Question

Describe how the cost principle applies to plant assets and explain the concept of depreciation.

Answer 1

How cost principle applies plant assets

A plant asset is a long term fixed asset that is used to produce or sell products and services for the company. These assets are tangible and expected to produce benefits for more than one year. Examples of plant asset are Land, building, equipment, machinary.

The cost principle requires that plant assets be recorded at cost. The cost consists of all expenditure necessary to acquire an asset and make it ready for it indended use. There are various costs added to the plant asset such as fright, installation costs, taxes. When one purchase a plant asset, the cost must be determined before recording the transaction. Cost is measured using cash paid for the item if it is cash transaction or determine the cash equelant price for the given up asset.

Journal entry when purchasing an asset

Asset account Dr.

To Cash Cr.

Concept of Depreciation

Depreciation is the allocation of cost of a plant asset to expense over its useful life in a rational and systematic manner. Plant assets are depreciated over their useful lives using the stright line or double declining depreciation method. Depreciation affect the balancesheet through accumulated depreciation, which is reported as a deduction from plant asset and it effects the income statement throught the depreciation expense.

Journal entry for deprecation

Depreciation Expense a/c Dr.

To Accumulated depreciation a/c Cr.

Please find the below key points to be considered in depreciation

• The book value of a plant asset may differ significantly from its market value.
• Depreciation applies only three classes of plant asset, Land improvement, building, equipment.
• Land is not a depreciable asset.
• The revenue producing ability of a depreciable asset declines during its useful life because of wear and tear.
• Factors in computing depreciation are cost, useful life, salvage value.