Chapter 9 - Summary
Determine the cost of plant assets.
Plant assets are long-lived assets acquired for use in the business and not
for resale to customers. The matching principle of accounting requires that
we include in the plant and equipment accounts those costs that will provide
services over a period of years. During these years, the use of the plant assets
contributes to the earning of revenues. The cost of a plant asset includes all
expenditures reasonable and necessary in acquiring the asset and placing it
in a position and condition for use in the operations of the business.
Distinguish between capital expenditures and revenue expenditures.
Capital expenditures include any material expenditure that will benefit several
accounting periods. Therefore, these expenditures are charged to asset accounts
(capitalized) and are recognized as expense in future periods.
Revenue expenditures are charged directly to expense accounts because either
(1) there is no objective evidence of future benefits or (2) the amounts are
Compute depreciation by the straight-line and declining-balance methods.
Straight-line depreciation assigns an equal portion of an asset's cost to expense
in each period of the asset's life. Declining-balance is an accelerated method.
Each year, a fixed (and relatively high) depreciation rate is applied to the
remaining book value of the asset. There are several variations of declining-balance
depreciation, including MACRS.
Account for disposals of plant assets.
When plant assets are disposed of, depreciation should be recorded to the date
of disposal. The cost is then removed from the asset account and the total recorded
depreciation is removed from the accumulated depreciation account. The sale
of a plant asset at a price above or below book value results in a gain or loss
to be reported in the income statement.
Because different depreciation methods are used for income tax purposes, the
gain or loss reported in income tax returns may differ from that shown in the
income statement. It is the gain or loss shown in the financial statement that
is recorded in the company's general ledger accounts.
Explain the nature of intangible assets, including goodwill.
Intangible assets are assets owned by the business that have no physical substance,
are noncurrent, and are used in business operations. Examples include trademarks
Among the most interesting intangible assets is goodwill. Goodwill is the present
value of future earnings in excess of a normal return on net identifiable assets.
It stems from such factors as a good reputation, loyal customers, and superior
management. Any business that earns significantly more than a normal rate of
return actually has goodwill. But goodwill is recorded in the accounts only
if it is purchased by acquiring another business at a price higher than
the fair market value of its net identifiable assets.
All intangible assets, including goodwill, should be amortized to expense over
their useful economic lives. This period may not exceed 40 years but usually
is much shorter.
Account for the depletion of natural resources.
Natural resources (or wasting assets) include mines, oil fields, and standing
timber. Their cost is converted into inventory as the resource is mined, pumped,
or cut. This allocation of the cost of a natural resource to inventories is
called depletion. The depletion rate per unit extracted equals the cost of the
resource (less residual value) divided by the estimated number of units it contains.
Explain the cash effects of transactions involving plant assets.
Depreciation is a noncash expense; cash expenditures for the acquisition of
plant assets are independent of the amount of depreciation for the period. Cash
payments to acquire plant assets (and cash receipts from disposals) appear in
the statement of cash flows, classified as investing activities.
Write-downs of plant assets also are noncash charges, which do not involve
Account for depreciation using methods other than straight-line or declining-balance.
Most companies that prepare financial statements in conformity with generally
accepted accounting principles use the straight-line method of depreciation.
Other accepted methods include the units-of-output method, sum-of-the-years'
digits, and in rare circumstances, decelerated depreciation methods.
This chapter completes our discussion of the valuation of the major types of
business assets. To review, we have seen that cash is reported in the financial
statements at face value, marketable securities at market value, accounts receivable
at their net realizable value, inventories at the lower-of-cost-or-market, and
plant assets at cost less accumulated depreciation. Two ideas that are consistently
reflected in each of these valuation bases are the matching principle and the
concept of conservatism. In the next chapter, we will turn our attention to
the measurement of liabilities.