CHAPTER 2

PLANT ASSETS, NATURAL RESOURCES AND INTANGIBLE ASSETS

Nature of plant assets
Long-lived is a general term that may be applied to assets of a permanent or
relatively fixed nature owned by a business enterprise.
Long-lived assets consist of:
1) Intangible assets and
2) Tangible assets
Intangible Assets
 Have no physical characteristics that we can see and touch but represent
exclusive privileges and rights to their owners.
 Are long-lived assets that are without physical characteristics, are not held for
sale, but are useful in the operations of an enterprise.
Intangibility denotes lack of physical substance. Intangible assets often include
patents, copyrights, trademarks, organization costs and goodwill. The cost of acquired
intangible assets is amortized over their estimated economic lives, but not in excess of 40
years. Research and development costs incurred in the creation of internally developed
intangible assets are recognized currently as expenses.
Tangible Assets
 Have physical characteristics that we can see and touch. Tangibility is the
characteristic of bodily substance, as exemplified by a tract of timber, a bridge or
a machine.
These tangible assets include:
a) Plant assets
b) Natural resources
a) Plant Assets
 Are long-lived tangible assets that are of a permanent nature, used in the
operations of the business.
 Other descriptive titles are frequently used are property, plant, and
equipment, used either alone or in various combinations.
To be classified as a plant asset, an asset must
a. have a useful service life of more than one year; and
b. Be used in business operations rather than held for resale.
The properties most frequently included in plant assets may be described in more
specific terms as equipment, furniture, tools, machinery, buildings, and land. On the
balance sheet, you will find these assets included under the heading “property, plant and
equipment”.
I. Land
Unlike the other kinds of tangible property, land has an indefinite economic life. In
general, land does not deteriorate with the passage of time and is not physically
exhausted through use. There may be exceptional cases. Agricultural land may suffer a
loss of usefulness through erosion or failure to maintain fertility. Building sites may be
damaged or destroyed by slides, floods, or earthquakes. Generally, land is accounted for
as a non-depreciable plant asset.

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 II. Property having a limited economic life
With the exception of land, all other plant assets have limited economic lives. The cost
of such assets is allocated through the process of depreciation to the cost of the goods and
services produced.
Characteristics of Plant Assets
1. Plant assets are generally are acquired for use rather than for sale.
2. In yielding services for many accounting periods, a plant asset does not change
in physical characteristic; that is, it does not become physically incorporated in
the finished goods of a business enterprise. For example, a building or machine
wears out and eventually loses its ability to perform efficiently, but its physical
components remain relatively unchanged. In contrast, material is incorporated in
finished goods.
3. They yield services over many years.
Plant assets include all long-lived tangible assets that are 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 a truck is used to deliver merchandise, but a business such as a truck dealership
would classify the same delivery truck as inventory because the truck is held for sale.
Although there is no standard criterion as to the minimum length of life necessary
for classification as plant assets or intangible assets, such assets must be capable of
repeated use or benefit and are ordinarily expected to last more than a year. However, the
asset need not actually be used continuously or even often. For example, items of stand
by equipment held for use in the event of a breakdown of regular equipment or for use
only during peak or emergency periods of activity are included in plant assets because the
equipment is used in the operations of the business.
Assets acquired for resale in the normal course of business cannot be
characterized as plant assets, regardless of their durability or the length of time they are
held. For example, land held for speculative or as a prospective building site or not yet
put in to service is a long-term investment rather than a plant asset because the land is no
being used by the business. When a building is constructed on the land and is placed in
service, the land is reported in the balance sheet under plant assets.
b) Natural resources
This term includes wasting assets that are subject to exhaustion through extraction. The
principal types of wasting assets are mineral deposits, oil and gas deposits, and standing
timber. In essence, natural resources are long-term inventories acquired for sale or use in
production over a number of years. The cost of acquiring and developing wasting assets
is allocated to expense in the form of depletion charges.
Acquisition cost of plant assets
The cost of acquiring a plant asset includes all expenditures necessary to get it in
place and ready for use. The acquisition cost of a plant asset is the amount of cash /or
cash equivalents given up to acquire that asset and place it in operating condition at its
proper location.

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 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
cost for used or damaged assets.
Expenditures resulting from carelessness or errors in installing the asset, from
vandalism, or from other unusual occurrences do not increase the usefulness of the asset
and should be treated as an expense. 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.
1. Land
Land is non-depreciable. The cost of land includes:
 The acquisition (purchase) (negotiated) price.
 All costs of closing the transaction and obtaining title, such as broker’s
commission, real-estate commission, attorney’s fees, existing mortgage
note assumed, legal fees, escrow fees (amount paid to agents), title
investigations, and title insurance premiums.
 All costs of surveying (surveying fees), clearing, draining, grading or
filling to make the land suitable for the desired use, including the cost of
demolishing existing unwanted (unneeded) structures-that is- when land
purchased as a building site contains an unusable building that must be
removed, the entire purchase price should be debited to land, including
the cost of removing the building less any cash received from the sale of
salvaged items, such as crops or fruit on the land; that occurs while the
land is being readied for use.
 Cost of landscaping and local assessments for side walks, streets, sewers
and water mines.
 Delinquent real estate taxes (unpaid taxes) (back taxes) (accrued
property taxes and other liens on land) assumed by purchaser or buyer.
The costs incurred to make the land suitable for its intended purposes such as cost of
clearing trees, or of leveling hills or filling low spots, are included in the cost of land.
Any salvage material recovered in the process of clearing land represents a cost offset.
Land held as a potential building site or for investment purposes is not currently used in
operations and should be reported under investments in the balance sheet rather than as a
part of the plant assets category. The carrying costs, such as property taxes and weed
control incurred prior to the time that the land is placed in use, are capitalized (added to
the cost of the land). When the site is placed in use, the land is reclassified from the
investment category to the plant assets category, and future carrying costs are recognized
as expenses.
2. Building
All necessary expenditures relating to the purchase or construction of a building are
charged to the Building account.
When an existing building is purchased, its cost includes:
Purchase price
Closing costs (attorney’s fees, title insurance, etc)
Cost of remodeling rooms and offices and replacing or repairing the roof, floors,
electrical wiring, and plumbing (or repair and remodeling costs)

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 Unpaid taxes assumed by the purchaser, legal costs and real estate commissions
paid.
When a new building is constructed, its cost consists of:
Contract price (payments to contractors)
Fees paid for architects and engineers for plans and supervision (Architect’s fees)
Building permits
Cost of digging the foundation (Excavation cost)
Labor and materials to build the building
Salaries f officers supervising the construction
Insurance and taxes incurred during the construction
Cost of temporary structures used for offices or for storing tools and materials
during construction of a new building
Interest incurred during construction period on money borrowed to finance the
construction
Any miscellaneous amounts earned from the building during construction reduce the
cost of the building. For example, if a small completed portion of the building is rented
out during construction of the remainder of the building, the rental proceeds are credited
to the Building account.
3. Land Improvements
The cost of land improvements includes all expenditures necessary to make the
improvements ready for their intended use. It is important to distinguish between the
cost of land and the land improvements because land has an indefinite life and land
improvements usually do not. Land improvement costs are capital expenditures and are
either recorded as land cost or recorded in a separate land improvements ledger
account.
Examples of land improvements include: temporary landscaping (such as bushes,
gardens, and trees), parking lots (costs of paving and lighting), drive ways and private
roads, the cost of fences, lawn and garden sprinkler systems
Some of the land improvements (such as landscaping and drainage) are as indefinite
economic lives as that of land, so included (added) to land cost. However, the cost of land
improvements such as side walks, streets and sewers may or may not have indefinite
economic lives. In many localities, the cost of streets, sewers, and similar improvements
are paid by the owners of the benefited property, but the local governmental unit agrees
to maintain and replace them if they are built to standard specifications. In such cases the
special assessments expenditure is a part of land cost, because it is permanent in nature.
However, if the property owner is responsible for eventual replacement of land
improvements, they have limited economic lives and are recorded in a separate Land
Improvements ledger account to facilitate depreciation accounting.
4. Machinery and Equipment
The cost of machinery or equipment consists of sellers net invoice price (whether
the discount is taken or not), sales and other taxes, legal fees, broker’s fees,
transportation (freight) charges, insurance during transit paid by the purchaser, cost of
installation, testing and break-in costs, costs of accessories, other costs needed to put the
machine or equipment in operating condition in its intended location for use
It also includes expenditures required in assembling, installing, and

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testing the unit. However, Motor vehicle licenses and accident insurance on company
trucks and cars are expensed as incurred, because they represent annual recurring
expenditures and do not benefit future periods.
The cost of machinery does not include costs of 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.
NB: The cost of machinery or equipment includes any cost incurred to get the machinery
and equipment ready for its intended use.
Nature of Depreciation
As time passes, all plant assets with the exception of land lose their capacity to yield
services. Accordingly, the cost of such assets should be transferred to the related expense
accounts in an ordinary manner during their expected useful life. This periodic cost
expiration is called “depreciation”.
Depreciation is the amount of plant asset cost allocated to each accounting period
benefiting from the plant asset’s use and is a process of allocation, not asset valuation.
All plant assets are subject to depreciation except land.
 Purpose of calculating depreciation of plant assets
(1) To properly measure net income through matching principle.
Depreciation expense is often a significant factor in determining net
income. For this reason, most financial statement users interested in
the amount of, and methods used to compute, a company’s
depreciation expense.
(2) To recognize the decline in the usefulness of plant assets.
Major Causes of Depreciation
Factors contributing to a decline in usefulness may be divided into two categories:
1) Physical Depreciation, which includes wear from use and
deterioration from the action of the elements, and
2) Functional (Economic) Depreciation, which includes
inadequacy and obsolescence.
1) Physical Depreciation or Physical Deterioration
 Results from the use of the assets-wear and tear- and the action of
elements (the forces of the nature). These physical forces terminate the
usefulness of plant assets by rendering them incapable of performing the
services for which they were intended and thus set the maximum limit on
economic life. Unusual events such as accidents, floods, and earth quakes
also serve to terminate or reduce the economic life of plant assets. For
example, an automobile may have to be replaced after a time because its
body rusted out.
2) Functional (Economic) Depreciation, which includes inadequacy and
obsolescence.
I. Inadequacy: – A plant asset becomes inadequate if its capacity is not
sufficient to meet the demands of increased production. The
inadequacy of plant asset is its inability to produce enough products or
provide enough services to meet current demands. For example, an air
line cannot provide air service for 125 passengers on a flight serviced
by a plane with a seating capacity of 90.

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 II. Obsolescence: – A plant asset is obsolete if the commodity that it
produces is no longer in demand or if a newer machine can produce a
commodity of better quality or at a great reduction in cost. 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 method of duplication obsolete.

The use of a plant asset in business operations transforms a plant asset cost to an
operation expense. Depreciation then, is a cost of operating a business. Because
depreciation does not require current cash out lay, it is often called a non cash expense;
cash was given up in the period when the asset was acquired, not during the periods when
depreciation expense is recorded.
The meaning of term “depreciation” as used in accounting is often misunderstood
because the same term is also commonly used in business to meet a decline in the market
value of an asset. The amount unexpired cost of plant assets reported in the balance sheet
is not likely to agree with the amount that could be realized from their sale. Plant assets
are held for use in the enterprise rather than as a going concern. Consequently, the
decision to dispose of a plant asset is based mainly on its usefulness to the enterprise and
not on its market value.
Accounting for Depreciation
If a plant asset is expected to have no value at the time that it is retired from service,
its entire initial cost should be spread over the expected useful life of the asset as
depreciation expense. Also, if a plant asset’s value at the time of retirement is expected to
be very small in comparison with the cost of the asset, this value may be ignored and the
entire cost speared over the asset’s expected useful life. If a plant asset is expected to
have a significant value at the time that it is retire from service, the different between its
initial cost and this value is the cost( depreciation cost) that should be speared over the
useful life of the asset as depreciation expense.
Factors to be considered in computing depreciation.
In determining the amount of depreciable cost (depreciation base) (cost minus
estimated salvage value) that is to be recognized as periodic depreciation expense, three
factors needed to be considered: the plant asset’s
(a) Initial cost: all expenditures necessary to acquire the asset and make it ready for
intended use.
(b) Residual value/Salvage value / scrap value: is the plant asset’s estimated value at the
time that it is to be retired from service. In other words, 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 trade in. In making the estimate, management should
consider how it plans to dispose of the asset and its exchange with similar assets.
(c) Useful life: refers to the length of time the company owning the assets intended to use
it; useful life is not necessarily the same time period 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, useful life may be expressed in
years, months, working hours, or units of production. Obsolescence may also affect

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useful life. For example, a machine may be capable of producing units for 20 years, but
it is expected to be obsolete in 6 years. Thus, its estimated useful life is 6 years – not 20.

Depreciation methods
Depreciation generally computed using one of the following methods.
1. Straight-line method
2. Units- of- production method
3. Accelerate depreciation methods (such as double declining
balance method and sum- of- the -years- digits method).
It is not necessary that an enterprise use a single method of computing depreciation for all
classes of its depreciable assets. The method used in the accounts and financial
statements may also differ from the methods used in determining income taxes and
property taxes.
As it is true for inventory methods, a company is normally free to adopt the method(s) of
depreciation it believes most appropriate for its business operations.
The theoretical guideline is to use a depreciation method that reflects most closely the
underlying economic circumstances. Thus, companies should adopt the depreciation
method that allocates plant asset cost to accounting period according to the benefits
received from the use of the asset.
In practice, the measurement of benefits from the use of a plant asset is impractical and
often not possible. As a result, a depreciation method must meet only on standard: The
depreciation method must allocate plant asset cost to accounting periods in a systematic
and rational manner.
Regardless of the method or methods chosen, the company must disclose its
depreciation method (s) in the footnotes to its financial statements.
“Note: Companies may use different depreciation methods for different plant assets.”
1. Straight line method
 The straight-line method of determining depreciation provides for
equal periodic charges to expense over the estimated life of the
asset.
 Under the straight-line method, depreciation is the same for each
year of the asset’s useful life. It is measure solely by the passage of
time. To apply the straight-line method, an equal amount of plant
asset cost is charged to each accounting period.
 In order to compute depreciation expense, it is necessary to
determine depreciable cost. Depreciable cost is the cost of the
assets less its salvage value. It is the total amount subject to
depreciation. Depreciable costs then, divided by the asset’s useful
life to determine depreciation expense.
 The formula for calculating depreciation under the straight line
method is :
Depreciation expense = Asset cost – Estimated salvage value
Per year Number of accounting periods in estimated
Useful life
Depreciable cost (depreciation Base) = Asset - Estimated
Cost Salvage Value

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  The distinguishing characteristic of the straight-line method of
depreciation is that each full year of service absorbs an equal
portion of cost.
.
 Use of the straight line method is appropriate for assets where
1) Time rather than obsolescence is the major factor
limiting the asset’s life and
2) Relatively constant amount of periodic services are
received from the asset. Assets that possess these
features include pipelines, fencing, and storage tanks.

The straight-line method is widely used because of its

simplicity. In addition, it provides a reasonable allocation of costs
to periodic revenue when usage is relatively the same from period
to period.

2. Units of Production 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, it is applied in situations where usage rather than obsolescence is the main
factor leading to the demise of the asset.
 The units of production method yields a depreciation
charges that varies with the amount of asset usage. To apply this method, the
length of the life of the asset is expressed in terms of productive capacity, such as
hours, miles or number of units.

 Under this method, depreciation is first computed for the

appropriate unit of production, and the depreciation for each accounting
period is then determined by multiplying the unit depreciation by the
number of units used.
The unit of activity method is ideally suited to factory machinery; production
can measure in terms of units of out put or in terms of machine hours used in operating
the machine. It is also possible to use this method for such items as delivery equipment
(miles driven) and air plane (hours in use). The units of activity method is generally not
suitable for such assets as building or furniture because depreciation for these assets in
more a function of time than of use.
The units-of-production depreciation formulas are:
Depreciation per unit = Asset Cost– Estimated salvage value
(Depreciation rate) Estimated total units of production (or service)
during useful life of asset

Depreciation per period = Depreciation per unit x Number of units of goods or

Services produced.

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 Note: when production of the asset varies significantly from one period to
another, the unit of activity (units –of-production) method results in the best
matching of expected costs with revenues.
3. Accelerated Depreciation Method
Accelerated depreciation method records 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 for the following reasons:
1) The value of the benefits received from the asset decline with age (for
example, office buildings).
2) The asset is a high-technology asset subject to rapid obsolescence (for
example, computers)
3) Repairs increase substantially in the asset’s later years and under this
method the depreciation and repairs remain fairly constant over the
assets life (for example, automobiles).
The two most common accelerated methods of depreciation are:
A. The double declining balance (DDB) method.
B. The sum – of – the – year’s – digits (SOYD) method.
A. Double-Declining Balance Method
The double-declining-balance (DDB) yields a declining periodic depreciation charge
over estimated life of the asset.
The DDB method of computing periodic depreciation charges is applied by first
calculating the straight-line rate depreciation rate. The straight-line rate is calculated by
dividing 100% by the number of years of useful life of the asset. Then, multiply this rate
by 2. The resulting double-declining rate is applied to the declining book value (cost
minus accumulated depreciation) of the asset.
Salvage value is ignored in making the calculations. However, at the point where book
value is equal to the salvage value, no more depreciation is taken.

The formula for DDB depreciation is:

Depreciation = (2 X Straight line rate) X (Asset – Accumulated
Per period Cost Depreciation)

Straight-line rate = 100%/Number of years of useful life of the asset

Note that estimated residual value is not considered in determining the depreciation rate.
It is also ignored in computing periodic depreciation, except that the asset should not be
depreciated below the estimated residual value.
B. Sum-of-the-Year’s-Digits method.
The sum-of-the-years –digits method yield result like those obtained by the use of the
double declining balance method.
This method is similar to the double declining balance method because it also assumes
that an asset is used more extensively during the first-years of operation. Under this
method, an important consideration is give to the number of years in the asset’s useful
life.
The periodic charge for depreciation declines steadily over the estimated life of the asset
because a successively smaller fraction is applied each year to the original cost of the
asset less the estimated residual value.

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The denominator of the fraction, which remains the same, is the sum of the digits
representing the years of life. The numerator is the fraction, which changes each year, is
the number of years of life remaining at the beginning of the year for which depreciation
is being computed.
The sum-of-the-years –digits (SOYD) method is so called because the consecutive digits
for each year of an asset’s estimated life are added together and used as the denominator
of a fraction. The numerator is the number of years of useful life remaining at the
beginning of the accounting period.
To compute that period’s depreciation expense, this fraction is then multiplied by the
acquisition cost of the asset less estimated salvage value.
The formula is:
Depreciation = Number of years of
Per period useful life remaining at (Asset - Estimated
beginning of accounting period X Cost salvage
Sum of Digits for value)
years of life (SOYD)
The years are totaled to find SOYD. For an asset with a 10-year useful life, the
SOYD=10+9+8+7+6+5+4+3+2+1=55.
Alternatively, rather than adding the digits for all years together, the following formula
can be used to find the SOYD for any given number of periods:
SOYD = n (n+1)
2
Where n is the number of periods in the assets useful life. Thus, SOYD for an asset with a
10-year useful life is:
SOYD= 10(10+1)/2 =15.
For the first year, the numerator is 5, for the second year 4 and so on. When the first use
of the asset does not coincide with the beginning of a fiscal year, it is necessary to
allocate each full year’s depreciation between the two fiscal years benefited.

Comparison of Depreciation
All four depreciation methods will yield the same total depreciation over the life of the
asset. However, each method will yield periodic charges which may vary significantly.
 The straight line-method (SLM): provides for equal (uniform) periodic charges to
depreciation expense over the estimated useful life of the asset.
 The units-of-production method: provides for periodic charges to depreciation
expense that may vary considerably, depending upon the amount of the asset
usage.
 Both the declining-balance and the sum-of –the-years digits methods provide for a
higher depreciation charge in the first year of use of the asset and a gradually
declining periodic charge there after. For this reason they are frequently referred
to as accelerated depreciation methods. These methods are most appropriate for
situations in which the decline in productivity or earning power of the asset is
proportionately greater in the early years of its use than in later years. Further
justification or their use is based on the tendency of repairs to increase with the age of
an asset. The reduced amounts of depreciation in later years are therefore offset to
some extent by increased maintenance expenses.

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 Thus, each method is acceptable in accounting, because each recognizes the decline in
service potential of the asset in a rational and systematic manner.

Revision of Periodic depreciation (Changes in Estimates)

After an asset is depreciated down to its estimated salvage value, no more depreciation is
recorded on the asset even if it continues to be used. However, when the estimated useful
life of an asset or its salvage value is found to be incorrect before the asset is depreciated
down to its estimated salvage value, revised depreciation charges are computed.
When a change in an estimate is required, the change is made in current and future
years but not to prior periods. Thus, when a change is made,
1) there is no correction of previously recorded depreciation expense,
2) Depreciation expense for current and future years is revised.
That is, 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. The rationale for this treatment is that continual restatement of prior
periods would adversely affect the reader’s confidence in financial statements.

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