Property, Plant, and Equipment I. Characteristics of Fixed Assets a.

Fixed assets are acquired for use in operations and not for resale. b. Long term in nature and subject to depreciation. c. Possess physical substance. II. Classification of Fixed Assets a. The following assets are shown separately on the balance sheet at original (historical) cost. i. Land (Property) ii. Buildings (Plant) iii. Equipment may include machinery, tools, furniture, & fixtures 1. Net Book Value net of Accumulated Depreciation iv. Accumulated Depreciation (Contra-Asset) 1. May be combined for two or more asset categories: a. Accumulated Depreciation Building b. Accumulated Depreciation Machine b. Fixed Assets are Nonmonetary Assets i. Monetary Assets (Liabilities) fixed in dollars regardless of changes in specific prices or changes in the general price level. 1. Cash, Accounts and Notes Receivable, etc. ii. Nonmonetary Assets (Liabilities) not fixed in dollars and instead fluctuates with changes in the price level. 1. Inventory, Property, Plant, Equipment, etc. III. Valuation of Fixed AssetsU.S. GAAP a. Purchased i. Historical cost is the basis for valuation. ii. Cash or cash equivalent price of obtaining the asset and bringing it to the location and condition necessary for its intended use. b. Donated Fixed Assets i. Record at FMV along with incidental costs incurred. ii. Journal Entry: 1. Fixed Asset (FMV) Gain on nonreciprocal transfer IV. Valuation of Fixed AssetsIFRSFixed assets are initially recognized at cost to acquire the asset. Subsequent to acquisition, fixed assets can be valued using the cost model or the revaluation model.

a. Cost ModelFA are reported at historical cost adjusted for accumulated depreciation and impairment. b. Revaluation Modela class of FA is revalued to FV and then reported at FV less subsequent accumulated depreciation and impairment. Revaluations must be made frequently enough to ensure that carrying amount does not differ materially from FV at the end of the reporting period. When FV differs materially from CV, a further revaluation is required. Revaluation must be applied to all items in a class of FA, not to individual FA. Land and buildings, machinery, furniture and fixtures, and office equipment are examples of FA classes. When FA are reported at FV, the historical cost equivalent must be disclosed. i. Revaluation LossesFV<CV; report on the income statement. ii. Revaluation GainsFV>CV; report in other comprehensive income and accumulated in equity as revaluation surplus. iii. ImpairmentIf revalued FA subsequently become impaired, the impairment is recorded by first reducing any revaluation surplus to zero with further impairment losses reported on the income statement. V. Cost of Equipment a. Include: i. All Expenditures related directly to their acquisition or construction 1. Invoice Price a. LESS Cash Discounts and other discounts b. PLUS Freight-in, Installation Charges (Testing and Preparing for Use), Sales and Federal Excise Taxes, and Interest during construction b. Capital Vs. Expense Proper accounting is determined based upon the purpose of the disbursement. 1. Additions Improve the quantity of fixed assets and are charged to cost of fixed assets. a. Journal Entry: Asset (machinery, etc.) Cash/Accounts Payable 2. Improvements (betterments) improve the quality of fixed assets and are charged to cost of fixed assets account. 3. Replacements involves a determination of what the unit of depreciation is. a. Composite if the entire unit is the unit of depreciation, expense the replacement as a repair. b. Component if units of the fixed asset are separated, remove original cost and related accumulated depreciation

of the component from the account and capitalize the replacement. 4. Repairs a. Ordinary repairs should be expensed as repair and maintenance b. Extraordinary repairs should be capitalized i. Charge the cost account if fixed asset efficiency is improved ii. Charge the A/D account if fixed asset life is extended VI. Cost of Land - When land has been purchased for the purpose of constructing a building, all costs incurred up to excavation for the new building are considered land costs. a. Land Cost Includes: i. Purchase Price, Brokers Commissions, Title and Recording Fees, Legal Fees, Draining of Swamps, Clearing of Brush and Trees, Site Development, Existing obligations assumed by buyer (including mortgages and back taxes), demolition of existing building, ii. LESS: Proceeds from sale of existing buildings, standing timber, etc. b. Land Improvements (Depreciable) i. Fences, Water Systems, Sidewalks, Paving, Landscaping, Lighting c. Interest Cost Interest cost during construction period may be added to cost of land improvement based on weighted average of accumulated expenditures. VII. Cost of Buildings a. Cost Includes: i. Purchase Price, All Repair charges neglected by the previous owner (deferred maintenance), Alternations and improvements, and Architects fees.

VIII. Basket Purchase of Land and Building allocate the purchase price based on the ratio of appraised values of individual items. IX. Investment PropertyIFRS Only a. Under IFRS, land or building held by an entity or by a lessee under a finance (capital) lease to earn rentals or for capital appreciation are classified and reported as investment property. The investment property designation includes property under construction or development for future use as investment property. U.S. GAAP does not include a specific definition or set of accounting rules for investment property. Investment property does not include owner-occupied

property, property held for sale in the ordinary course of business, or property being constructed or developed, unless the property is under construction or development for future use as an investment property. b. Cost of Investment Property i. Purchase Price ii. Expenses directly related to purchase, including legal services, professional fees, property transfer taxes and other taxes. c. Capitalize vs. ExpenseCapitalize the following: i. Costs incurred to subsequently add to the property ii. Cost to replace part of the property iii. Cost to service the property; does not include cost of day-to-day servicing, repairs, and maintenance costs, labor or minor parts. d. Investment Property Measurement Modelsafter initial recognition, investment property can be reported under two different models: i. Cost Model: investment property is reported on the B/S at cost less accumulated depreciation (if appropriate). When the cost model is used, the FV of the investment property must be disclosed. ii. FV Model: investment property is reported on the B/S at FV and is not depreciated. The best evidence for FV is current prices in an active market for similar property in the same location and condition. FV reflects market conditions at the end of the accounting period. Once adopted, FV measurement must be applied consistently until the asset is disposed of or can no longer be classified as investment property b/c it is owner-occupied or will be developed for sale in the ordinary course of business. 1. Gains and Losses: the investment property should be revalued with regularity so that the CV does not differ materially from FV. A g/l arising from a change in the FV of investment property is recognized in earnings in the period in which it arises. X. Fixed Assets Constructed by a Company a. Direct materials and direct labor b. Repairs and maintenance expenses which add value to fixed asset. c. Overhead, including direct items of overhead d. Do not include profit XI. Capitalization of Interest Costs a. Construction Period Interest should be capitalized (based on weighted average of accumulated expenditures) as part of the historical cost of acquiring fixed assets such as:

b.

c.

d.

e.

i. Buildings, machinery, or land improvements ii. Fixed assets intended for sale or lease and constructed as discrete projects iii. Land Improvements if a structure is in place on the land, charge the interest cost to the structure (and not the land) Interest Cost Interest cost is based on interest obligations having: i. Stated (explicit) interest rate, or if not stated, use Imputed interest rates per APBO #21 (interest on receivables and payables) or Imputed interest rate per FASB #13 (leases). Do NOT Capitalize Interest Cost i. On inventory routinely manufactured ii. On assets held before or after construction period iii. During intentional delays in construction ONLY Capitalize Interest on Borrowing Necessary for That Project i. Computing Capitalized Cost 1. Weighted Average Amount of Accumulated Expenditures capitalized interest costs for a particular period are determined by applying an interest rate to the average amount of accumulated expenditures for the qualifying asset during the period 2. Interest Rate on Borrowings the interest rate paid on borrowings (used for asset construction) during a particular period should be used to determine the amount of interest costs, which should be capitalized for the period. 3. Interest Rate on Excess Expenditures (Weighted Average) if the average accumulated expenditure outstanding exceeds the amount of the related specific new borrowing, interest cost should be computed on the excess. The interest rate that should be used on the excess is the weighted average interest rate for other borrowings of the company. ii. Not to Exceed Actual Interest Costs total capitalized interest costs for any particular period may not exceed the total interest costs actually incurred by an entity during that period. iii. Do NOT reduce Capitalizable Interest Do not reduce capitalizable interest by income received on the unexpended portion of the loan. Capitalization of Interest Period i. Begins when three conditions are present: 1. Expenditures for the asset have been made 2. Activities that are necessary to get the asset ready for its intended use are in progress 3. Interest cost is being incurred ii. Continues as long as the three conditions are present.

iii. Ends when the asset is substantially complete and ready for the intended use. f. Disclose in Financial Statements i. Total interest cost incurred during the period. ii. Capitalized interest cost for the period. Summary Before During After Construction Construction Construction Expense N/A Expense Capitalize Expense Expense

Borrowed funds (not use) Borrowed funds (weighted average of accumulated expense) Excess (about amount borrowed) expenditures (weighted average interest rate)

N/A

Capitalize

Expense

XII.

Depreciable Assets and Depreciation The basic principle of matching revenue and expenses is applied to long-lived assets that are not held for sale in the ordinary course of business. The systematic and rational allocation used to achieve matching is usually accomplished by depreciation, amortization, or depletion, according to the type of long-lived asset involved. a. Kinds of Depreciation i. Physical Depreciation related to an assets deterioration and wear over a period of time. ii. Functional Depreciation arises from obsolescence or inadequacy of the asset to perform efficiently. Obsolescence may result from diminished demand for the product that the depreciable asset produces or from the availability of a new depreciable asset that can perform the same function for substantially less cost. b. Terms i. Salvage Value salvage or residual value is an estimate of the amount that will be realized at the end of the useful life of a depreciable asset. Frequently, depreciable assets have little or no scrap value at the end of their estimated useful life and, if immaterial, the amounts may be ignored in calculating depreciation. ii. Estimated Useful Life period of time over which an assets cost will be depreciated. It may be revised at any time but any revision must be accounted for prospectively, in current and future periods only.

XIII. Depreciation Methods The goal of a depreciation method should be to provide for a reasonable, consistent matching of revenue and expense by systematically allocating the cost of the depreciable asset over its estimated useful life. The actual accumulation of depreciation in the books is accomplished by using a contra account, such as accumulated depreciation or allowance for depreciation. The amount subject to depreciation is the difference between the cost and residual or salvage value and is called the depreciable base. XIV. Composite (Entire Unit) vs. Component Depreciation a. Advantages of Component Depreciation Over Composite Depreciation i. Depreciation expense for the year would be more accurate because each component item would be depreciated over its useful life. ii. Repair and maintenance expense would be more accurate because replacements of components would be excluded from expense and capitalized. b. Component Depreciation is not available for MACRS recovery property for tax purposes because depreciation expense under the component method is generally higher and MACRS is already high. However, it does appear to be available when straight-line depreciation is elected. c. Composite (Dissimilar Assets) or Group (Similar Assets) Depreciation the process of averaging the economic lives of a number of property units and depreciating the entire class of assets over a single life, thus simplifying record keeping of assets and depreciation calculations. i. No gain or loss is recognized when one asset in the group is retired when a group or composite asset is sold or retired, the accumulated depreciation is treated differently than the accumulated depreciation of a single asset. If the average service life of the group of assets has not been reached when an asset is retired, the gain or loss that results is absorbed in the accumulated depreciation account. The accumulated depreciation account is debited (credited) for the difference between the original cost and the cash received. d. The methods can use Straight-line, Sum-of-the-Years Digits, or Declining Balance methods of Depreciation for GAAP purposes.

EX: Composite (Group) Depreciation Estimated Salvage $50,000 $20,000 $0 $70,000 Depreciable Cost $500,000 $180,000 $40,000 $720,000 Estimated Life in Years 20 15 5 Annual Depreciation $25,000 $12,000 $8,000 $45,000

Machine A Machine B Machine C Totals

Total Cost $550,000 $200,000 $40,000 $790,000

Average composite life = $720,000 / $45,000 = 16 years Average composite rate = $45,000 / $790,000 = 5.7% Disposal: Machine A is sold in 10 years for $260,000 (Loss is not recognized, however accumulated depreciation must be reduced) Cash Accumulated Depreciation Machine A XV. $260,000 $290,000 $550,000

Basic Depreciation Methods a. Straight-line i. Depreciation per period = (Cost Salvage) / Estimated Useful Life ii. Advantages: Simple to compute, applies to virtually all assets, consistent from year to year, and wide acceptability iii. Disadvantages: does not reflect difference in usage of asset from year to year and does not always match costs with revenue b. Sum-of-the-Years Digits one of the accelerated methods of depreciation that provides higher depreciation expense in the early years and lower charges in the later years. i. Formula: (Remaining Life/Sum of the Years Digits) * Depreciable Base ii. S= (N * (N + 1)) / 2 = Denominator iii. The numerator is the remaining life of the asset at the beginning of the current year iv. EX: An asset cost $11,000 with a $1,000 salvage value and estimated life of four years. 1. First year: 4/10 * $10,000 = $4,000 2. Second year: 3/10 * $10,000 = $3,000 3. Third year: 2/10 * $10,000 = $2,000 4. Fourth year: 1/10 * $10,000 = $1,000

c. Declining Balance most common accelerated method is the double declining balance method. i. Calculation the first years depreciation is double the straight-line rate. In succeeding years, the same percentage is applied to the remaining book value. ii. Salvage Value no allowance is made for salvage value because the method always leaves a remaining balance, which is treated as salvage value. However, the asset should not be depreciated below the estimated salvage value. iii. Advantages: matches costs to revenues since greater utility is reflected in greater depreciation during earlier years; as the amount of depreciation decreases, repairs and maintenance charges increase thereby tending to balance out one another. iv. Disadvantages: Does not reflect changes in the activity of the asset, computation can be complex, greater disparity in the amount of depreciation between earlier years and later years which is inconsistent, and there is a possibility that with decreasing depreciation and increasing repairs and maintenance that income is artificially smoothed over the years. d. Units of Production (Productive Output) the unit-of-production method relate depreciation to the estimated production capability of an asset and are expressed in a rate per unit or hour. i. (Cost Salvage Value) / Estimated units or hours = rate per unit or hour ii. Rate per unit or hour * Units or Hours = Depreciation iii. Advantages: Matches costs with revenues and reflects activity of the enterprise. iv. Disadvantages: if no activity, no depreciation expensed, cannot be used for all assets, and can be complex because it requires clerical work and records e. Partial Year Depreciation when an asset is placed in service during the year, the depreciation expense is taken only for the portion of they year that the asset is used. f. Disposals i. Sale of an asset during its useful life Debit Cash and Accumulated Depreciation; Credit Asset at Cost AND difference is Gain or Loss ii. Write off fully depreciated asset Debit Accumulated Depreciation and Credit asset at full cost iii. Total and Permanent Impairment Debit Accumulated Depreciation and Loss Due to Impairment; Credit asset at full cost

iv. Partial Impairment Debit Loss Due to Impairment and Credit Accumulated Depreciation g. Disclosure allowances for depreciation and depletion should be deducted from the assets to which they relate. The following disclosures of depreciable assets and depreciation should be made in the financial statements or notes: i. Depreciation expense for the period ii. Balance of major classes of depreciable assets by nature or function iii. Accumulated depreciation allowances by classes or in total iv. The methods uses, by major classes, in computing depreciation XVI. Depletion allocation of the cost of wasting assets such as oil, gas, and minerals to production a. Terms i. Purchase Cost includes any expenditure necessary to purchase and then prepare the land for the removal of resources. ii. Residual Value similar to salvage value; monetary worth of a depleted asset after the resources have been removed. iii. Depletion Base (Cost Residual Value) iv. Methods 1. Cost Depletion (Unit Depletion Rate) 2. Percentage Depletion (Not GAAP Tax Only) a. Based on a percentage of sales; allowed by Congress as a tax deduction to encourage exploration in a very risky business; Usually exceeds cost depletion; Limited to 50% of net income from the depletion property computed before the percentage depletion allowance. b. Unit Depletion Rate (Depletion per Unit) unit depletion is the amount of depletion recognized per unit extracted. i. Calculation: 1. Depletion Base: Cost to Purchase Property PLUS Development costs to prepare the land for extraction PLUS any estimated restoration costs LESS Residual Value of land after the resources are extracted. 2. Depletion per unit = Depletion Base / Estimated Removable Units ii. Total depletion is calculated by multiplying the unit depletion rate times the number of units extracted. If all units extracted are not sold, then depletion must be allocated between COGS and Inventory. The amount of depletion to be included in COGS is calculated by multiplying the unit depletion rate by the number of units sold. Depletion applicable to units extracted but not sold is allocated to inventory as direct materials.