Question

Describe the classification of plant assets and intangible assets, as well as the means for recording their acquisition (everything that is included in the historical cost) and disposal. Discuss the differences in the accounting treatment for repairs and capital improvements to plant assets.

Answer 1

On a classified balance sheet, the asset section contained long term assets including things:

1. Plant assets (also called property, plant and equipment or fixed assets)
2. Long term investments
3. Intangible assets

Plant assets 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.

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”.

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”.

Examples of intangible assets include:

• Research and development (R&D)
• Amortization
• A patent
• A copyright
• A franchise
• A trademark
• A lease
• A leasehold improvement
• Goodwill

Initial recording of plant assets

When a company acquires a plant asset, accountants record the asset at the cost of acquisition (historical cost).   When a plant asset is purchased for cash, its acquisition cost is simply the agreed on cash price. 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 cost incurred to acquire and place the asset in operating condition at its proper location. 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 as longs as the item was not damaged after purchase. Unnecessary costs (such as traffic tickets or fines or repairs that occurred after purchase) that must be paid as a result of hauling machinery to a new plant are not part of the acquisition cost of the asset.

Recording Land

The cost of land includes its purchase price and other many other costs including:

• real estate commissions,
• title search and title transfer fees,
• title insurance premiums,
• 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.

The accountant debits the entire costs 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. 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.

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:

•Writing off the asset’s cost.

•Writing off the accumulated depreciation.

•Recording any consideration (usually cash) received or paid or to be received or paid.

•Recording the gain or loss, if any.

Repairs and Improvements

Expenses relating to depreciable assets fall into two broad categories: ordinary expenditures and capital expenditures. Ordinary expenditures include normal repairs, maintenance, and upkeep. The costs associated with these items are considered normal operating expenses, and they are recorded by debiting expense accounts and crediting cash or another appropriate account. Capital expendituresincrease an asset's usefulness or service life, and they are recognized by increasing the asset's net book value.

There are two ways to increase an asset's net book value: the asset account can be debited, thus increasing the recognized cost of the asset, or the asset's corresponding accumulated depreciation account can be debited, thus decreasing the amount of depreciation previously allocated to the asset. If the capital expenditure serves primarily to increase the asset's usefulness or value, the asset account should be debited. On the other hand, if the capital expenditure serves primarily to increase the asset's useful life or salvage value, the accumulated depreciation account should be debited. Such judgments are not always clear cut, and discussions about the best way to record capital expenditures are usually covered in more advanced accounting courses.