Core Concepts of Accounting – Numbers and People Week 2

HANDOUT 2.1

OPERATIONAL ASSETS

WHAT ARE OPERATIONAL ASSETS?

Operational assets are used in operating the business and are not held for resale.
For accounting purpose fixed operational assets are classified as:
▪ Tangible Property, Plant and Equipment (also referred to as Capital Assets, Plant
Assets) – those assets which are actively used in operation, not held as an
investment or for resale, relatively long-lived, have physical substance and provide
future benefits
▪ Intangibles assets – goodwill, patents, trademarks and trade-names, copyrights
There are three classes of tangible fixed assets:
▪ Depreciable assets such as buildings, equipment and furniture
▪ Assets which are subject to depletion – such as mineral deposits
▪ Those not subject to depreciation or depletion – such as land
The accounting for property, plant and equipment fundamentally rests on the cost principle
and the matching principle.

ACCOUNTING PROCEDURES FOR PPE

Acquisitions of fixed assets are recorded in the accounts at cost.
The acquisition cost is measured by the cash outlay made to acquire the asset or by the
market value of the asset exchanged for the acquired asset.

Example 1
On 1/1/2013 ABC Company purchases equipment for $18,000 in cash.
The journal entry is: Plant Assets (Equipment) 18,000
Cash 18,000

Depreciation Expenses
Fixed assets are acquired and utilized because of their revenue-generating potential.
Therefore, as their economic values are used in generating revenue, a portion of their cost
must be matched (periodically) with these revenues.
▪ Depreciation – the accounting process of allocating the cost of an asset to the periods
of asset benefits (the term is used for tangible property, plant and equipment)
▪ Depletion – a similar process for natural resources
▪ Amortization – a similar process for intangible assets
In the above example, assume that the estimated service life of the acquired asset is equal
to 6 years. Then for the simplest straight-line depreciation schedule (see the details below in
this Handout 2.1):
▪ Annual Depreciation Expense = $3,000

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Core Concepts of Accounting – Numbers and People Week 2

Example 2
At the end of 2013 an adjusting entry is recorded:
Depreciation Expense 3,000
Accumulated Depreciation 3,000

Depreciation Methods
▪ Straight-line method – cost minus residual value is allocated equally to each year of
the asset’s useful life
▪ Units-of-output method – cost minus residual value is divided by the estimated units
of lifetime output. Annual depreciation expense is determined by multiplying the per
unit depreciation by the actual amount of units of output
▪ Sum-of-the-years’-digits method – depreciation expense for the year is calculated by
multiplying the depreciable cost by
Year number in reverse order
Sum-of-the-years’-digits
▪ Accelerated depreciation schedules
 Fixed-rate declining-balance method – each period’s depreciation expense is a
fixed rate of the net book value at the beginning of the period
 Double-rate declining balance method – depreciation is calculated by applying the
double straight-line rate to the undepreciated cost of the asset
 ACRS schedules – depreciation charges for each year in percentages of the total
cost of the asset are provided in a special table

Sales of Plant, Property and Equipment

When a company sells a plant asset, a gain or a loss on the sale is calculated by comparing
the book value with the amount received.

Example 3
A machine that costs $15,000 and has a book value of $7,000 is sold for $8,500.
The journal entry is:
Cash 8,500
Accumulated Depreciation 8,000
Plant and Equipment 15,000
Gain on disposal of plant assets 1,500

Comments
▪ All plant assets, excluding land, are depreciable. The depreciation reflects a decline
in value with use. Practically, it is recorded so as to allocate the cost of plant and
equipment over the year of use
▪ Land is assumed to have unlimited life, and is not subject to depreciation. When land
is purchased as a building site and has an old building on it the cost of the land
includes the entire purchase price plus any cost incurred in tearing down the existing
building
Land improvements (fences, driveways) are recorded separately and depreciated
over their estimated useful life

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Core Concepts of Accounting – Numbers and People Week 2

INTANGIBLE ASSETS
Intangible assets have no physical substance and convey certain legal and economic rights
to the entity. Examples of the intangible assets include:
▪ Patents – the exclusive right to benefit from an invention. Patents in the US have
legal life of seventeen years
▪ Trademarks and trade-names provide the right to prohibit competitors from using the
symbol and name of the company
▪ Franchises are agreements under which the franchisor grants to the franchisee the
right to market a certain products or services under the franchisor’s name
▪ Copyrights grant the holder the exclusive right to benefit from creative work
▪ Goodwill represents the otherwise unrecorded assets of a firm, e.g. management
experience and expertise, customer relationships, superior location for conducting
business activities, etc.

Accounting for Intangibles

▪ Intangible assets can be purchased or developed internally
▪ Research and (R&D) costs are expensed in the period in which they are incurred
▪ Usually, intangible assets appear in the books only when they are purchased
▪ They are amortized, using a straight-line method, over their estimated useful life,
which is assumed not to exceed 40 years

Measurement of Goodwill
▪ Goodwill is recorded only when purchased
▪ It represents the difference between the price paid and the fair market value of net
assets acquired when a company purchases a significant interest in another
company’s common stock