to develop the site (USD 300,000), or a
total of USD 900,000. The unit (per ton) depletion charge is USD 1 (or USD 900,000/900,000 tons). The formula
to compute the depletion cost of a period is:
Depletion cost of a period = Depletion cost per unit× Number of units extracted during period
In this example, if 100,000 tons are mined in 2010, this entry records the depletion cost of USD 100,000 (USD 1
X 100,000) for the period:
Depletion (-SE) 100,000

50
Accumulated Depletion—Ore Deposits4 (-A) 100,000
To record depletion for 2010.
5

The Depletion account contains the "in the ground" cost of the ore or natural resource mined. Combined with
other extractive costs, this cost determines the total cost of the ore mined. To illustrate, assume that in addition to
the USD 100,000 depletion cost, mining labor costs totaled USD 320,000, and other mining costs, such as
depreciation, property taxes, power, and supplies, totaled USD 60,000. If 80,000 tons were sold and 20,000
remained on hand at the end of the period, the firm would allocate the total cost of USD 480,000 as follows:
Depletion cost USD 100,000
Mining labor costs 320,000
Other mining costs 60,000
Total cost of 100,000 tons mined (USD 4.80
per ton) USD 480,000
Less: One inventory (20,000 tons at USD
4.80) 96,000
Cost of ore sold (80,000 tons at USD 4.80) USD 384,000

Note that the average cost per ton to mine 100,000 tons was USD 4.80 (or USD 480,000/100,000). The income
statement would show cost of ore sold of USD 384,000. The mining company does not report depletion separately
as an expense because depletion is included in cost of ore sold. The balance sheet would show inventory of ore on
hand (a current asset) at USD 96,000 (or USD 4.80 X 20,000). Also, it would report the cost less accumulated
depletion of the natural resource as follows:
One deposits $900,000
Less: Accumulated depletion 100,000 $ 800,000

Another method of calculating depletion cost is the percentage of revenue method. Because firms use this
method only for income tax purposes and not for financial statements, we do not discuss it in this text.
Companies depreciate plant assets erected on extractive industry property the same as other depreciable assets.
If such assets will be abandoned when the natural resource is exhausted, they depreciate these assets over the
shorter of the (a) physical life of the asset or (b) life of the natural resource. In many cases, firms compute periodic
depreciation charges using the units-of-production method. Using this method matches the life of the plant asset
with the life of the natural resource. This method is recommended where the physical life of the plant asset equals
or exceeds the resource's life but its useful life is limited to the life of the natural resource.
Assume a mining company acquires mining property with a building it plans to use only in the mining
operations. Also assume that the firm uses the units-of-production method for computing building depreciation.
Relevant facts are:
Building cost $310,000
Estimated physical life of building 20 year
s
Estimated salvage value of building (after mine is $ 10,000
exhausted)
Capacity of mine 1,000,000 tons
Expected life of mine 10 year
s

5 Instead of crediting the accumulated depletion account, the Ore Deposits account could have been credited
directly. But for reasons indicated earlier, the credit is usually to an accumulated depletion account.

Introduction to Accounting : The Language of Business – Supplemental Textbook 51

 Because the life of the mine (10 years or 1,000,000 tons) is shorter than the life of the building (20 years), the
building should be depreciated over the life of the mine. The basis of the depreciation charge is tons of ore rather
than years because the mine's life could be longer or shorter than 10 years, depending on how rapidly the ore is
removed.
Suppose that during the first year of operations, workers extracted 150,000 tons of ore. Building depreciation
for the first year is USD 45,000, computed as follows:
Asset cost – Estimated salvage value
Depreciation per unit =
Total tons of ore∈mine that can be economically extracted
$ 310,000−$ 10,000
= tons=$ 0.30 per ton
1,000,000
Depreciation for year=Depreciation per unit X Units extracted
USD 0.30 per ton X 150,000 tons=USD 45,000
On the income statement, depreciation on the building appears as part of the cost of ore sold and is carried as
part of inventory cost for ore not sold during the period. On the balance sheet, accumulated depreciation on the
building appears with the related asset account.
Plant assets and natural resources are tangible assets used by a company to produce revenues. A company also
may acquire intangible assets to assist in producing revenues.

Intangible assets
Although they have no physical characteristics, intangible assets have value because of the advantages or
exclusive privileges and rights they provide to a business. Intangible assets generally arise from two sources: (1)
exclusive privileges granted by governmental authority or by legal contract, such as patents, copyrights, franchises,
trademarks and trade names, and leases; and (2) superior entrepreneurial capacity or management know-how and
customer loyalty, which is called goodwill.
All intangible assets are nonphysical, but not all nonphysical assets are intangibles. For example, accounts
receivable and prepaid expenses are nonphysical, yet classified as current assets rather than intangible assets.
Intangible assets are generally both nonphysical and noncurrent; they appear in a separate long-term section of the
balance sheet entitled "Intangible assets".
Initially, firms record intangible assets at cost like most other assets. However, computing an intangible asset's
acquisition cost differs from computing a plant asset's acquisition cost. Firms may include only outright purchase
costs in the acquisition cost of an intangible asset; the acquisition cost does not include cost of internal
development or self-creation of the asset. If an intangible asset is internally generated in its entirety, none of its
costs are capitalized. Therefore, some companies have extremely valuable assets that may not even be recorded in
their asset accounts. To explain the reasons for this practice, we discuss the history of accounting for research and
development costs next.
Research and development (R&D) costs are costs incurred in a planned search for new knowledge and in
translating such knowledge into new products or processes. Prior to 1975, businesses often capitalized research and
development costs as intangible assets when future benefits were expected from their incurrence. Due to the
difficulty of determining the costs applicable to future benefits, many companies expensed all such costs as
incurred. Other companies capitalized those costs that related to proven products and expensed the rest as
incurred.

52
 As a result of these varied accounting practices, in 1974 the Financial Accounting Standards Board in Statement
No. 2 ruled that firms must expense all research and development costs when incurred, unless they were directly
reimbursable by government agencies and others. Immediate expensing is justified on the grounds that (1) the
amount of costs applicable to the future cannot be measured with any high degree of precision; (2) doubt exists as
to whether any future benefits will be received; and (3) even if benefits are expected, they cannot be measured.
Thus, research and development costs no longer appear as intangible assets on the balance sheet. The Board applies
the same line of reasoning to other costs associated with internally generated intangible assets, such as the internal
costs of developing a patent.
Amortization is the systematic write-off of the cost of an intangible asset to expense. A portion of an intangible
asset's cost is allocated to each accounting period in the economic (useful) life of the asset. All intangible assets are
not subject to amortization. Only recognized intangible assets with finite useful lives are amortized. The finite
useful life of such an asset is considered to be the length of time it is expected to contribute to the cash flows of the
reporting entity. (Pertinent factors that should be considered in estimating useful life include legal, regulatory, or
contractual provisions that may limit the useful life). The method of amortization should be based upon the pattern
in which the economic benefits are used up or consumed. If no pattern is apparent, the straight-line method of
amortization should be used by the reporting entity.
Recognized intangible assets deemed to have indefinite useful lives are not to be amortized. Amortization will
however begin when it is determined that the useful life is no longer indefinite. The method of amortization would
follow the same rules as intangible assets with finite useful lives. 6
Straight-line amortization is calculated the same was as straight-line depreciation for plant assets. Generally, we
record amortization by debiting Amortization Expense and crediting the intangible asset account. An accumulated
amortization account could be used to record amortization. However, the information gained from such accounting
would not be significant because normally intangibles do not account for as many total asset dollars as do plant
assets.
A patent is a right granted by the federal government. This exclusive right enables the owner to manufacture,
sell, lease, or otherwise benefit from an invention for a limited period. The value of a patent lies in its ability to
produce revenue. Patents have a legal life of 17 years. Protection for the patent owner begins at the time of patent
application and lasts for 17 years from the date the patent is granted.
When purchasing a patent, a company records it in the Patents account at cost. The firm also debits the Patents
account for the cost of the first successful defense of the patent in lawsuits (assuming an outside law firm was hired
rather than using internal legal staff). Such a lawsuit establishes the validity of the patent and thereby increases its
service potential. In addition, the firm debits the cost of any competing patents purchased to ensure the revenue-
generating capability of its own patent to the Patents account.
The firm would amortize the cost of a purchased patent over its finite life which reasonably would not exceed its
legal life. If a patent cost USD 40,000 and has a useful life of 10 years, the journal entries to record the patent and
periodic amortization are:
Patents (+A) 40,000
Cash (-A) 40,000
To record purchases of patent.

6 FASB, SFAS No. 142. " Goodwill and Other Intangible Assets" (CT: FASB, June 2001), par. 11.

Introduction to Accounting : The Language of Business – Supplemental Textbook 53

Patient Amortization Expense (-SE) 4,000
Patents (-A) 4,000
To record annual patent amortization.
For a patent that becomes worthless before it is fully amortized, the company expenses the unamortized balance
in the Patents account.
As noted earlier, all R&D costs incurred in the internal development of a product, process, or idea that is later
patented must be expensed, rather than capitalized. In the previous example, the company amortized the cost of the
purchased patent over its useful life of 10 years. If the patent had been the result of an internally generated product
or process, the firm would have expensed its cost of USD 40,000 as incurred, in accordance with Statement No. 2
of the Financial Accounting Standards Board.
A copyright is an exclusive right granted by the federal government giving protection against the illegal
reproduction by others of the creator's written works, designs, and literary productions. The finite useful life for a
copyright extends to the life of the creator plus 50 years. 7 Most publications have a limited (finite) life; a creator
may amortize the cost of the copyright to expense on a straight-line basis or based upon the pattern in which the
economic benefits are used up or consumed.
A franchise is a contract between two parties granting the franchisee (the purchaser of the franchise) certain
rights and privileges ranging from name identification to complete monopoly of service. In many instances, both
parties are private businesses. For example, an individual who wishes to open a hamburger restaurant may
purchase a McDonald's franchise; the two parties involved are the individual business owner and McDonald's
Corporation. This franchise would allow the business owner to use the McDonald's name and golden arch, and
would provide the owner with advertising and many other benefits. The legal life of a franchise may be limited by
contract.
The parties involved in a franchise arrangement are not always private businesses. A government agency may
grant a franchise to a private company. A city may give a franchise to a utility company, giving the utility company
the exclusive right to provide service to a particular area.
In addition to providing benefits, a franchise usually places certain restrictions on the franchisee. These
restrictions generally are related to rates or prices charged; also they may be in regard to product quality or to the
particular supplier from whom supplies and inventory items must be purchased.
If periodic payments to the grantor of the franchise are required, the franchisee debits them to a Franchise
Expense account. If a lump-sum payment is made to obtain the franchise, the franchisee records the cost in an asset
account entitled Franchise and amortizes it over the finite useful life of the asset. The legal life (if limited by
contract) and the economic life of the franchise may limit the finite useful life.
A trademark is a symbol, design, or logo used in conjunction with a particular product or company. A trade
name is a brand name under which a product is sold or a company does business. Often trademarks and trade
names are extremely valuable to a company, but if they have been internally developed, they have no recorded asset
cost. However, when a business purchases such items from an external source, it records them at cost and
amortizes them over their finite useful life.

7 In 1998 Congress changed the period from 50 to 70 years. At this writing, the Supreme Court was reviewing the
constitutionality of this change.

54
 A lease is a contract to rent property. The property owner is the grantor of the lease and is the lessor. The
person or company obtaining rights to possess and use the property is the lessee. The rights granted under the lease
are a leasehold. The accounting for a lease depends on whether it is a capital lease or an operating lease.
Capital leases A capital lease transfers to the lessee virtually all rewards and risks that accompany
ownership of property. A lease is a capital lease if, among other provisions, it (1) transfers ownership of the leased
property to the lessee at the end of the lease term or (2) contains a bargain purchase option that permits the lessee
to buy the property at a price significantly below fair market value at the end of the lease term.
A capital lease is a means of financing property acquisitions; it has the same economic impact as a purchase
made on an installment plan. Thus, the lessee in a capital lease must record the leased property as an asset and the
lease obligation as a liability. Because a capital lease is an asset, the lessee depreciates the leased property over its
useful life. The lessee records part of each lease payment as interest expense and the balance as a payment on the
lease liability.
The proper accounting for capital leases for both lessees and lessors has been an extremely difficult problem. We
leave further discussion of capital leases for an intermediate accounting text.
Operating leases A lease that does not qualify as a capital lease is an operating lease. A one-year lease on an
apartment and a week's rental of an automobile are examples of operating leases. Such leases make no attempt to
transfer any of the rewards and risks of ownership to the lessee. As a result, there may be no recordable transaction
when a lease is signed.
In some situations, the lease may call for an immediate cash payment that must be recorded. Assume that a
business signed a lease requiring the immediate payment of the annual rent of USD 15,000 for each of the first and
fifth years of a five-year lease. The lessee would record the payment as follows:
Prepaid Rent (+A) 15,000
Leasehold (+A) 15,000
Cash (-A) 30,000
To record first and fifth years' rent on a five-year
lease.
Since the Leasehold account is actually a long-term prepaid rent account for the fifth year's annual rent, it is an
intangible asset until the beginning of the fifth year. Then the Leasehold account becomes a current asset and may
be transferred into a Prepaid Rent account. Accounting for the balance in the Leasehold account depends on the
terms of the lease. In the previous example, the firm would charge the USD 15,000 in the Leasehold account to
expense over the fifth year only. It would charge the balance in Prepaid Rent to expense in the first year. Thus,
assuming the lease year and fiscal year coincide, the entry for the first year is:
Rent Expense (-SE) 15,000
Prepaid Rent (-A) 15,000
To record rent expense.
The entry in the fifth year is:
Rent Expense (-SE) 15,000
Leasehold (-A) 15,000
To record rent expense.
The accounting for the second, third, and fourth years would be the same as for the first year. The lessee records
the rent in Prepaid Rent when paid in advance for the year and then expenses it. As stated above, the lessee may

Introduction to Accounting : The Language of Business – Supplemental Textbook 55

transfer the amount in the Leasehold account to Prepaid Rent at the beginning of the fifth year by debiting Prepaid
Rent and crediting Leasehold. If this entry was made, the previous entry would have credited Prepaid Rent.
In some cases, when a lease is signed, the lump-sum payment does not cover a specific year's rent. The lessee
debits this payment to the Leasehold account and amortizes it over the life of the lease. The straight-line method is
required unless another method can be shown to be superior. Assume the USD 15,000 rent for the fifth year in the
example was, instead, a lump-sum payment on the lease in addition to the annual rent payments. An annual
adjusting entry to amortize the USD 15,000 over five years would read:
Rent Expense (-SE) 3,000
Leasehold (-A) 3,000
To amortize leasehold.
In this example, the annual rental expense is USD 18,000: USD 15,000 annual cash rent plus USD 3,000
amortization of leasehold (USD 15,000/5).
The lessee may base periodic rent on current-year sales or usage rather than being a constant amount. For
example, if a lease called for rent equal to 5 per cent of current-year sales and sales were USD 400,000 in 2010, the
rent for 2010 would be USD 20,000. The rent would either be paid or an adjusting entry would be made at the end
of the year.
A leasehold improvement is any physical alteration made by the lessee to the leased property in which
benefits are expected beyond the current accounting period. Leasehold improvements made by a lessee usually
become the property of the lessor after the lease has expired. However, since leasehold improvements are an asset
of the lessee during the lease period, the lessee debits them to a Leasehold Improvements account. The lessee then
amortizes the leasehold improvements to expense over the period benefited by the improvements. The amortization
period for leasehold improvements should be the shorter of the life of the improvements or the life of the lease. If
the lease can (and probably will) be renewed at the option of the lessee, the life of the lease should include the
option period.
As an illustration, assume that on 2010 January 2, Wolf Company leases a building for 20 years under a
nonrenewable lease at an annual rental of USD 20,000, payable on each December 31. Wolf immediately incurs a
cost of USD 80,000 for improvements to the building, such as interior walls for office separation, ceiling fans, and
recessed lighting. The improvements have an estimated life of 30 years. The company should amortize the USD
80,000 over the 20-year lease period, since that period is shorter than the life of the improvements, and Wolf
cannot use the improvements beyond the life of the lease. If only annual financial statements are prepared, the
following journal entry properly records the rental expense for the year ended 2010 December 31:
Rent Expense (or Leasehold Improvement Expense) 4,000
(-SE)
Leasehold Improvements (-A) 4,000
To record amortization of leasehold improvement.
Rent Expense (-SE) 20,000
Cash (-A) 20,000
To record annual rent.
Thus, the total cost to rent the building each year equals the USD 20,000 cash rent plus the amortization of the
leasehold improvements.

56
 Although leaseholds are intangible assets, leaseholds and leasehold improvements sometimes appear in the
property, plant, and equipment section of the balance sheet.
In accounting, goodwill is an intangible value attached to a company resulting mainly from the company's
management skill or know-how and a favorable reputation with customers. A company's value may be greater than
the total of the fair market value of its tangible and identifiable intangible assets. This greater value means that the
company generates an above-average income on each dollar invested in the business. Thus, proof of a company's
goodwill is its ability to generate superior earnings or income.
A goodwill account appears in the accounting records only if goodwill has been purchased. A company cannot
purchase goodwill by itself; it must buy an entire business or a part of a business to obtain the accompanying
intangible asset, goodwill.
To illustrate, assume that Lenox Company purchased all of Martin Company's assets for USD 700,000. Lenox
also agreed to assume responsibility for a USD 350,000 mortgage note payable owed by Martin. Goodwill is the
difference between the amount paid for the business including the debt assumed (USD 700,000 + USD 350,000 =
USD 1,050,000) and the fair market value of the assets purchased. Notice that Lenox would use the fair market
value of the assets rather than book value to determine the amount of goodwill. The following computation is for
the goodwill purchased by Lenox:
Cash paid $ 700,000
Mortgage note payable 350,000
Total price paid $1,050,000
Less fair market values of
individually
identifiable assets:
Accounts receivable $ 95,000
Merchandise inventory 100,000
Land 240,000
Buildings 275,000
Equipment 200,000
Patents 65,000 975,000
Goodwill $ 75,000
The USD 75,000 is the goodwill Lenox records as an intangible asset; it records all of the other assets at their
fair market values, and the liability at the amount due.

Introduction to Accounting : The Language of Business – Supplemental Textbook 57

ANY COMPANY
Partial Balance Sheet
2010 June 30
Property, plant, and equipment
Land $ 30,000
Buildings $ 75,000
Less: Accumulated depreciation 45,000 30,000
Equipment $ 9,000
Less: Accumulated depreciation 1,500 7,500
Total property, plant, and equipment $ 67,500
Natural resources:
Mineral deposits $300,000
Less: Accumulated depreciation 100,000
Total natural resources $200,00
0
Intangible assets:
Patents $ 10,000
Goodwill 20,000 $ 30,000
Total intangible assets
Exhibit 15: Partial balance sheet
Specific reasons for a company's goodwill include a good reputation, customer loyalty, superior product design,
unrecorded intangible assets (because they were developed internally), and superior human resources. Since these
positive factors are not individually quantifiable, when grouped together they constitute goodwill. The journal entry
to record the purchase is:
Accounts Receivable (+A) 95,000
Merchandise Inventory (+A) 100,000
Land (+A) 240,000
Buildings (+A) 275,000
Equipment(+A) 200,000
Patents (+A) 65,000
Goodwill(+A) 75,000
Cash (-A) 700,000
Mortgage Note Payable (+L) 350,000
To record the purchase of Martin Company's assets
and
assumption of mortgage note payable.
The intangible asset goodwill is not amortized. Goodwill is to be tested periodically for impairment. The amount
of any goodwill impairment loss is to be recognized in the income statement as a separate line before the subtotal
income from continuing operations (or similar caption). 8 The goodwill account would be reduced by the same
amount.9
Look at Exhibit 15, a partial balance sheet for ANY company. Unlike plant assets or natural resources, intangible
assets usually are a net amount in the balance sheet.

8 Discussion of testing for impairment is beyond the scope of this text. For more information on such testing see
SFAS No. 142.
9 SFAS No. 142. par. 18.

Introduction to Accounting : The Language of Business – Supplemental Textbook 58

 Analyzing and using the financial results—Total assets turnover
In determining the productivity of assets, management may compare one year's assets turnover ratio to a
previous year's. Total assets turnover shows the relationship between the dollar volume of sales and the average
total assets used in the business. To calculate this ratio:
Net sales
Total assets turnover=
Average total assets
This ratio indicates the efficiency with which a company uses its assets to generate sales. When the ratio is low
relative to industry standards or the company's ratio in previous years, it could indicate an over-investment in
assets, a slow year in sales, or both. Thus, if the ratio is relatively low and there was no significant decrease in sales
during the current year, management should identify and dispose of any inefficient equipment.
The total assets turnover in a recent year for several actual companies was as follows:
Total Assets ($ thousands)
Net Sales Beginning
Company ($ thousands) of Year End of Year Average Turnove
r
Procter & $ 39,244,000 $ 34,366,000 $ $ 109.41%
Gamble 37,374,300 35,870,150
Tyco 28,931,900 32,344,300 36,374,300 79.54%
International 40,404,300
Kimball 1,261,171 723,651 678,984 701,318 179.83%
International
These three companies compete in very different industries. However, they are all manufacturers. To see if each
of these companies is performing above standard, management should compare its company's percentage to the
industry's standard. In addition, calculating this ratio over approximately five years would help management see
any trends indicating problems or confirm successful asset management.
This chapter concludes your study of accounting for long-term assets. In Chapter 12, you learn about classes of
capital stock.
Understanding the learning objectives
• By comparing an asset's book value (cost less up-to-date accumulated depreciation) with its sales price, the
company may show either a gain or a loss. If sales price is greater than book value, the company shows a gain.
If sales price is less than book value, the company shows a loss. If sales price equals book value, no gain or loss
results.
• When a plant asset is retired from service, the asset's cost and accumulated depreciation must be removed
from the plant asset accounts.
• Plant assets are sometimes wrecked in accidents or destroyed by fire, flood, storm, and other causes. If the
asset was not insured, the loss is equal to the book value. If the asset was insured, only the amount of the loss
exceeding the amount to be recovered from the insurance company would be debited to a loss account.
• In exchanges of nonmonetary assets having commercial substance, the firm records the asset received at
either (1) the stated cash price of the new asset or (if the cash price is not stated) (2) the known fair market
value of the asset given up plus any cash paid.
• In exchanges of nonmonetary assets not having commercial substance, the firm records the new asset at the
book value of the old asset plus the cash paid.

59
 An ethical perspective:
ABC corporation

In 2010, prior to the tax law change permitting the amortization of goodwill for tax purposes, ABC
Corporation acquired XYZ Company for USD 10,000,000 cash. ABC acquired the following assets:

Accounts receivable $80,000

Old Book Fair Market
Value Value
Merchandise inventory $ 200,000 $ 300,000
Buildings 3,000,000 4,000,000
Land 1,000,000 3,000,000
Equipment 500,000 700,000

An experienced appraiser with an excellent reputation established the fair market value of the
assets. ABC also assumed the liability for paying XYZ's USD 50,000 of accounts payable.
John Gilbert, ABC's accountant, prepared the following journal entry to record the purchase: In
explaining the entry to ABC's president, Gilbert said that the assets had to be recorded at their fair
market values. He also stated that the goodwill could not be amortized for accounting purposes or
tax purposes.

Accounts Receivable 80,000

(+A)
Merchandise Inventory 300,000
(+A)
Buildings (+A) 4,000,000
Land (+A) 3,000,000
Equipment (+A) 700,000
Goodwill (+A) 1,970,000
Accounts Payable (+L) 50,000
Cash (-A) 10,000,000
To record the
purchase of XYZ
Company.

The president reacted with, "It is not fair that we are prohibited from amortizing goodwill when it is
a part of the cost of the purchase. Besides, appraisals are very inexact, and maybe some of our other
assets are worth more than the one appraiser indicated. I want you to reduce goodwill down to USD
470,000 and assign the other USD 1,500,000 to the buildings and equipment. Then, we can benefit
from the depreciation on these assets. If I need to find an appraiser who will support the new
allocations, I will."
When Gilbert protested, the president stated, "If you are going to have a future with us, you need to
be a team player. We just cannot afford to lose those tax deductions." Gilbert feared that if he did
not go along, he would soon be unemployed.

Introduction to Accounting : The Language of Business – Supplemental Textbook 60

 • Depletion charges usually are computed by the units-of-production method. Total cost is divided by the
estimated number of units that are economically extractable from the property. This calculation provides a per
unit depletion cost that is multiplied by the units extracted each year to obtain the depletion cost for that year.
• Depreciable assets located on extractive industry property should be depreciated over the shorter of the (1)
physical life of the asset or (2) life of the natural resource. The periodic depreciation charges usually are
computed using the units-of-production method. Using this method matches the life of the plant asset with the
life of the natural resource.
• Only outright purchase costs are included in the acquisition cost of an intangible asset. If an intangible
asset is internally generated, its cost is immediately expensed.
• Intangibles should be amortized over their finite useful lives. The method of amortization should be based
upon the pattern in which the economic benefits are used up. If no pattern is apparent, straight-line
amortization should be used.
Net sales
• Total assets turnover=
Average total assets
• This ratio indicates the efficiency with which a company uses its assets to generate sales.

Demonstration problem
Demonstration problem A O n 2007 January 2, Darton Company purchased a machine for USD 36,000
cash. The machine has an estimated useful life of six years and an estimated salvage value of USD 1,800. Darton
uses the straight-line method of depreciation.
a. Compute the book value of the machine as of 2010 July 1.
b. Assume the machine was disposed of on 2010 July 1. Prepare the journal entries to record the disposal of the
machine under each of the following unrelated assumptions:
• The machine was sold for USD 12,000 cash.
• The machine was sold for USD 18,000 cash.
• The machine and USD 24,000 cash were exchanged for a new machine that had a cash price of USD
39,000. The exchange has commercial substance.
• The machine was completely destroyed by fire. Darton expects to recover cash of USD 10,800 from the
insurance company.
Demonstration problem B Howard Company acquired on 2010 January 1, a tract of property containing
timber at a cost of USD 8,000,000. After the timber is removed, the land will be worth about USD 3,200,000 and
will be sold to another party. Costs of developing the site were USD 800,000. A building was erected at a cost of
USD 160,000. The building had an estimated physical life of 20 years and will have an estimated salvage value of
USD 80,000 when the timber is gone. It was expected that 50,000,000 board feet of timber can be economically
cut. During the first year, 16,000,000 board feet were cut. Howard uses the units-of-production basis to depreciate
the building.
Prepare the entries to record:
a. The acquisition of the property.
b. The development costs.
c. Depletion cost for the first year.

61
 d. Depreciation on the building for the first year.
Demonstration problem C O n 2010 January 2, Bedford Company purchased a 10-year sublease on a
warehouse for USD 30,000. Bedford will also pay annual rent of USD 6,000. Bedford immediately incurred costs of
USD 20,000 for improvements to the warehouse, such as lighting fixtures, replacement of a ceiling, heating system,
and loading dock. The improvements have an estimated life of 12 years and no residual value.
Prepare the entries to record:
a. The payment for the sublease on a warehouse.
b. The rent payment for the first year.
c. The payment for the improvements.
d. Amortization of the leasehold for the first year.
e. Amortization of the leasehold improvements for the first year.
Solution to demonstration problem
Solution to demonstration problem A
DARTON COMPANY
a. Schedule to Compute Book Value
2010 July 1
Cost $ 36,000
Less accumulated depreciation:
($35,000 - $1,800)/6 years= $5,700 per year 19,950
$5,700 X 31 1/2 years = $19,950 $ 16,050
Book value
b. (1) Cash (+A) 12,000
Accumulated Depreciation—Machinery (+A) 19,950
Loss from Disposal of Plant Assets (-SE) 4,050 36,000
Machinery (-A)
To record the sale of machinery at loss.
(2) Cash (+A) 18,000
Accumulated Depreciation—Machinery (+A) 19,950 36,000
Machinery (-A) 1,950
Gain on Disposal of Plant Assets (+SE)
To record sale of machinery at a gain.

Introduction to Accounting : The Language of Business – Supplemental Textbook 62

Machinery (new) (+A) 39,000
Accumulated Depreciation—Machinery (+A) 19,950
Loss from Disposal of Plant Asset (-SE) 1,050
Machinery (old) (-A) 36,000
Cash (-A) 24,000
To record exchange of machines.
The exchange has commercial substance.
Receivable from Insurance Company (+A) 10,800
Accumulated Depreciation—Machinery (+A) 19,950
Fire Loss (-SE) 5,250
Machinery (-A) 36,000
To record loss of machinery.
Solution to demonstration problem B
a. Land (+A) 3,200,00
Timber Stands (+A) 0
Cash (-A) 4,800,00 8,000,00
To record purchase of land and timber. 0 0
b. Timber Stands (+A) 800,000
Cash (-A) 800,000
To record costs of development of the site.
c. Depletion (-SE) 1,792,00
Accumulated Depletion—Timber Stands (-A) 0 1,792,00
To record depletion for 2007. 0
($4,800,000 + $800,000/50,000,000 = $0.112 per
board foot.
$0.112 X 16,000,000 = $1,792,000.)
d. Depreciation Expense—Buildings (-SE) 25,600
Accumulated Depreciation—Buildings (-A) 25,600
To record depreciation expense:
($160,000 - $80,000)/50,000,000 board feet = $0.0016
per board foot.
$0.0016 X 16,000,000 = $25,600.
Solution to demonstration problem C
a. Leasehold (+A) 30,000
Cash (-A) 30,000
To record purchase of sublease on warehouse.
b. Rent Expense (-SE) 6,000
Cash (-A) 6,000
To record annual rent payment.
c. Leasehold Improvements (+A) 20,000
Cash (-A) 20,000
To record payment for leasehold improvements.
d. Rent Expense(-SE) 3,000
Leasehold (-A) 3,000
To record leasehold amortization for 2007:
Annual amortization = $30,000/10 years
= $3,000
e. Rent Expense (-SE) 2,000
Leasehold Improvements (+A) 2,000
To amortize leasehold improvements:
Annual amortization = $20,000/10years
= $2,000

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 Key terms
Amortization The term used to describe the systematic write-off of the cost of an intangible asset to
expense.
Capital lease A lease that transfers to the lessee virtually all of the rewards and risks that accompany
ownership of property.
Commercial substance The result if an exchange of nonmonetary assets causes future cash flows to differ
significantly.
Copyright An exclusive right granted by the federal government giving protection against the illegal
reproduction by others of the creator's written works, designs, and literary productions.
Depletion The exhaustion of a natural resource; an estimate of the cost of the resource that was removed
from its natural setting during the period.
Finite Useful Life Length of time an intangible asset is expected to contribute to the cash flows of the
entity.
Franchise A contract between two parties granting the franchisee (the purchaser of the franchise) certain
rights and privileges ranging from name identification to complete monopoly of service.
Goodwill An intangible value attached to a company resulting mainly from the company's management skill
or know-how and a favorable reputation with customers. Evidenced by the ability to generate an above-
average rate of income on each dollar invested in the business.
Intangible assets Items that have no physical characteristics but are of value because of the advantages or
exclusive privileges and rights they provide to a business.
Lease A contract to rent property. Grantor of the lease is the lessor; the party obtaining the rights to possess
and use property is the lessee.
Leasehold The rights granted under a lease.
Leasehold improvement Any physical alteration made by the lessee to the leased property in which
benefits are expected beyond the current accounting period.
Natural resources Resources supplied by nature, such as ore deposits, mineral deposits, oil reserves, gas
deposits, and timber stands supplied by nature.
Operating lease A lease that does not qualify as a capital lease.
Patent A right granted by the federal government giving the owner the exclusive right to manufacture, sell,
lease, or otherwise benefit from an invention for a limited period.
Research and development (R&D) costs Costs incurred in a planned search for new knowledge and in
translating such knowledge into a new product or process.
Total assets turnover Equal to Net sales/Average total assets. This ratio indicates the efficiency with
which a company uses its assets to generate sales.
Trademark A symbol, design, or logo used in conjunction with a particular product or company.
Trade name A brand name under which a product is sold or a company does business.
Wasting assets See Natural resources.
Self-test
True-false
Indicate whether each of the following statements is true or false.
When a plant asset is still being used after it has been fully depreciated, depreciation can be taken in excess of its
cost.
In an exchange of nonmonetary assets having commercial substance, the new asset is recorded at the fair market
value of the asset received or the fair market value of the asset given up plus cash paid, whichever is more clearly
evident.
In calculating depletion, the residual value of acquired land containing an ore deposit is included in total costs
subject to depletion.
All recorded intangible assets are subject to amortization.

Introduction to Accounting : The Language of Business – Supplemental Textbook 64

 Multiple-choice
Select the best answer for each of the following questions.
When a fully depreciated asset is still in use:
a. Prior years' depreciation should be adjusted.
b. The cost should be adjusted to market value.
c. Part of the depreciation should be reversed.
d. The cost and accumulated depreciation should remain in the ledger and no more depreciation should be
taken.
e. It should be written off the books.
A truck costing USD 45,000 and having an estimated salvage value of USD 4,500 and an original life of five
years is exchanged for a new truck. The cash price of the new truck is USD 57,000, and a trade-in allowance of USD
22,500 is received. The old truck has been depreciated for three years using the straight-line method. The new truck
would be recorded at:
a. USD 55,200.
b. USD 57,000.
c. USD 34,500.
d. USD 43,200.
e. None of the above.
Land containing a mine having an estimated 1,000,000 tons of economically extractable ore is purchased for
USD 375,000. After the ore deposit is removed, the land will be worth USD 75,000. If 100,000 tons of ore are
mined and sold during the first year, the depletion cost charged to expense for the year is:
a. USD 300,000.
b. USD 37,500.
c. USD 30,000.
d. USD 375,000.
e. None of the above.
Bren Company purchased a patent for USD 36,000. The patent is expected to have a finite life of 10 years even
though its legal life is 17 years. The amortization for the first year is:
a. USD 36,000.
b. USD 3,600.
c. USD 2,118.
d. USD 3,240.
e. None of the above.
Now turn to “Answers to self-test” at the end of the chapter to check your answers.

Questions
➢ When depreciable plant assets are sold for cash, how is the gain or loss measured?
➢ A plant asset that cost USD 27,000 and has a related accumulated depreciation account balance of
USD 27,000 is still being used in business operations. Would it be appropriate to continue recording

65
 depreciation on this asset? Explain. When should the asset's cost and accumulated depreciation be
removed from the accounting records?
➢ A machine and USD 22,500 cash were exchanged for a delivery truck. The exchange has commercial
substance. How should the cost basis of the delivery truck be measured?
➢ A plant asset was exchanged for a new asset of a similar type. How is the cost of the new asset
determined?
➢ When nonmonetary assets not having commercial substance are exchanged, a resulting gain is not
recognized. Discuss why this is so.
➢ What is the proper accounting treatment for the costs of removing or dismantling a company's old
plant assets?
➢ Distinguish between depreciation, depletion, and amortization. Name two assets that are subject
to depreciation, to depletion, and to amortization.
➢ Distinguish between tangible and intangible assets, and classify the assets named in part (a)
accordingly.
➢ A building with an estimated physical life of 40 years was constructed at the site of a coal mine. The
coal mine is expected to be completely exhausted within 20 years. Over what length of time should
the building be depreciated, assuming the building will be abandoned after all the coal has been
extracted?
➢ What are the characteristics of intangible assets? Give an example of an asset that has no physical
existence but is not classified as an intangible asset.
➢ What reasons justify the immediate expensing of most research and development costs?
➢ Over what length of time should intangible assets be amortized?
➢ Should costs incurred on internally generated intangible assets be capitalized in asset accounts?
➢ Describe the typical accounting for a patent.
➢ During 2010, Hardy Company incurred USD 123,000 of research and development costs in its
laboratory to develop a patent that was granted on 2010 December 29. Legal fees (outside counsel)
and other costs associated with registration of the patent totaled USD 22,800. What amount should
be recorded as a patent on 2010 December 29?
➢ What is a capital lease? What features may characterize a capital lease?
➢ What is the difference between a leasehold (under an operating lease contract) and a leasehold
improvement? Is there any difference in the accounting procedures applicable to each?
➢ Walt Company leased a tract of land for 40 years at an agreed annual rental fee of USD 18,000. The
effective date of the lease was 2009 July 1. During the last six months of 2009, Walt constructed a
building on the land at a cost of USD 450,000. The building was placed in operation on 2010
January 2, at which time it was estimated to have a physical life of 50 years. Over what period should
the building be depreciated? Why?
➢ You note that a certain store seems to have a steady stream of regular customers, a favorable
location, courteous employees, high-quality merchandise, and a reputation for fairness in dealing

Introduction to Accounting : The Language of Business – Supplemental Textbook 66

 with customers, employees, and suppliers. Does it follow automatically that this business should
have goodwill recorded as an asset? Explain.
Exercises
Exercise A Plant equipment originally costing USD 32,400, on which USD 21,600 of up-to-date depreciation
has been accumulated, was sold for USD 8,100.
a. Prepare the journal entry to record the sale.
b. Prepare the entry to record the sale of the equipment if USD 90 of removal costs were incurred to allow the
equipment to be moved.
Exercise B On 2009 August 31, Hutch Company sold a truck for USD 6,900 cash. The truck was acquired on
2006 January 1, at a cost of USD 17,400. Depreciation of USD 10,800 on the truck has been recorded through 2008
December 31, using the straight-line method, four-year expected useful life, and an expected salvage value of USD
3,000.
Prepare the journal entries to update the depreciation on the truck on 2009 August 31, and to record the sale of
the truck.
Exercise C A machine costing USD 120,000, on which USD 90,000 of up-to-date depreciation has been
accumulated, was completely destroyed by fire. What journal entry should record the machine's destruction and the
resulting fire loss under each of the following unrelated assumptions?
a. The machine was not insured.
b. The machine was insured, and it is estimated that USD 22,500 will be recovered from the insurance company.
Exercise D Kale Company owned an automobile acquired on 2007 January 1, at a cash cost of USD 35,100; at
that time, the automobile was estimated to have a useful life of four years and a USD 2,700 salvage value.
Depreciation has been recorded through 2009 December 31, on a straight-line basis. On 2010 January 1, the
automobile was traded for a new automobile. The old automobile had a fair market value (trade-in allowance) of
USD 6,750. Cash of USD 31,050 was paid. The exchange has commercial substance.
Prepare the journal entry to record the trade-in under generally accepted accounting principles.
Exercise E Equipment costing USD 330,000, on which USD 225,000 of up-to-date accumulated depreciation
has been recorded, was disposed of on 2009 January 2. What journal entries are required to record the equipment's
disposal under each of the following unrelated assumptions?
a. The equipment was sold for USD 120,000 cash.
b. The equipment was sold for USD 87,000 cash.
c. The equipment was retired from service and hauled to the junkyard. No material was salvaged.
d. The equipment was exchanged for similar equipment having a cash price of USD 450,000. A trade-in
allowance of USD 150,000 from the cash price was received, and the balance was paid in cash. The exchange has no
commercial substance.
e. The equipment was exchanged for similar equipment having a cash price of USD 450,000. A trade-in
allowance of USD 75,000 was received, and the balance was paid in cash. The exchange has commercial substance.
Exercise F Nola Mining Company purchased a tract of land containing ore for USD 630,000. After spending
USD 90,000 in exploration costs, the company determined that 600,000 tons of ore existed on the tract but only
500,000 tons could be economically removed. No other costs were incurred. When the company finishes with the
tract, it estimates the land will be worth USD 180,000. Determine the depletion cost per ton.

67
 Exercise G Boyd Company paid USD 7,200,000 for the right to extract all of the mineral-bearing ore,
estimated at 10 million tons, that can be economically extracted from a certain tract of land. During the first year,
Boyd Company extracted 1,000,000 tons of the ore and sold 800,000 tons. What part of the USD 7,200,000
should be charged to expense during the first year?
Exercise H The Slate Mining Company acquired a tract of land for mining purposes and erected a building on-
site at a cost of USD 675,000 and having no salvage value. Though the building has a useful life of 10 years, the
mining operations are expected to last only 6 years. The company has determined that 800,000 tons of ore exist on
the tract but only 600,000 tons can be economically removed. If 100,000 tons of ore are extracted in the first year
of operations, what is the appropriate depreciation charge using the units-of-production method?
Exercise I Talse Company purchased a patent on 1995 January 1, at a total cost of USD 61,200. In 2006
January, the company hired an outside law firm and successfully defended the patent in a lawsuit. The legal fees
amounted to USD 13,500. What will be the amount of patent cost amortized in 2009? (The finite useful life of the
patent is the same as its legal life—17 years.)
Exercise J Don Jackson paid Hungry Hannah's Hamburgers USD 54,000 for the right to operate a fast-food
restaurant in Thomasville under the Hungry Hannah's name. Jackson also agreed to pay an operating fee of 0.5 per
cent of sales for advertising and other services rendered by Hungry Hannah's. Jackson began operations on 2009
January 2. Sales for 2009 amounted to USD 540,000. The finite useful life of the franchise is 40 years.
Give the entries to record the payment of the USD 54,000 and to record expenses incurred relating to the right
to use the Hungry Hannah's name.
Exercise K Lem Company leased the first three floors in a building under an operating lease contract for a 10-
year period beginning 2009 January 1. The company paid USD 240,000 in cash (not representing a specific
period's rent) and agreed to make annual payments equal to 1 per cent of the first USD 1,500,000 of sales and 0.5
per cent of all sales over USD 1,500,000. Sales for 2009 amounted to USD 4,500,000. Payment of the annual
amount will be made in January 2010.
Prepare journal entries to record the cash payment of 2009 January 1, and the proper expense to be recognized
for the use of the space in the leased building for 2009.
Exercise L Rye Company purchased all of the assets of Shef Company for USD 900,000. Rye Company also
agreed to assume responsibility for Shef Company's liabilities of USD 90,000. The fair market value of the assets
acquired was USD 810,000. How much goodwill should be recorded in this transaction? Give the journal entry to
record this transaction.
Problems
Problem A Orr Company traded in an automobile that cost USD 18,000 and on which USD 15,000 of up-to-
date depreciation has been recorded for a new automobile with a cash price of USD 34,500. The company received
a trade-in allowance (its fair value) for the old automobile of USD 2,100 and paid the balance in cash. The exchange
has commercial substance.
Record the exchange of automobiles.
Problem B On 2007 January 2, Blake Company purchased a delivery truck for USD 78,750 cash. The truck has
an estimated useful life of six years and an estimated salvage value of USD 6,750. The straight-line method of
depreciation is being used.
a. Prepare a schedule showing the computation of the book value of the truck on 2009 December 31.

Introduction to Accounting : The Language of Business – Supplemental Textbook 68

 b. Assume the truck is to be disposed of on 2010 July 1. Prepare the journal entry to record depreciation for the
six months ended 2010 June 30.
c. Prepare the journal entries to record the disposal of the truck on 2010 July 1, under each of the following
unrelated assumptions:
i. The truck was sold for USD 26,250 cash.
ii. The truck was sold for USD 48,000 cash.
iii. The truck was retired from service, and it is expected that USD 20,625 will be received from the
sale of salvaged materials.
iv. The truck and USD 60,000 cash were exchanged for office equipment that had a cash price of
USD 105,000. The exchange has commercial substance.
v. The truck and USD 67,500 cash were exchanged for a new delivery truck that had a cash price of
USD 112,500. The exchange has no commercial substance.
vi. The truck was completely destroyed in an accident. Cash of USD 25,500 is expected to be
recovered from the insurance company.
Problem C Eagle Moving Company purchased a new moving van on 2009 October 1. The cash price of the new
van was USD 33,750, and the company received a trade-in allowance of USD 5,600 for a 2007 model. The balance
was paid in cash. The 2007 model had been acquired on 2007 January 1, at a cost of USD 22,500. Depreciation has
been recorded through 2008 December 31, on a straight-line basis, with three years of expected useful life and no
expected salvage value. The exchange has no commercial substance.
Prepare journal entries to update the depreciation and to record the exchange of the moving vans.
Problem D On 2009 January 1, Moyer Company had the following balances in some of its accounts:
Accumulate
d
Asset Depreciatio
n
Land $ 624,000
Leasehold 780,000
Buildings 3,425,760 $ 286,650
Equipment 2,995,200 1,389,960
Trucks 449,280 158,790
• The leasehold covers a plot of ground leased on 2005 January 1, for a period of 20 years.
• Building No. 1 is on the owned land and was completed on 2008 July 1, at a cost of USD 1,965,600; its life
is set at 40 years with no salvage value. Building No. 2 is on the leased land and was completed on 2005 July 1,
at a cost of USD 1,460,160; its life is also set at 40 years with no expected salvage value.
• The equipment had an expected useful life of eight years with no estimated salvage value.
• Truck A, purchased on 2007 January 1, at a cost of USD 149,760, had an expected useful life of 2 1/2 years
and a salvage value of USD 9,360. Truck B, purchased on 2007 July 1, at a cost of USD 131,040, had an
expected life of two years and an estimated salvage value of USD 21,840. Truck C, purchased on 2008 July 1, at
a cost of USD 168,480, had an expected life of three years and an estimated salvage value of USD 21,060.
The following transactions occurred in 2009:
Jan. 2 Rent for 2009 on leased land was paid, USD 87,360.

69
 April 1 Truck B was traded in for truck D. The cash price of the new truck was USD 149,760. A trade-in
allowance of USD 28,080 was granted from the cash price. The balance was paid in cash. Truck D has an expected
life of 20 years and an estimated salvage value of USD 9,360. The exchange has commercial substance.
1 Truck A was sold for USD 28,080 cash.
Prepare journal entries to record the 2009 transactions and the necessary 2009 December 31, adjusting entries,
assuming a calendar-year accounting period. Use the straight-line depreciation method.
Problem D On 2009 January 2, York Mining Company acquired land with ore deposits at a cash cost of USD
1,800,000. Exploration and development costs amounted to USD 192,000. The residual value of the land is
expected to be USD 360,000. The ore deposits contain an estimated 6 million tons. Present technology will allow
the economical extraction of only 85 per cent of the total deposit. Machinery, equipment, and temporary sheds were
installed at a cost of USD 255,000. The assets will have no further value to the company when the ore body is
exhausted; they have a physical life of 12 years. In 2007, 200,000 tons of ore were extracted. The company expects
the mine to be exhausted in 10 years, with sharp variations in annual production.
a. Compute the depletion charge for 2009. Round to the nearest cent.
b. Compute the depreciation charge for 2009 under the units-of-production method.
c. If all other mining costs, except depletion, amounted to USD 1,260,000, what was the average cost per ton
mined in 2009? (The depreciation calculated in b is included in the USD 1,260,000.)
Problem E East Company spent USD 249,900 to purchase a patent on 2009 January 2. Management assumes
that the patent's finite useful life is 17 years. In January 2010, the company hired an outside law firm and
successfully defended the patent in a lawsuit at a cost of USD 48,000. Also, in January 2010, the company paid
USD 72,000 to obtain patents that could, if used by competitors, make the earlier East patent useless. The
purchased patents will never be used.
Give the entries for 2009 and 2010 to record the information relating to the patents.
Problem F Following are selected transactions and other data relating to Long Company for the year ended
2009 December 31.
a. The company rented the second floor of a building for five years on 2009 January 2, and paid the annual rent
of USD 18,000 for the first and fifth years in advance.
b. In 2008, the company incurred legal fees of USD 54,000 paid to an outside law firm in applying for a patent
and paid a fee of USD 18,000 to a former employee who conceived a device that substantially reduced the cost of
manufacturing one of the company's products. The patent on the device has a market value of USD 540,000 and is
expected to be useful for 10 years.
c. In 2008, the company entered into a 10-year operating lease on several floors of a building, paying USD
36,000 in cash immediately and agreeing to pay USD 18,000 at the end of each of the 10 years of life in the lease.
The company then incurred costs of USD 72,000 to install partitions, shelving, and fixtures. These items would
normally last 25 years.
d. The company spent USD 21,600 promoting a trademark in a manner that it believed enhanced the value of
the trademark considerably. The trademark has an indefinite life.
e. The company incurred costs amounting to USD 180,000 in 2008 and USD 234,000 in 2009 for research and
development of new products that are expected to enhance the company's revenues for at least five years.

Introduction to Accounting : The Language of Business – Supplemental Textbook 70

 f. The company paid USD 180,000 to the author of a book that the company published on 2009 July 2. Sales of
the book are expected to be made over a two-year period from that date.
For each of the situations just described, prepare only the journal entries to record the expense applicable to
2009.
Alternate problems
Alternate problem A Ray, Inc., purchased a new 2010 model automobile on 2010 December 31. The cash
price of the new automobile was USD 28,080, from which Ray received a trade-in allowance of USD 4,320 for a
2008 model traded in. The 2008 model had been acquired on 2008 January 1, at a cost of USD 20,700.
Depreciation has been recorded on the 2008 model through 2009 December 31, using the straight-line method, an
expected four-year useful life, and an expected salvage value of USD 2,700. The exchange has commercial
substance.
a. Record depreciation expense for 2010.
b. Prepare the journal entries needed to record the exchange of automobiles.
Alternate problem B On 2007 January 1, Wood Company purchased a truck for USD 43,200 cash. The truck
has an estimated useful life of six years and an expected salvage value of USD 5,400. Depreciation on the truck was
computed using the straight-line method.
a. Prepare a schedule showing the computation of the book value of the truck on 2009 December 31.
b. Prepare the journal entry to record depreciation for the six months ended 2010 June 30.
c. Prepare journal entries to record the disposal of the truck on 2010 June 30, under each of the following
unrelated assumptions:
(a) The truck was sold for USD 3,600 cash.
(b) The truck was sold for USD 25,200 cash.
(c) The truck was scrapped. Used parts valued at USD 6,660 were salvaged.
(d)The truck (which has a fair market value of USD 10,800) and USD 32,400 of cash were exchanged
for a used back hoe that did not have a known market value. The transaction has commercial substance.
(e) The truck and USD 29,700 cash were exchanged for another truck that had a cash price of USD
51,300. The exchange has no commercial substance.
(f) The truck was stolen July 1, and insurance proceeds of USD 7,560 were expected.
Alternate problem C Kine Company purchased a new Model II computer 2009 October 1. Cash price of the
new computer was USD 24,960; Jackson received a trade-in allowance of USD 9,300 from the cash price for a
Model I computer. The old computer was acquired on 2007 January 1, at a cost of USD 23,040. Depreciation has
been recorded through 2008 December 31, on a straight-line basis, with an estimated useful life of four years and
USD 3,840 expected salvage value. The exchange has commercial substance.
Prepare the journal entries to record the exchange.
Alternate problem D On 2009 July 1, Morgan Company had the following balances in some of its accounts:
Accumulate
d
Asset Depreciatio
n
Land $ 672,000
Leasehold 252,000

71
Buildings 3,151,680 $369,768
Equipment 1,370,880 436,800
Trucks 238,560 71,652
The leasehold covers a plot of ground leased on 2004 July 1, for a period of 25 years under an operating lease.
The office building is on the leased land and was completed on 2005 July 1, at a cost of USD 967,680; its
physical life is set at 40 years. The factory building is on the owned land and was completed on 2004 July 1, at a
cost of USD 2,184,000; its life is also set at 40 years with no expected salvage value.
The equipment has a 15-year useful life with no expected salvage value.
The company owns three trucks—A, B, and C. Truck A, purchased on 2007 July 1, at a cost of USD 53,760, had
an expected useful life of three years and a salvage value of USD 3,360. Truck B, purchased on 2008 January 2, at a
cost of USD 84,000, had an expected life of four years and an estimated salvage value of USD 6,720. Truck C,
purchased on 2009 January 2, at a cost of USD 100,800, had an expected life of five years and an estimated salvage
value of USD 10,080.
The following transactions occurred in the fiscal year ended 2010 June 30:
2009
July 1 Rent for2009 July 1, through 2010 June 30, on leased land was paid, USD 31,920.
Oct. 1 Truck A was traded in on truck D. Cash price of the new truck was USD 107,520. Cash of USD 90,720 was
paid. Truck D has an expected life of four years and a salvage value of USD 5,880. The exchange has no commercial
substance.
2010
Feb. 2 Truck B was sold for USD 47,040 cash.
June 1 Truck C was completely demolished in an accident. The truck was not insured.
Prepare journal entries to record these transactions and the necessary 2010 June 30, adjusting entries. Use the
straight-line depreciation method.
Alternate problem E In December 2008, Brown Company acquired a mine for USD 2,700,000. The mine
contained an estimated 10 million tons of ore. It was also estimated that the land would have a value of USD
240,000 when the mine was exhausted and that only 4 million tons of ore could be economically extracted. A
building was erected on the property at a cost of USD 360,000. The building had an estimated useful life of 35 years
and no salvage value. Specialized mining equipment was installed at a cost of USD 495,000. This equipment had an
estimated useful life of seven years and an estimated USD 33,000 salvage value. The company began operating on
2009 January 1, and put all of its assets into use on that date. During the year ended 2009 December 31, 400,000
tons of ore were extracted. The company decided to use the units-of-production method to record depreciation on
the building and the straight-line method to record depreciation on the equipment.
Prepare journal entries to record the depletion and depreciation charges for the year ended 2009 December 31.
Show calculations.
Alternate problem F Trask Company purchased a patent for USD 108,000 on 2009 January 2. The patent
was estimated to have a finite life of 10 years. The USD 108,000 cost was properly charged to an asset account and
amortized in 2009. On 2010 January 1, the company incurred legal and court costs of USD 32,400 in a successful
defense of the patent in a lawsuit. The legal work was performed by an outside law firm.
a. Compute the patent amortization expense for 2009 and give the entry to record it.

Introduction to Accounting : The Language of Business – Supplemental Textbook 72

 b. Compute the patent amortization expense for 2010 and give the entry to record it.
Alternate problem G Selected transactions and other data for Grant Company:
a. The company purchased a patent in early January 2006 for USD 144,000 and began amortizing it over its
finite life of 10 years. In early January 2008, the company hired an outside law firm and successfully defended the
patent in an infringement suit at a cost of USD 38,400.
b. Research and development costs incurred in 2008 of USD 43,200 were expected to provide benefits over the
three succeeding years.
c. On 2009 January 2, the company rented space in a warehouse for five years at an annual fee of USD 9,600.
Rent for the first and last years was paid in advance.
d. A total of USD 96,000 was spent uniformly throughout 2009 by the company in promoting its lesser known
trademark, which is expected to have a finite useful life of 20 years.
e. In January 2007, the company purchased all of the assets and assumed all of the liabilities of another
company, paying USD 192,000 more than the fair market value of all identifiable assets acquired, less the liabilities
assumed. The company expects the cash flow benefits for which it paid the USD 192,000 to last 10 years (finite
useful life).
For each of these unrelated transactions, prepare journal entries to record only those entries (required for 2009.
Note any items that do not require an entry in 2009.
Beyond the numbers-Critical thinking
Business decision case A During your audit examination of the Shirley Company's Plant, Property, and
Equipment accounts, the following transaction came to your attention. On 2009 January 2, machine A was
exchanged for machine B. Shirley Company acquired machine A for USD 90,000 on 2007 January 2. Machine A
had an estimated useful life of four years and no salvage value, and the machine was depreciated on the straight-
line basis. Machine B had a cash price of USD 108,000. In addition to machine A, cash of USD 30,000 was given up
in the exchange. Machine B has an estimated useful life of five years and no salvage value, and the machine is being
depreciated using the straight-line method. The exchange has no commercial substance. Upon further analysis, you
discover that the company recorded the transaction as an exchange of nonmonetary assets having commercial
substance instead of one not having commercial substance. You must now determine the following:
a. What journal entry did the Shirley Company make when it recorded the exchange of machines? (Show
computations.)
b. What journal entry should the Shirley Company have made to record the exchange of machines?
c. Assume the error was discovered on 2010 December 31, before adjusting journal entries have been made.
What journal entries should be made to correct the accounting records? (Adjustments of prior years' net income
because of errors should be debited or credited to Retained Earnings.) What adjusting journal entry should be
made to record depreciation for 2010? (Ignore income taxes.)
d. What effect did the error have on reported net income for 2009? (Ignore income taxes.)
e. How should machine B be reported on the 2010 December 31, balance sheet?
Business decision case B Currently, many corporations are looking for acquisition opportunities. Tyre, Inc.,
is trying to decide whether to buy Amite Company or Beauman Company. Tyre, Inc., has hired you as a consultant
to analyze the two companies' financial information and to determine the more advantageous acquisition. Your

73
review of the companies' books has revealed that both Amite and Beauman have assets with the following book
values and fair market values:

Introduction to Accounting : The Language of Business – Supplemental Textbook 74

 Fair
Market
Book Value Value
Accounts receivable $150,000 $ 150,000
Inventories 450,000 750,000
Land 375,000 675,000
Buildings 450,000 1,050,000
Equipment 180,000 300,000
Patents 120,000 150,000
Liabilities assumed on the purchase of either company include accounts payable, USD 300,000, and notes
payable, USD 75,000.
The only difference between the companies is that Amite has net income that is about average for the industry,
while Beauman's net income is greatly above average for the industry.
Top-level management at Tyre, Inc., has asked you to respond in writing to the following possible situations:
a. Assume Tyre, Inc., can buy Amite Company for USD 2,700,000 or Beauman Company for USD 3,450,000.
Prepare the journal entries to record the acquisition of Amite Company and Beauman Company. What accounts for
the difference between the purchase price of the two companies?
b. Assume Tyre, Inc, can buy either company for USD 2,700,000. Write a report for Tyre, Inc., advising which
company to buy.
Annual report analysis C The mission of Rational Software Corporation is to ensure the success of customers
constructing the software systems that they depend on.
Using the following excerpts from Rational Software's annual reports, calculate the firm's total assets turnover
for 2004 and 2003. (Amounts are in USD thousands.)
2004 2003 2002
Net sales $ 814,935 $ 572,190 $ 411,816
Total assets 1,709,323 1,225,776 453,956
In a written report, discuss the meaning of the total assets turnover ratio and what the ratio means to
management and investors. Use the total assets turnover ratios you computed for Rational Software as an example
in your report.
Ethics case D Based on the situation described in the ethics case regarding ABC Corporation, respond in
writing to the following questions.
a. Depending on his actions, what are the possible consequences for John Gilbert in this situation?
b. Assuming that the president cannot find another appraiser to support the new allocations, what would you do
if you were Gilbert?
c. If the president can find a reputable appraiser to support these new allocations, what would you do if you were
Gilbert?
Group project E In teams of two or three students, find a recent annual report that includes intangible assets
on the balance sheet. Select one member of each team to give an informal presentation discussing intangible asset
disclosures on the face of the statements and in the notes to the financial statements. All members should be
prepared to discuss intangible asset disclosures from their annual report in detail.
Group project F In a group of one or two other students, go to the library and locate Statement of Financial
Accounting Standards No. 2, "Accounting for Research and Development Costs", published by the Financial
Accounting Standards Board. Write a report to your instructor giving the highlights of the standard. For instance,

75
what alternatives were considered and why did the board conclude that all research and development costs should
be expensed when incurred?
Group project G In a group of one or two other students, go to the library and locate Statement of Financial
Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of", published by the Financial Accounting Standards Board. Write a report to your instructor giving
the highlights of the standard. For instance, what does "impairment" mean and what are its causes? How can one
determine that impairment of an asset has possibly occurred? Also review some of the background information as
to why this was important enough for the FASB to act.
Using the Internet—A view of the real world
Visit the Accounting News Network at Microsoft's website:
http://sba.microsoft.com/apnews/default.asp
Click on each icon to investigate the information available at this site. Browse any of the areas that look
interesting. How would accounting practitioners make good use of this site? In a report to your instructor,
summarize the features available at this site.
Visit the Small Business Administration site at:
http://www.sba.gov
Suppose you wanted to start a small business. What helpful information would you find at this site? Would this
site provide information on how to finance the business? Browse around this site to see what it offers. Then write a
report to your instructor summarizing the types of helpful information this site provides.
Answers to self-test
True-false
False. No more depreciation can be taken on a fully depreciated plant asset.
True. The new asset is recorded at the fair market value of the asset received or given up, whichever is more
clearly evident.
False. The residual value of land should be deducted from total costs subject to depletion.
False. Only intangible assets with finite useful lives should be amortized.
Multiple-choice
d. The cost and accumulated depreciation should not be removed from the accounts until the disposal of the
asset.
a. On the date of exchange, the book value of the old truck is USD 20,700 (USD 45,000 minus accumulated
depreciation of USD 24,300). The trade-in allowance of USD 22,500 indicates a gain on exchange of USD 1,800. In
an exchange of nonmonetary assets not having commercial substance, a gain is not recognized, but reduces the cost
of a new asset. Therefore, the cost of the new truck is USD 55,200 (USD 57,000 minus USD 1,800), and no gain is
recognized.
c. The depletion charge for the first year is:
 USD 375,000 – USD75,000
Depletion charger per ton=
1,000,000
= USD 0.30
Depletion charge for the year=USD 0.30×100,000
= USD 30,000

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Since all of the ore that was extracted was sold, all of the USD 30,000 is expensed as cost of ore sold.
b. The patent is amortized over 10 years:
USD 36,000
Annual amortization expense=
10
= USD 3,600

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Introduction to Accounting : The Language of Business – Supplemental Textbook