CHAPTER 3

PLANT ASSETS, NATURAL RESOURCES AND INTANGIBLE ASSETS

Nature of plant assets
Long-lived is a general term that may be applied to assets of a permanent or relatively fixed nature owned by a business
enterprise.
Long-lived assets consist of:
1) Intangible assets and
2) Tangible assets
Intangible Assets
 Have no physical characteristics that we can see & touch but represent exclusive privileges and rights to their
owners.
 Are long-lived assets that are without physical characteristics, are not held for sale, but are useful in the
operations of an enterprise.
Intangibility denotes lack of physical substance. Intangible assets often include patents, copyrights, trademarks,
organization costs and goodwill. The cost of acquired intangible assets is amortized over their estimated economic lives,
but not in excess of 40 years. Research and development costs incurred in the creation of internally developed intangible
assets are recognized currently as expenses.
Tangible Assets
 Have physical characteristics that we can see and touch. Tangibility is the characteristic of bodily substance, as
exemplified by a tract of timber, a bridge or a machine.
These tangible assets include:
a) Plant assets
b) Natural resources
a) Plant Assets
 Are long-lived tangible assets that are of a permanent nature, used in the operations of the business.
 Other descriptive titles are frequently used are property, plant, and equipment, used either alone or in
various combinations.
To be classified as a plant asset, an asset must
a. have a useful service life of more than one year; and
b. Be used in business operations rather than held for resale.
c. Has a physical substance.
d. They are subject for depreciation except land
The properties most frequently included in plant assets may be described in more specific terms as equipment, furniture,
tools, machinery, buildings, and land. On the balance sheet, you will find these assets included under the heading
“property, plant and equipment”.
I. Land
Unlike the other kinds of tangible property, land has an indefinite economic life. In general, land does not deteriorate
with the passage of time and is not physically exhausted through use. There may be exceptional cases. Agricultural land
may suffer a loss of usefulness through erosion or failure to maintain fertility. Building sites may be damaged or
destroyed by slides, floods, or earthquakes. Generally, land is accounted for as a non-depreciable plant asset.

II. Property having a limited economic life

With the exception of land, all other plant assets have limited economic lives. The cost of such assets is allocated through
the process of depreciation to the cost of the goods and services produced.
Characteristics of Plant Assets
1. Plant assets are generally are acquired for use rather than for sale.

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 2. In yielding services for many accounting periods, a plant asset does not change in physical characteristic; that is,
it does not become physically incorporated in the finished goods of a business enterprise. For example, a building
or machine wears out and eventually loses its ability to perform efficiently, but its physical components remain
relatively unchanged. In contrast, material is incorporated in finished goods.
3. They yield services over many years.
Plant assets include all long-lived tangible assets that are used to generate the principal revenues of the business.
Inventory is a tangible asset but not a plant asset because inventory is usually not long-lived and it is held for sale rather
than for use. What represents a plant asset to one company may be inventory to another. For example, a business such as a
retail appliance store may classify a delivery truck as a plant asset because a truck is used to deliver merchandise, but a
business such as a truck dealership would classify the same delivery truck as inventory because the truck is held for sale.
Although there is no standard criterion as to the minimum length of life necessary for classification as plant assets
or intangible assets, such assets must be capable of repeated use or benefit and are ordinarily expected to last more than a
year. However, the asset need not actually be used continuously or even often. For example, items of stand by equipment
held for use in the event of a breakdown of regular equipment or for use only during peak or emergency periods of
activity are included in plant assets because the equipment is used in the operations of the business.
Assets acquired for resale in the normal course of business cannot be characterized as plant assets, regardless of
their durability or the length of time they are held. For example, land held for speculative or as a prospective building site
or not yet put in to service is a long-term investment rather than a plant asset because the land is no being used by the
business. When a building is constructed on the land and is placed in service, the land is reported in the balance sheet
under plant assets.
b) Natural resources
This term includes wasting assets that are subject to exhaustion through extraction. The principal types of wasting
assets are mineral deposits, oil and gas deposits, and standing timber. In essence, natural resources are long-term
inventories acquired for sale or use in production over a number of years. The cost of acquiring and developing wasting
assets is allocated to expense in the form of depletion charges.
Acquisition cost of plant assets
The cost of acquiring a plant asset includes all expenditures necessary to get it in place and ready for use. The
acquisition cost of a plant asset is the amount of cash /or cash equivalents given up to acquire that asset and place it in
operating condition at its proper location.
Thus, 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 cost for used or damaged assets.
Expenditures resulting from carelessness or errors in installing the asset, from vandalism, or from other unusual
occurrences do not increase the usefulness of the asset and should be treated as an expense. Unnecessary costs (such as
traffic tickets or fines) that must be paid as a result of hauling machinery to a new plant are not part of the acquisition cost
of the asset.
1. Land
Land is non-depreciable. The cost of land includes:
 The acquisition (purchase) (negotiated) price.
 All costs of closing the transaction and obtaining title, such as broker’s commission, real-estate
commission, attorney’s fees, existing mortgage note assumed, legal fees, escrow fees (amount paid to
agents), title investigations, and title insurance premiums.
 All costs of surveying (surveying fees), clearing, draining, grading or filling to make the land suitable
for the desired use, including the cost of demolishing existing unwanted (unneeded) structures-that is-
when land purchased as a building site contains an unusable building that must be removed, the entire
purchase price should be debited to land, including the cost of removing the building less any cash
received from the sale of salvaged items, such as crops or fruit on the land; that occurs while the land is
being readied for use.
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  Cost of landscaping and local assessments for sidewalks, streets, sewers and water mines.
 Delinquent real estate taxes (unpaid taxes) (back taxes) (accrued property taxes and other liens on land)
assumed by purchaser or buyer.
The costs incurred to make the land suitable for its intended purposes such as cost of clearing trees, or of leveling hills
or filling low spots, are included in the cost of land. Any salvage material recovered in the process of clearing land
represents a cost offset.
Land held as a potential building site or for investment purposes is not currently used in operations and should be
reported under investments in the balance sheet rather than as a part of the plant assets category. The carrying costs, such
as property taxes and weed control incurred prior to the time that the land is placed in use, are capitalized (added to the
cost of the land). When the site is placed in use, the land is reclassified from the investment category to the plant assets
category, and future carrying costs are recognized as expenses.
2. Building
All necessary expenditures relating to the purchase or construction of a building are charged to the Building account.
When an existing building is purchased, its cost includes:
 Purchase price
 Closing costs (attorney’s fees, title insurance, etc)
 Cost of remodeling rooms and offices and replacing or repairing the roof, floors, electrical wiring, and plumbing
(or repair and remodeling costs)
 Unpaid taxes assumed by the purchaser, legal costs and real estate commissions paid.
When a new building is constructed, its cost consists of:
 Contract price (payments to contractors)
 Fees paid for architects and engineers for plans and supervision (Architect’s fees)
 Building permits
 Cost of digging the foundation (Excavation cost)
 Labor and materials to build the building
 Salaries f officers supervising the construction
 Insurance and taxes incurred during the construction
 Cost of temporary structures used for offices or for storing tools and materials during construction of a new
building
 Interest incurred during construction period on money borrowed to finance the construction
Any miscellaneous amounts earned from the building during construction reduce the cost of the building. For example,
if a small completed portion of the building is rented out during construction of the remainder of the building, the rental
proceeds are credited to the Building account.
3. Land Improvements
The cost of land improvements includes all expenditures necessary to make the improvements ready for their
intended use. It is important to distinguish between the cost of land and the land improvements because land has an
indefinite life and land improvements usually do not. Land improvement costs are capital expenditures and are either
recorded as land cost or recorded in a separate land improvements ledger account.
Examples of land improvements include: temporary landscaping (such as bushes, gardens, and trees), parking lots (costs
of paving and lighting), drive ways and private roads, the cost of fences, lawn and garden sprinkler systems
Some of the land improvements (such as landscaping and drainage) are as indefinite economic lives as that of land, so
included (added) to land cost. However, the cost of land improvements such as side walks, streets and sewers may or may
not have indefinite economic lives. In many localities, the cost of streets, sewers, and similar improvements are paid by
the owners of the benefited property, but the local governmental unit agrees to maintain and replace them if they are built
to standard specifications. In such cases the special assessments expenditure is a part of land cost, because it is permanent

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in nature. However, if the property owner is responsible for eventual replacement of land improvements, they have limited
economic lives and are recorded in a separate Land Improvements ledger account to facilitate depreciation accounting.

4. Machinery and Equipment

The cost of machinery or equipment consists of sellers net invoice price (whether
the discount is taken or not), sales and other taxes, legal fees, broker’s fees, transportation (freight) charges, insurance
during transit paid by the purchaser, cost of installation, testing and break-in costs, costs of accessories, other costs needed
to put the machine or equipment in operating condition in its intended location for use. It also includes expenditures
required in assembling, installing, and testing the unit. However, Motor vehicle licenses and accident insurance on
company trucks and cars are expensed as incurred, because they represent annual recurring expenditures and do not
benefit future periods.
The cost of machinery does not include costs of removing and disposing of a replaced, old machine that has been
used in operations. Such costs are part of the gain or loss on disposal of the old machine.
NB: The cost of machinery or equipment includes any cost incurred to get the machinery and equipment ready for its
intended use.
SUMMERY OF COST OF PLANT ASSET

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Nature of Depreciation
As time passes, all plant assets with the exception of land lose their capacity to yield services. Accordingly, the cost of
such assets should be transferred to the related expense accounts in an ordinary manner during their expected useful life.
This periodic cost expiration is called “depreciation”.
Depreciation is the amount of plant asset cost allocated to each accounting period benefiting from the plant asset’s use
and is a process of allocation, not asset valuation. All plant assets are subject to depreciation except land.
 Purpose of calculating depreciation of plant assets
(1) To properly measure net income through matching principle. Depreciation expense is often a significant factor in
determining net income. For this reason, most financial statement users interested in the amount of, and methods
used to compute, a company’s depreciation expense.
(2) To recognize the decline in the usefulness of plant assets.
Major Causes of Depreciation
Factors contributing to a decline in usefulness may be divided into two categories:
1) Physical Depreciation, which includes wear from use and deterioration from the action of the elements, and
2) Functional (Economic) Depreciation, which includes inadequacy and obsolescence.
1) Physical Depreciation or Physical Deterioration
 Results from the use of the assets-wear and tear- and the action of elements (the forces of the nature). These
physical forces terminate the usefulness of plant assets by rendering them incapable of performing the services for
which they were intended and thus set the maximum limit on economic life. Unusual events such as accidents,
floods, and earth quakes also serve to terminate or reduce the economic life of plant assets. For example, an
automobile may have to be replaced after a time because its body rusted out.
2) Functional (Economic) Depreciation, which includes inadequacy and obsolescence.
I. Inadequacy: – A plant asset becomes inadequate if its capacity is not sufficient to meet the demands of increased
production. The inadequacy of plant asset is its inability to produce enough products or provide enough services to
meet current demands. For example, an airline cannot provide air service for 125 passengers on a flight serviced by
a plane with a seating capacity of 90.
II. Obsolescence: – A plant asset is obsolete if the commodity that it produces is no longer in demand or if a newer
machine can produce a commodity of better quality or at a great reduction in cost. The obsolescence of an asset is
its decline in usefulness brought about by inventions and technological progress. For example, the development of
the xerographic process of reproducing printed matter rendered almost all previous method of duplication obsolete.

The use of a plant asset in business operations transforms a plant asset cost to an operation expense. Depreciation
then, is a cost of operating a business. Because depreciation does not require current cash out lay, it is often called a non-
cash expense; cash was given up in the period when the asset was acquired, not during the periods when depreciation
expense is recorded.
The meaning of term “depreciation” as used in accounting is often misunderstood because the same term is also
commonly used in business to meet a decline in the market value of an asset. The amount unexpired cost of plant assets
reported in the balance sheet is not likely to agree with the amount that could be realized from their sale. Plant assets are
held for use in the enterprise rather than as a going concern. Consequently, the decision to dispose of a plant asset is based
mainly on its usefulness to the enterprise and not on its market value.

Accounting for Depreciation

If a plant asset is expected to have no value at the time that it is retired from service, its entire initial cost should be
spread over the expected useful life of the asset as depreciation expense. Also, if a plant asset’s value at the time of
retirement is expected to be very small in comparison with the cost of the asset, this value may be ignored and the entire
cost speared over the asset’s expected useful life. If a plant asset is expected to have a significant value at the time that it

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is retire from service, the different between its initial cost and this value is the cost (depreciation cost) that should be
speared over the useful life of the asset as depreciation expense.
Factors to be considered in computing depreciation.
In determining the amount of depreciable cost (depreciation base) (cost minus estimated salvage value) that is to be
recognized as periodic depreciation expense, three factors needed to be considered: the plant asset’s
(a) Initial cost: all expenditures necessary to acquire the asset and make it ready for intended use.
(b) Residual value/Salvage value / scrap value: is the plant asset’s estimated value at the time that it is to be retired from
service. In other words, salvage value (or scrap value) is the amount of money the company expects to recover, less
disposal costs, on the date a plant asset is scrapped, sold, or trade in. In making the estimate, management should consider
how it plans to dispose of the asset and its exchange with similar assets.
(c) Useful life: refers to the length of time the company owning the assets intended to use it; useful life is not necessarily
the same time period as either economic life or physical life. The economic life of a car may be 7 years and its physical
life may be 10 years, but if a company has a policy of trading cars every 3 years, useful life may be expressed in years,
months, working hours, or units of production. Obsolescence may also affect useful life. For example, a machine may be
capable of producing units for 20 years, but it is expected to be obsolete in 6 years. Thus, its estimated useful life is 6
years – not 20.

Depreciation methods
Depreciation generally computed using one of the following methods.
 Straight-line method
 Units- of- production method
 Accelerate depreciation methods (double declining balance method & sum- of- the -years- digits method).
It is not necessary that an enterprise use a single method of computing depreciation for all classes of its depreciable assets.
The method used in the accounts and financial statements may also differ from the methods used in determining income
taxes and property taxes.
As it is true for inventory methods, a company is normally free to adopt the method(s) of depreciation it believes most
appropriate for its business operations.
The theoretical guideline is to use a depreciation method that reflects most closely the underlying economic
circumstances. Thus, companies should adopt the depreciation method that allocates plant asset cost to accounting period
according to the benefits received from the use of the asset.

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In practice, the measurement of benefits from the use of a plant asset is impractical and often not possible. As a result, a
depreciation method must meet only on standard: The depreciation method must allocate plant asset cost to accounting
periods in a systematic and rational manner.
Regardless of the method or methods chosen, the company must disclose its depreciation method (s) in the footnotes to
its financial statements.
“Note: Companies may use different depreciation methods for different plant assets.”
1. Straight line method
 The straight-line method of determining depreciation provides for equal periodic charges to expense over the
estimated life of the asset.
 Under the straight-line method, depreciation is the same for each year of the asset’s useful life. It is measure solely
by the passage of time. To apply the straight-line method, an equal amount of plant asset cost is charged to each
accounting period.
 In order to compute depreciation expense, it is necessary to determine depreciable cost. Depreciable cost is the cost
of the assets less its salvage value. It is the total amount subject to depreciation. Depreciable costs then, divided by
the asset’s useful life to determine depreciation expense.
 The formula for calculating depreciation under the straight line method is :
Depreciation expense = Asset cost – Estimated salvage value
Per year Number of accounting periods in estimated
Useful life
Depreciable cost (depreciation Base) = Asset - Estimated
Cost Salvage Value
For example, assume that the cost of a depreciable asset is $24,000, its estimated residual value is $2,000, and its
estimated life is 5 years.
The distinguishing characteristic of the straight-line method of depreciation is that each full year of service absorbs an
equal portion of cost. ANNUAL DEPRECIATION is computed as follows

.
 Use of the straight line method is appropriate for assets where
1) Time rather than obsolescence is the major factor limiting the asset’s life and
2) Relatively constant amount of periodic services is received from the asset. Assets that possess these
features include pipelines, fencing, and storage tanks.

The straight-line method is widely used because of its simplicity. In addition, it provides a reasonable allocation
of costs to periodic revenue when usage is relatively the same from period to period.

2. Units of Production Method

 The units-of-production depreciation method assigns an equal amount of depreciation to each unit of product
manufactured or service rendered by an asset. Since this method of depreciation is based on physical output, it is
applied in situations where usage rather than obsolescence is the main factor leading to the demise of the asset.
 The units of production method yield a depreciation charges that varies with the amount of asset usage. To apply this
method, the length of the life of the asset is expressed in terms of productive capacity, such as hours, miles or number
of units.

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 Under this method, depreciation is first computed for the appropriate unit of production, and the depreciation for each
accounting period is then determined by multiplying the unit depreciation by the number of units used.
The unit of activity method is ideally suited to factory machinery; production can measure in terms of units of output or
in terms of machine hours used in operating the machine. It is also possible to use this method for such items as delivery
equipment (miles driven) and air plane (hours in use). The units of activity method is generally not suitable for such assets
as building or furniture because depreciation for these assets in more a function of time than of use.
The units-of-production depreciation formulas are:
Depreciation per unit = Asset Cost– Estimated salvage value
(Depreciation rate) Estimated total units of production (or service)
during useful life of asset

Depreciation per period = Depreciation per unit x Number of units of goods or Services produced.
Note: when production of the asset varies significantly from one period to another, the unit of activity (units –of-
production) method results in the best matching of expected costs with revenues.

Assume that a machine with a cost of $24,000 and an estimated residual value of $2,000 is expected to have an estimated
life of 10,000 operating hours.

The depreciation for a unit of one hour is computed as follows:

Assuming that the machine was in operation for 2,100 hours during a year, the depreciation for that year would be $4,620
($2.20 2,100 hours)
3. Accelerated Depreciation Method
Accelerated depreciation method records higher amounts of depreciation during the early years of an asset’s life and
lower amounts in the asset’s later years. A business might choose an accelerated depreciation for the following reasons:
1) The value of the benefits received from the asset decline with age (for example, office buildings).
2) The asset is a high-technology asset subject to rapid obsolescence (for example, computers)
3) Repairs increase substantially in the asset’s later years and under this method the depreciation and repairs remain
fairly constant over the assets life (for example, automobiles).
The two most common accelerated methods of depreciation are:
A. The double declining balance (DDB) method.
B. The sum – of – the – year’s – digits (SOYD) method.
A. Double-Declining Balance Method
The double-declining-balance (DDB) yields a declining periodic depreciation charge over estimated life of the asset.
The DDB method of computing periodic depreciation charges is applied by first calculating the straight-line rate
depreciation rate. The straight-line rate is calculated by dividing 100% by the number of years of useful life of the asset.
Then, multiply this rate by 2. The resulting double-declining rate is applied to the declining book value (cost minus
accumulated depreciation) of the asset.
Salvage value is ignored in making the calculations. However, at the point where book value is equal to the salvage value,
no more depreciation is taken.

The formula for DDB depreciation is:

Depreciation = (2 X Straight line rate) X (Asset – Accumulated
Per period Cost Depreciation)

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Straight-line rate = 100%/Number of years of useful life of the asset
Note that estimated residual value is not considered in determining the depreciation rate. It is also ignored in computing
periodic depreciation, except that the asset should not be depreciated below the estimated residual value.

B. Sum-of-the-Year’s-Digits method.
The sum-of-the-years –digits method yield result like those obtained by the use of the double declining balance method.
This method is similar to the double declining balance method because it also assumes that an asset is used more
extensively during the first-years of operation. Under this method, an important consideration is give to the number of
years in the asset’s useful life.
The periodic charge for depreciation declines steadily over the estimated life of the asset because a successively smaller
fraction is applied each year to the original cost of the asset less the estimated residual value.
The denominator of the fraction, which remains the same, is the sum of the digits representing the years of life. The
numerator is the fraction, which changes each year, is the number of years of life remaining at the beginning of the year
for which depreciation is being computed.
The sum-of-the-years –digits (SOYD) method is so called because the consecutive digits for each year of an asset’s
estimated life are added together and used as the denominator of a fraction. The numerator is the number of years of
useful life remaining at the beginning of the accounting period.
To compute that period’s depreciation expense, this fraction is then multiplied by the acquisition cost of the asset less
estimated salvage value.
The formula is:
Depreciation = Number of years of
Per period useful life remaining at (Asset - Estimated
beginning of accounting period X Cost salvage
Sum of Digits for value)
years of life (SOYD)
The years are totaled to find SOYD. For an asset with a 10-year useful life, the SOYD=10+9+8+7+6+5+4+3+2+1=55.
Alternatively, rather than adding the digits for all years together, the following formula can be used to find the SOYD for
any given number of periods:
SOYD = n (n+1)
2
Where n is the number of periods in the assets useful life. Thus, SOYD for an asset with a 10-year useful life is:
SOYD= 10(10+1)/2 =15.
For the first year, the numerator is 5, for the second year 4 and so on. When the first use of the asset does not coincide
with the beginning of a fiscal year, it is necessary to allocate each full year’s depreciation between the two fiscal years
benefited.
Comparison of Depreciation
All four depreciation methods will yield the same total depreciation over the life of the asset. However, each method will
yield periodic charges which may vary significantly.

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 The straight line-method (SLM): provides for equal (uniform) periodic charges to depreciation expense over the
estimated useful life of the asset.
 The units-of-production method: provides for periodic charges to depreciation expense that may vary considerably,
depending upon the amount of the asset usage.
 Both the declining-balance and the sum-of –the-years digits’ methods provide for a higher depreciation charge in the
first year of use of the asset and a gradually declining periodic charge thereafter. For this reason, they are frequently
referred to as accelerated depreciation methods. These methods are most appropriate for situations in which the
decline in productivity or earning power of the asset is proportionately greater in the early years of its use than in later
years. Further justification or their use is based on the tendency of repairs to increase with the age of an asset. The
reduced amounts of depreciation in later years are therefore offset to some extent by increased maintenance expenses.
Thus, each method is acceptable in accounting, because each recognizes the decline in service potential of the asset in
a rational and systematic manner.
Revision of Periodic depreciation (Changes in Estimates)
After an asset is depreciated down to its estimated salvage value, no more depreciation is recorded on the asset even if it
continues to be used. However, when the estimated useful life of an asset or its salvage value is found to be incorrect
before the asset is depreciated down to its estimated salvage value, revised depreciation charges are computed.
When a change in an estimate is required, the change is made in current and future years but not to prior periods.
Thus, when a change is made,
1) there is no correction of previously recorded depreciation expense,
2) Depreciation expense for current and future years is revised.
That is, these revised charges do not correct past depreciation taken; they merely compensate for past incorrect charges
through changed expense amounts in current and future periods. The rationale for this treatment is that continual
restatement of prior periods would adversely affect the reader’s confidence in financial statements.

To illustrate, assume that a fixed asset purchased for $130,000 was originally estimated to have a useful life of 30 years
and a residual value of $10,000. The asset has been depreciated at $4,000 per year [($130,000 $10,000) 30 years] for 10
years by the straight-line method. At the end of ten years, the asset’s book value (undepreciated cost) is $90,000,
determined as follows:

During the eleventh year, it is estimated that the remaining useful life is 25 years (instead of 20) and that the residual
value is $5,000 (instead of $10,000). The depreciation expense for each of the remaining 25 years is $3,400, computed as
follows:

SPECIAL DEPRECIATION METHODS

Some times each of the four depreciation methods discussed so far may not be suitable because the assets involved have
unique characteristics, or the nature of the industry requires that a special depreciation method be use of these methods,
the group and composite methods are discussed below:
Group and Composite Methods

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Depreciation methods are usually applied to a single asset. Under some circumstances, however, a number (group) of
asset accounts are depreciated using one rate. For example, an enterprise such as Ethiopian Telecommunication Corp.
might depreciate telephone poles, microwave systems, or switchboards by groups.

Group depreciation - the term “group” refers to a collection of assets that are similar in nature. The group method is
frequently used when the assets are fairly homogeneous and have approximately the same useful lives. The group method
more closely approximates a single-unit cost procedure because the dispersion from the average is not as great.
Composite-rate depreciation - the term “composite” refers to collection of assets that are not similar (or dissimilar) in
nature.
The composite method is used when the assets are heterogeneous and have different lives. When depreciation is
computed on the basis of a composite group of assets of differing life spans, a rate based on averages must be developed.
This is done by (1) computing the annual depreciation for each asset, (2) determining the annual depreciation, and (3)
dividing the sum thus determined by the total cost of the assets.
ILLUSTRATION
Assume TANA Transport Share Co. depreciates its group of cars, buses, and trucks on the basis of composite-
depreciation method.
Original Residual Depreciable Estimated Annual Dep.
Asset Cost Value Cost Life (straight line method)
Cars Br.400,000 Br. 80,000 Br. 320,000 8 years Br. 40,000
Buses 2,400,000 240,000 2,160,000 10 years 216,000
Trucks 1,500,000 150,000 1,350,000 9 years 150,000
Br. 4,300,000 Br. 470,000 Br. 3,830,000 Br. 406,000

Composite depreciation rate = Br. 406,000 = 9.44%

Br. 4,300,000
If no change exists in the asset account, the group of assets will be depreciated to the residual or salvage value at the rate
of Br. 406,000 (Br. 4,300,000 x 9.44%) a year.
CAPITAL AND REVENUE EXPENDITURES
Capital Expenditures- are expenditures that improve the operating efficiency (or capacity) or costs incurred to achieve
greater future benefits.

In addition to the acquisition of plant assets, capital expenditures included additions and betterments.

An addition is an enlargement to the physical layout of a plant asset. Suppose for example, if a new wing is added to a
building, the benefits from the expenditure will be received over several years, and the amount paid for it should be
debited to the asset account.

A betterment, on the other hand, is an improvement that does not add to the physical layout of the asset. Installation of an
air conditioning system is an example of betterment, Replacement of a concrete floor for a wooden floor is also
betterment that will provide benefits over a number of years, so its cost should be charged (debited) to an asset account.

Another types of capital expenditures include extraordinary repairs. Extraordinary repairs are repairs of a more
significant nature. They affect the estimated residual value or estimated useful life of an asset. For example, a boiler for
heating a building may be given a complete overhaul, at a cost of Br. 3000 that will prolong its economic life by 5 years.

Extraordinary repairs are recorded by debiting the accumulated depreciation account and crediting cash, under the
assumption that some of the depreciation previously recorded has now been eliminated. The effect of this reduction in the
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accumulated depreciation account is to increase the book value of the asset by the cost of the extraordinary repair. As a
result, the new book value of the asset should be depreciated over the new estimated useful life.

Revenue expenditures
Revenue expenditures are expenditures incurred in order to maintain the normal operating efficiency of the asset.

Among the more usual kinds of revenue expenditures for plant asset are the repairs, maintenance, lubrication, Cleaning
and inspection necessary to keep an asset in good working condition.
Ordinary repairs are expenditures that are necessary to keep an asset in good operating conditions. Trucks must have
tune-ups, their tires and batteries must be replaced regularly, and other routine repairs must be made. Offices and halls
must be painted regularly, and broken tiles or woodwork must be replaced. Such repairs benefits only the current period
and therefore must be charged against the revenue in the current fiscal period.

DISPOSAL OF PLANT ASSETS

A plant asset rarely lasts exactly as long as its estimated life. If it lasts longer than its estimated life, it is not depreciated
more than the point at which its carrying value equals its residual value. The purpose of depreciation is to spread
(allocate) the depreciable cost of the asset over the economic life of the asset. Thus, the total accumulated depreciation
should never exceed the total depreciable cost. If the asset is still used in the business beyond the end of its estimated life,
its cost and accumulated depreciation remain in the ledger accounts. Proper records will thus be available for maintaining
control over plant assets. If the residual value is zero, the book value of a fully depreciated asset is zero until the asset is
disposed of. If such an asset is discarded, no gain or loss results.
A plant asset may be disposed by:
(1) Discarding it as worthless
(2) Selling it or
(3) Trading it in on a new asset
Discarding of a Plant Asset
If a plant asset is of no further use to the business and cannot be sold or traded, then the plant asset is discarded. If the
asset has no book value. (i.e., if it is fully depreciated), the plant asset account is credited for the amount of the original
cost of the item being discarded. At the same time, the accumulated depreciation account is debited for the amount of the
total accumulated depreciation of the item being discarded. In this case neither gain nor loss is realized. On the other hand,
if a plant asset has a book value (if not fully depreciated) at the time it is discarded, the business incurs a loss.
Illustration - 1
Suppose, on July 5, year 5, equipment that was acquired On Jan 10, year 1, at a cost of Br. 11,000, is discarded as
worthless. The discarded equipment has a carrying value of Br. 2000 at the time of disposal. The carrying value is
computed as the difference between the cost of asset Br. 11,000 and accumulated depreciation, Br. 9000. A loss equal to
the carrying value should be recorded when the equipment is discarded.
The journal entry required to discard the plant asset as of July 5, year 5, is:
Accumulated Depreciation, Equipment …………9000.00
Loss on disposal of plant Asset…………………2000.00
Equipment ……………………………………..11000.00
Discarding Equipment, no longer used in the business.
Sale of Plant Asset
The entry to record the sale of an asset for cash is similar to the one illustrated above except that the receipt of cash should
also be recorded. The following entries show how to record the sale of equipment under three assumptions about the
selling price. In the first case, the Br. 2000 cash received is exactly equal to the book value of the equipment (which is
equal to Br. 2000).
Case 1. Sold at an amount equal to Book value, Br. 2000, no gain or loss results.
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 Year 5
July 5. Cash ……………………………………2000.00
Accumulated Depreciation, Equip……...9000.00
Equipment ………………………………..11000.00
Sale of equipment at an amount equal to book value
Case 2. Sold at Br. 1500 cash; Loss of Br. 500, (BV = Br. 2000)
Year 5
July 5. Loss on sale of equipment………………….500.00
Accumulated Depreciation……………………… 9000.00
Cash ……………………………………………….1500.00
Equipment…………………………………11000.00
Sale of equipment at less than the book value. Loss of Br. 500(1500-2000)
Case 3. Sold at Br. 3000 cash; gain of Br. 1000, cash received through
Sale less book value of the asset (Br. 3000 – Br. 2000)
Year 5
July 5.
Cash ……………………………………….3000.00
Accumulated Depr, Equipment……………9000.00
Equipment……………………………………………..11000.00
Gain on sale of plant asset……………………………...1000.00
Sale of equipment at more than the book value; gain of Br. 1000,
(Br. 3000 – Br.2000) recorded
5.2.3 Exchange of Plant Assets

Businesses also dispose of plant assets by trading them by other plant assets. Exchanges may involve similar assets, such
as an old machine traded-in on a newer model, or dissimilar assets, such as a machine traded-in on a truck. In either case,
the purchase price is reduced by the amount of the trade-in allowance.

The basic accounting for exchanges of plant assets is similar to accounting for sales of plant assets for cash. If the trade-in
allowance received is greater than the carrying value of the assets book value, there has been a gain. If the trade-in
allowance is less than the book value (carrying value), there has been a loss.

There are special rules for recognizing these gains and losses, depending on the nature of the assets exchanged.
Exchange Losses Gains
Recognized Recognized
For Financial Reporting Purposes:

 Of similar assets………………………… Yes……………………………….No

 Of Dissimilar assets……………………….. Yes…………………………….. Yes

For Income Tax purposes:

 Of similar assets…………………………… No………………………….. No

 Of dissimilar assets………………………… Yes……………………… Yes

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Both Gains and Losses are recognized when a company exchanges dissimilar assets. Assets are dissimilar when they
perform different functions; assets are similar when they perform the same function.

For financial reporting purposes, gains on exchanges of similar assets are not recognized because the earning lives of the
asset book value are not considered to be completed.

When a company trades-in an older machine on a newer machine of the same type, the economic substance of the
transaction is the same as that of a major renovation and upgrading of the older machine.

Accounting for exchange of similar assets is complicated by the fact that neither gains nor losses are recognized for
income tax purposes.

Loss Recognized on the Exchange

A loss is recognized for financial reporting purposes on all exchange in which a material loss occurs.
Illustration-2

To illustrate the recognition of a loss, assume that the business exchange a machine with a cost of Br. 11,000, and
accumulated depreciation of Br. 9000 for a newer more modern machine (similar asset) on the following terms:

Cost of new machine ………………………Birr 12000.

Trade-in Allowance for old machine……………(1500)
Cash payment required (Boot)……………..Birr 10500.

Solution
In the illustration above, the trade-in allowance (1500) is less than the carrying value (Br. 2000) of the old machine. The
loss on the exchange is Br. 500, (Br. 2000 – Br. 1500). Therefore, the journal entry required to record the exchange of
assets would be as follows: (for financial reporting purpose)
Year 5.
July 5. Equipment (New)……………………..12,000.00
Accum. Depreciation-Equip…………………...9,000.00
Loss on Exchange of plant assets………………. 500.00
Equipment (old)……………………………………11,000.00
Cash…………………………….…………………. 10,500.00
Loss Not Recognized on the Exchange
In the previous illustration, in which a loss was recognized, the new asset was recorded at the purchase price of Br. 12000
and a loss of Br. 500 was recognized. If the transaction is for similar assets and is to be recorded for income tax purpose,
the loss should not be recognized. In this case, the cost basis of the new asset will reflect the effect of the unrecorded
loss. The cost basis for the new asset, therefore, is computed by adding the cash payment to the carrying value of
the old asset:
Cost basis of new asset= boot + book value or
Cost of New + loss
Carrying (Book) value of old Equipment……………………..Birr 2,000.00
Cash paid (Boot given)………………………………………… 10,500.00
Cost-basis of new Equipment ……………………………… Birr 12,500.00

Note that no loss is recognized in the entry to record this transaction.

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 Year 5.
July 5. Equipment (New)……………………………….12,500.00
Accumulated Depreciation……………………… 9,000.00
Equipment (old)……………………………11,000.00
Cash……………………………………….. 10,500.00
NB. The new equipment is recorded (reported) at a purchase price of Br. 12000 plus the unrecognized loss of Br. 500. the
post postponement of the loss. Since depreciation of the new equipment will be computed based on a cost of Br. 12500
instead of Br. 12000, the “unrecognized” loss results in more depreciation each year on a new equipment than the loss had
been recognized.

Gain Recognized on the Exchange

Gains on exchanges are recognized for financial reporting purposes when dissimilar assets are exchanged. To illustrate the
recognition of a gain, assume the following terms in which the machines being exchanged serve different functions:

Price of new machine………………………………Birr 12,000.00

Trade-in Allowance for old machine………………….(3000)
Cash payment required (Boot given)……………….Birr 9,000.00

Here the trade-in allowance (Br. 3000) exceeds the carrying value (Br. 2000) of the old machine by Br. 1000. thus, there
is a gain on the exchange, if the trade-in allowance represents the fair mark value of the old machine. Assuming that this
condition is true, the entry to record the transaction is as follows:
Years 5
July 5. Equipment (New)……………………………12,000
Accumulated Depreciation…………………….9,000
Equipment (old)………………………….11,000
Cash ……………………………………… 9,000
Gain on exchange of Equip………………..1,000
Gain Not Recognized on the Exchange:
A gain on an exchange should not be recognized in the accounting records if the assets perform similar functions. The cost
basis for the new equipment must indicate the effect of the unrecorded gain. This cost basis is computed by adding the
cash payment to the carrying value of the old asset:
Carrying value of old equipment …………………………..Birr 2,000.00
Cash paid (Boot Given)………………………………………… 9,000.00
Cost basis of new Equipment……………………………. Birr 11,000.00

The entry to record the transaction is as follows:

Year 5
July 5. Equipment (New)……………………………..11,000.00
Accumulated Depreciation…………………… 9,000.00
Equipment (old)…………………………………..11,000.00
Cash…………………………………………………9,000.00

ACCOUNTING FOR INTANGIBLE ASSETS AND NATURAL RESOURCES

Intangible Assets: are long-term assets that do not have physical substance and in most cases relate to legal rights or
advantages held.

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Intangible assets include patents, copyrights, trademarks, franchises, organization costs, leaseholds, leasehold
improvements, and goodwill. The allocation of intangible assets to the periods they benefit is called amortization.

Patents
patents, which the federal government issues to inventors. These rights continue in effect for 20
years. A business may purchase patent rights from others, or it may obtain patents developed by its
own research and development efforts.
The initial cost of a purchased patent, including any related legal fees, is debited to an asset
account. This cost is written off, or amortized, over the years of the patent’s expected usefulness.
This period of time may be less than the remaining legal life of the patent. The estimated useful life
of the patent may also change as technology or consumer tastes change.

The straight-line method is normally used to determine the periodic amortization.

When the amortization is recorded, it is debited to an expense account and credited directly to the
patents account.

COPYRIGHTS AND TRADEMARKS

The exclusive right to publish and sell a literary, artistic, or musical composition is granted
by a copyright. Copyrights are issued by the federal government and extend for 70 years
beyond the author’s death. The costs of a copyright include all costs of creating the work
plus any administrative or legal costs of obtaining the copyright. A copyright that is
purchased from another should be recorded at the price paid for it. Copyrights are
amortized over their estimated useful lives.

Intangibles, which mainly consist of artist contracts and music catalogs, are being
amortized on a straight-line basis principally over 16 years and 21 years, respectively.
A trademark is a name, term, or symbol used to identify a business and its products. For
example, the distinctive red-and-white Coca-Cola logo is an example of a trademark.

GOODWILL

In business, goodwill refers to an intangible asset of a business that is created from such favorable factors as
location, product quality, reputation, and managerial skill.
Goodwill allows a business to earn a rate of return on its investment that is often in excess of the normal rate for
other firms in the same business.
Generally accepted accounting principles permit goodwill to be recorded in the accounts only if it is objectively
determined by a transaction.
Illustration - 3
Assume that on Jan 2,2002 MOHA Soft Drink Bottling company purchased a patent on a unique bottle cap for Br. 54,000.
The entry to record the patent would be as follows:
2002

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 Jan 2. Patent……………………………..54,000
Cash……………………………………..54,000
To record the purchase of Bottle cap patent

Assume that MOHA’s management determines that, although the patent for the bottle cap will last for seventeen years,
the product using the cap will be sold only for the next six years. The entry to record the annual amortization would be as
follows:

Amortization Expense………………………..9,000.00
Patent……………………………………………9,000.00
To record annual amortization of patent (Br. 54000/ 6 years)
Note that the patent account is reduced directly by the amount of the amortization expense. This is in contrast to other
long-term asset accounts in which depreciation or depletion is accumulated in a separate contra account.

If the patent becomes worthless before it is fully amortized, the remaining carrying value is written off as a loss. For
instance, assume that after the first two years MOHA soft Drink Bottling Company’s chief competitor’s offers a bottle
with a new type of cap that makes MOHA’s cap obsolete. The entry to record the loss is:

Loss on patent……………………………36,000.00
Patent……………………………………36,000.00
To record the loss resulting from patents becoming worthless.
Depletion of Natural Resources
We now turn our attention to another group of long-lived assets natural resources, such as minerals, oil, and timber or
lumber. These natural resources are extracted from the earth.

Depletion is the accounting measure used to allocate the acquisition cost of natural resources. Depletion differs from
depreciation because depletion focuses specifically on the physical use and exhaustion of the natural resources, while
depreciation focuses more broadly on any reduction of the economic value of a plant or fixed asset. The costs of natural
resources are usually classified as long-terms assets.
Depletion expense is the measure of that portion of long-term assets that is used up in a particular period.
Illustration - 4
Suppose for example, MIDROC Construction has acquired the right to use 10,000 acres of land in Kibre-Mengist territory
to mine for gold at a total cost of, Br. 10,000.000. The Company estimated that the mine will; provide approximately
500,000 grams of gold. The depletion rate established is computed in the following manner.
Total cost – Salvage value = Depletion cost per unit.
Total estimated units available

Br. 10,000,000 = Br. 20 per gram

500,000 units
If 100,000 grams are extracted in the first year, then the depletion for the year is 2000.000 (1000,000 x Br. 20.00). The
entry to record the depletion is therefore:
Depletion Expense…………………..2,000,000
Accumulated Depletion……………………….2,000,000

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