Review Class for ACT111-0 and ACT112-0

E.T Yuchengco School of Business and Management

MODULE 9
PLANT ASSETS

Plant Assets
Plant assets are resources that have a physical substance (a definite size and shape), are used in the
operations of a business and are not intended for sale to customers. They are also called property,
plant, and equipment; plant and equipment; or fixed assets.
Cost of Plant Assets
Plant assets are recorded at cost in accordance with the cost principle of accounting. Cost consists of
all expenditures necessary to (1) acquire the asset, and (2) make it ready for its intended use.
The cost of land includes the cash purchase price, closing costs such as title and attorneys fees, real
estate brokers commissions, and accrued property taxes and other liens on the land assumed by the
purchaser. All necessary costs incurred in making land ready for its intended use are debited to the Land
account.
Land improvements are structural additions made to land, such as driveways, parking lots, fences,
landscaping, and underground sprinklers. The cost of land improvements includes all expenditures
needed to make the improvements ready for their intended use.
The cost of buildings includes all necessary costs related to the purchase or construction of a building:
a. When a building is purchased, such costs include the purchase price, closing costs, and real estate
brokers commission.
b. Costs to make the building ready for its intended use include expenditures for remodeling and
replacing or repairing the roof, floors, wiring, and plumbing.
c. When a new building is constructed, cost consists of the contract price plus payments for architects
fees, building permits, interest payments during construction, and excavation costs.
The cost of equipment consists of the cash purchase price, sales taxes, freight charges, and insurance
paid by the purchaser during transit. Cost includes all expenditures required in assembling, installing,
and testing the unit. Recurring costs such as licenses and insurance are expensed as incurred.
Depreciation
Depreciation is the process of allocating to expense the cost of a plant asset over its useful (service) life
in a rational and systematic manner.
a. The cost allocation is designed to provide for the proper matching of expenses with revenues in
accordance with the expense recognition principle.
b. During an assets life, its usefulness may decline because of wear and tear or obsolescence.
c. Recognition of depreciation does not result in the accumulation of cash for the replacement of the
asset.
Three factors that affect the computation of depreciation are (1) cost, (2) useful life, and (3) salvage
value.
Three methods of recognizing depreciation are (a) straight-line, (b) units of activity, and (c) decliningbalance.
a. Each method is acceptable under generally accepted accounting principles.
b. Management selects the method that is appropriate in the circumstances.
c. Once a method is chosen, it should be applied consistently.
Straight-Line Method
Under the straight-line method depreciation is the same for each year of the asset's useful life. The
formula for computing annual depreciation expense is:
Depreciable Cost Useful Life (in years) = Depreciation Expense
To illustrate the computation, assume that the Benson Company purchased a delivery truck for P11,000
on January 1 with an estimated salvage value of P1,000 at the end of its four-year service life. Annual
depreciation is P2,500 [(P11,000 - P1,000 4)].

Review Class for ACT111-0 and ACT112-0

E.T Yuchengco School of Business and Management

The straight-line method predominates in practice.

This method is simple to apply and it matches expenses and revenues appropriately when the use of the
asset is reasonably uniform throughout the service life.
Units-of-Production (or Activity) Method
Under the units-of-production method, service life is expressed in terms of the total units of production
or expected use from the asset, rather than time. The formulas for computing depreciation expense are:
a. Depreciable Cost Total Units of Activity = Depreciation Cost per Unit
b. Depreciation Cost per Unit x Units of Activity during the Year = Depreciation Expense
To illustrate the computation, assume that Benson Company expects to drive the truck purchased in
above for 100,000 miles and that 30,000 miles are driven in the first year. Depreciation for the first year is
P3,000.
In using this method, it is often difficult to make a reasonable estimate of total activity.
When the productivity of an asset varies significantly from one period to another, this method results in
the best matching of expenses with revenues.
Reducing-Balance (or Declining-Balance) Method
The reducing-balance method produces a decreasing annual depreciation expense over the useful life
of the asset. The formula for computing depreciation expense is:
Book Value at Beginning of Year x Declining Balance Rate = Depreciation Expense
To illustrate the computation, assume that Benson Company uses a declining-balance rate that is double
the straight-line rate of 25%. Depreciation in the first year is P5,500 (P11,000 X 50%).
Under this method, the depreciation rate remains constant from year to year, but the book value to which
the rate is applied declines each year.
This method is compatible with the matching principle because the higher depreciation in early years is
matched with the higher benefits received in these years.
Expenditures During Useful Life
Ordinary repairs are expenditures to maintain the operating efficiency and expected productive life of the
plant asset. They are debited to Repairs Expense as incurred and are often referred to as revenue
expenditures.
Additions and improvements are costs incurred to increase the operating efficiency, productive capacity,
or expected useful life of the plant asset. These expenditures are usually material in amount and occur
infrequently during the period of ownership.
Capital expenditures increase the companys investment in productive facilities.
These expenditures include additions and improvements.
Plant Asset Disposals
Plant assets may be disposed of by (a) retirement, (b) sale, or (c) exchange.
At the time of disposal, it is necessary to determine the book value of the plant asset.
a. If the disposal occurs during the year, depreciation for the fraction of the year to the date of disposal
must be recorded.
b. The book value is then eliminated by debiting the Accumulated Depreciation account for the total
depreciation to the date of disposal and crediting the asset account for the cost of the asset.
Retirement of Plant Assets
In accounting for a disposal by retirement,
A. If the asset is fully depreciated, the entry is a debit to Accumulated Depreciation and a credit to the
plant asset account.
B. If the asset is retired before it is fully depreciated and no scrap or salvage value is received, a loss on
disposal occurs.

Review Class for ACT111-0 and ACT112-0

E.T Yuchengco School of Business and Management

Sale of Plant Assets

In a disposal by sale, the book value of the asset is compared with the proceeds received from the sale.
a. If the proceeds of the sale exceed the book value, a gain on disposal occurs.
b. If the proceeds of the sale are less than the book value of the asset, a loss on disposal occurs.
Sample Theory Questions
1. Which of the following items should be expensed as incurred?
A. Broker's fees on the purchase of a long-lived asset.
B. Repair of damage occurring during installation of new equipment.
C. Freight charges on the purchase of equipment.
D. Normal installation fees on the purchase of equipment.
2. Which of the following types of subsequent expenditures is not normally capitalized?
A. Additions.
C. Repairs and maintenance.
B. Improvements.
D. Rearrangements.
3. Which of the following is considered an accelerated depreciation method?
A. Straight line.
C. Double declining balance.
B. Last in, first out.
D. Units of production.
4. The journal entry to record the sale or disposition of a depreciable plant asset always includes:
A. Recognition of a gain.
B. A debit to the Accumulated Depreciation account for the related accumulated depreciation.
C. Recognition of a loss.
D. A debit to the asset account for the book value of the asset.
5. The sale of a depreciable asset resulting in a loss indicates that the proceeds from the sale were:
A. Less than current market value.
C. Greater than book value.
B. Greater than cost.
D. Less than book value.
Computational Drills
1. Foster Corporation purchased a new machine for its assembly process on August 1, 2014. The cost
of this machine was P235,800. The company estimated that the machine would have a trade-in value
of P25,800 at the end of its service life. Its life is estimated at 10 years, and its working hours are
estimated at 42,000 hours. Year-end is December 31.
Required: Compute the depreciation expense under the following methods. Each of the following
should be considered unrelated.
a. Straight-line depreciation for 2014 and 2015.
b. Activity method for 2014 and 2015, assuming that machine usage was 800 and 3,400 hours,
respectively.
c. Double-declining balance for 2014 and 2015.
2. On June 28, 2014, a business sold for P1,500 a plant asset that cost P5,000. The asset had a 5-year
useful life, no salvage value, and had been used by the business since January 1, 2011. Straight-line
depreciation was used. The fiscal year ends on December 31. What was the result of selling the plant
asset?