Chapter Two: Plant Assets, Natural Resources and Intangible Assets

Nature of Plant Assets

 Acquired for use in normal business operations and not for resale
 Tangible assets that are permanent in nature and usually subject to depreciation
 Have an expected life of more than one year.
Example: Equipment, Furniture, Machinery, Building, etc.
Assets acquired for re-sale in the normal course of business cannot be characterized as plant
asset, regardless of their durability or the length of time they are held.
For example, undeveloped land or other real estate acquired as a speculation should be listed
on the balance sheet in the asset section entitled “investment”.
Cost of Plant Assets
Plant assets are valued in the accounts at historical cost; the cost necessary to get it and
place it ready for use.
 Costs associated with the acquisitions of a plant asset but which does
not increase the usefulness of the asset should not be included as the cost of the plant
asset.
Example: Costs which result from carelessness, error in installation or for any other
unusual occurrence
(a) The cost of constructing a building includes
 Material costs
 Fees paid to architects, engineers for plans and supervisions,
 Insurance incurred during construction
 Interests incurred to finance the construction through borrowing
i (b) The cost of land
 Negotiated price
 Broker’s commission
 Title fees
 Surveying fee
 Related imposed tax on the purchase title transfer
 The cost of leveling

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  The cost of removing the unwanted building less any salvage value must also be
charged to the cost of land.
Nature of deprecation
As time passes, all plant assets with the exception to land lose their capacity to yield service.
Therefore, the cost of these plant assets should be transferred to the related expense account
in an orderly manner during their expected useful life.
 The periodic cost expiration is called Depreciation
 Depreciation results from
– Physical wear and tear
– Obsolescence
• Depreciation is an allocation of the cost of an asset over its useful life.
• We accumulate the assets depreciation in a Contra-Asset account Accumulated
Depreciation
Factors for depreciation
Physical Functional
-Wear out -Obsolescence (uselessness)
-Deterioration -Inadequacy (insufficiency)
• Depreciation does not mean a decline in market value of asset, but the periodical cost
expiration due to physical and functional reasons.
• Depreciation is NOT a process of valuation.
• Depreciation does NOT mean setting aside cash to replace assets as they wear out.
Accounting for depreciation
In determining the amount of depreciation three factors are required
 Initial cost
 Estimated Useful life of Plant Asset
 Estimated residual value: the plant asset’s estimated value at the time that it is to
be retired from service
o Also is called Scrap Value or a Trade in Value.
o Neither the residual value nor useful life is known for sure but they have
to be estimated.

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 Depreciable cost = Initial cost – Residual value
 Is distributed between the useful life to determine the periodic
depreciation expense
There is no hard and fast rule for estimating both residual value and useful life but both are
affected by management policy.
 Other factors like climate, frequency of use, maintenance and minimum standard
of efficiency will affect the estimate.
The four most common methods used for determining expired cost of plant assets:
1. straight line method
2. units of production
3. declining balance
4. sum of years digit
It is not necessary that an enterprise use a single method of computing depreciation for all
classes of its depreciable assets.
Furthermore the method used in the accounts and Financial Statement may differ from the
method used in determining income tax and property tax.
1. Straight Line Depreciation
Provides for equal periodic charges of depreciation expense over the estimated life of the
asset. The Periodical Depreciation = Cost - Residual value
Useful life
Example The cost of depreciable asset is 16,000.00, estimated residual value is Br.1, 000.00
& estimated useful life 5 years
Annual depreciation (periodical depreciation): =16,000.00 (cost) – 1,000.00(residual value)
5 years (estimated useful life)
= 3,000.00 Br. /year
If the asset is purchased and was first used on October 12, 2002 and assuming the period
ends on December 31, 2002.
The period’s depreciation of the product = 3,000 X 3/12=750
On the other hand if the asset was first placed into use on October 16, 2002 then the
depreciation would be
The period’s depreciation of the product = 3,000 X 2/12=500

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Further more in a straight line depreciation method; we could use %age depreciation; using
the cost and the useful life of the asset, with no regard to the residual value of the asset.
Example: for the former example; 1/5 years X 100% = 20%
Each year 20% of the total cost will be the depreciation expense.
The straight line method is the most widely used method because of its simplicity.
Furthermore this method justifies a reasonable allocation of costs when the usage is
relatively the same from period to period.
2. Units of production method:
This method provides depreciation that varies with the units produced, with the amount of
asset usage.
 In this method, the useful life of the asset is expressed in terms of productive
capacity asset, like Hours Miles, and Number of units … etc.
Example: Assume a machine with a cost of Br. 16,000.00 and estimated residual value of
Br. 1,000.00 is expected to have estimated life of 10,000 operating Hrs.
The depreciation is Cost – Residual
Estimated production capacity
= 16,000.00 (cost) – 1,000.00 (residual value)
10,000 hrs (estimated capacity production capacity)
= Br. 1.5/hr
Assume that during the year 2002, the machine was in operation for 2,200 hrs, therefore, the
depreciation for the year will be: 2,200hr X 1.5 birr = 3,300.00 Br
This method is more logical when amount of usage of plant asset changes from period to period.
3. Double declining method
Declining method yields a declining periodic depreciation charges over the estimated life of
a plant asset, of all other declining method, double declining method is the most popular
one.
 Mostly is calculated by doubling the straight line depreciation rate, which is
computed as a percentage of useful life of the plant asset.
Illustration: Assume on January 01, 2000 a machine with a cost of Br.16, 000.00 and
estimated residual value of Br.1, 500.00 is expected to have estimated life of 5 years.
The depreciation using double declining method is calculated as shown below

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 Accumulated Book value at Book value at
Depreciation of Beginning of the Deprecation the end of the
Cost the Year year Rate for the year year
1 16,000.00 -- 16,000.00 40% 6,400.00 9,600.00
2 16,000.00 6,400.00 9,600.00 40% 3,840.00 5,760.00
3 16,000.00 10,240.00 5,760.00 40% 2,304.00 3,456.00
4 16,000.00 12,544.00 3,456.00 40% 1,382.40 2,073.50
5 16,000.00 13,926.40 2,073.50 ---- 573.60 1,500.00

Fifth year Deprecation: 2,073.50 - 1,500 = 573

 double declining rate =>1/5*2 = 20% X 2 = 40 %
4. Sum of the years digits method
This method yields results like those obtained by use of the decline-balance method. The
periodic charge for depreciation declines steadily over the estimated life of the asset because
successively smaller fraction is applied each year to the original cost of the asset less the
residual value. The denominator fraction, which remains constant, represents the sum of the
digits represented by year’s life.
Example: An asset has a cost of Br 16,000.00 and residual value Br 1,000.00 and useful life
of five year. The depreciation for the five useful lives is presented as follows:-
Accumulated. Book value at
Cost less residual Depreciation Depreciation at the end the end of the
Year value Rate for the year of the year year
1st 15,000.00 5/15 5,000.00 5,000.00 11,000.00
2nd 15,000.00 4/15 4,000.00 9,000.00 7,000.00
3rd 15,000.00 3/15 3,000.00 12,000.00 4,000.00
4th 15,000.00 2/15 2,000.00 14,000.00 3,000.00
5th 15,000.00 1/15 1,000.00 15,000.00 1,000.00

The double declining method and the sum of the years digit method provides the highest
depreciation in first year of the asset use and gradually declining there after; for this reason
they are called Accelerated Depreciation Method.

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 The straight line method provides a uniform expense over the periods, and the units of
production method provide periodical depreciation charges, that vary considerably,
depending on the amount of usage of the asset.
Capital and revenue expenditure
Capital expenditure: - are expenditures for acquiring plant assets or for addition to plant
asset and expenditures that add to the utility of plant assets for more than one accounting
period.
These expenses are debited to the asset account itself or to the accumulated depreciation.
These expenditures affect the depreciation expense of more than one period.
Common capital expenditures related to plant assets are
 Additions
 Betterments
 Extraordinary repairs
A. Addition to plant assets: -expenditures for additions to the existing plant assets
would be debited to the plant asset accounts. The costs of additions would be
depreciated over the estimated useful life of the additions.
Example: the cost of adding an air conditioning system to a building or of adding a
wing to a building would be treated as capital expenditure.
B. Betterments: - are expenditures that increase operating efficiency or capacity for the
remaining useful life of plant assets, this expenditure would be added to the plant
asset account, and be depreciated over its estimated useful life. Or these costs could
be debited to the accumulated depreciation of the precise asset to remove the account
accumulated as depreciation.
Example: when the power supply unit attracted to a machine is replaced by a better
one which has a greater capacity.
C. Extra ordinary repairs: - are expenditures which increase the useful life of an asset
beyond the original estimate. These expenditures are debited directly to the
accumulated depreciation account, rather than to the asset account itself.
Disposal of Plant Asset
Plant asset which are not useful may be discarded, sold or applied towards purchase of another asset.
For any reason, when plant assets are disposed, it is necessary to remove the book value of the asset

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from the accounts. This is done by debiting the accumulated depreciation account balance for the total
depreciation to the date of disposal and crediting the asset account for the cost of the asset
Discarding Plant Asset
When plant assets are no longer useful to the business and have no market value, they are
discarded. If the asset has been fully depreciated; no loss is realized.
Sale of plant asset: - the entries for the sale of plant asset are similar to disposal, but here
we have cash or other assets received.
Exchange of Plant Asset: - Old equipments are often traded in for new equipments having
a similar use.
Natural Resource: Are resources gained naturally
Depletion: - are the periodic allocation of the cost of material ores and other minerals
removed from the earth.
The depletion is allocated based on the relationship of cost of the estimated size of mineral
deposit on the quantity extracted during the particular period.
Example: Assume that the cost of certain minerals right is Br 400,000.00 and that the
deposit is estimated at 1,000,000 tons of one of uniform grade.
The depletion per ton = Br 400,000.00 = Br 0.40/ tone
1,000,000
If during 2002, 90,000 thousand tones of ores were extracted the depletion expense, journal
entry
December 31, Depletion Expense 36,000.00
Accumulated Depletion 36,000.00
(Calculation= 90,000 X Br 0.40 = 36,000.00)
Accumulated depletion account is contra asset account. It is presented in the balance sheet
as a deduction form the cost of mineral deposit.
Intangible Asset: -
The basic principle of accounting for intangible assets are like those described earlier for
plant assets. The major concerns are the determination of the acquisition costs and the
recombination of periodic cost expiration. These periodic costs expiration are called
Amortization.
1. Patent: rights to inventors, evidenced by patent. Some organization may acquire (Purchase).

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 2. The cost of airing the patent is debited to an asset account; and then written off or amortized
over its expected useful life.
A separate contra account is not used mostly for amortizing intangible assets. Periodical
amortizations are directly written off to the asset account.

The expected useful life of a patent may be less than its legal life. For example, a patent may
become worthless due to changing technology or consumer tastes.
Example: Assume that on January 01, 2000, an enterprise acquired a patent for Br 100,000.
Although its useful life is estimated as only five years:
The entry to record the amortization for 2000 is: -
Dec. 31, 2000 Amortization Expense 20,000.00
Patent 20,000.00
3. Copy Rights: - these are exclusive rights to publish and sell literary, artistic or musical
compositions. The cost assigned to copy rights included all costs of creating
the work plus the cost of obtaining the copy right.
The copy right that is purchased form another should be debited at a price
paid for it.
Copy rights are issued by federal government and extend for 50 years beyond
the authors death. But because of uncertainty regardless of useful life they
are usually amortized in a short period of time.
4. Good Will: - is an intangible asset that attaches to a business as a result of such favorable
factors as location, product superiority, reputation, and managerial skill.
Its existence is evidenced by the ability of the business to earn a rate of return on the
investment that is in excess of the normal rate for other firms in the same line of business.
Goodwill is recorded only if it could be objectively measured, then it will be deprecated
over its expected period of time. Companies record goodwill only when an entire business is
purchased. In that case, goodwill is the excess of cost over the fair value of the net assets
(assets less liabilities) acquired.
In recording the purchase of a business, the company debits (increases) the identifiable
acquired assets, and credits liabilities at their fair values, a credit cash for the purchase price,
and records the difference as goodwill. Goodwill is not amortized because it is considered to
have an indefinite life.
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