Financial Accounting

(PGDM- 2015-16)

Session -15: Accounting for Long-lived Assets

Sriranga Vishnu
Faculty (F&A Area)
 Long-lived Assets – Introduction

• Tangible Assets-
– Building, Plant, Machinery, Furniture, etc.
– Depreciate over a period of time

• Intangible Assets-
– Non-physical entities – Patents, Software, Goodwill, etc.
– Amortized over a period

• Natural Resources-
– Land, Coal, Oil, etc.
– Deplete with passage of time
 Acquiring Plant and Equipments

• Low Cost Items– Generally expensed; Limit varies

– Capitalized facility may contain low cost items; expensed when
replaced

• Maintenance and Betterment- Maintenance is upkeep;

Generally expensed. Betterment is up-gradation; Treated
as asset and capitalized

• Replacement– Can be an asset or expanse

– Replacement of a component / part of asset is expensed
 Acquiring Plant and Equipments

• Items included in cost – All expenditure done in order to

make an equipment ready to use.
– Capitalization is higher if all costs are included
– For simplicity and property tax purposes, only purchase price is
considered

• For self-constructed assets- All material, direct labour

and fair amount of indirect costs are added. Interest cost
is also added for capitalization
– If Interest cost is capitalized and not expensed, current year
Income increases but decreases for subsequent years of assets
useful life
 Acquiring Plant and Equipments

• Non-Cash Items– During exchanges, fair market value of

the acquired tangibles is estimated; if not possible, value
of new asset is used

• Assets acquired through donations or at substantially low

prices are recorded at fair value.

• Basket Purchase– A group of items clubbed together. The

firm should make prudent estimates to separate the cost
of items component-wise
 Accounting for Depreciation
• Depreciation– Expensing the capitalized item
– Deterioration and Obsolescence limit the life of an asset
• Residual or Salvage value
• Useful life of the asset –Service Life

• Methods of Depreciation-
– Straight Line
– Declining Balance (Written Down method)
– Sum of years' digit method
– Units of Production method
 Methods of Depreciation

• Straight Line Method– Net acquisition cost is expensed

over useful life of asset in equal amounts
– Calculation is relatively simple
– Cost and revenue are matched

• Written Down Method– A depreciation percentage is

applied on the acquisition cost at the beginning of the
accounting period. Asset is never completely written-off
– The amount for final period is simply written off
– The method matches the services provided by an asset
– Risk of obsolescence is reduced
– Lower income in the initial years, higher subsequently
 Methods of Depreciation

• Sum of years' digit method – Similar to Written down

method. Depreciation is applied to net cost. The rate of
depreciation is determined by dividing the remaining
useful life of the asset by the sum of the useful life

• Units-of-Production method– The depreciation rate is

determined by dividing the net cost by the estimated
total no. of units that will be produced during useful life.
This rate is then multiplied by no. of units produced/year
– This method is related with usage of assets
– Depreciation is matched with level of activity
– Estimation of products to be produced is difficult
 Accounting for Depreciation

• For tax purposes, firms normally use the written-down

method, For Financial Reporting, any of the methods can
be chosen consistently

• For different kinds of assets, different methods can be

adopted. However, firms generally stick to a single
method

• If an item has been fully depreciated and is still in

possession of the firm, it is shown in B/S at zero amount
 Accounting for Natural Resources

• For natural resources, the term ‘Depletion’ is used. When

extracted, they are treated as inventory

• Cost allocation for extraction of natural resources:

– Full cost method – all costs are capitalized
– Successful efforts method – success costs are capitalized,
others are expensed

• Depletion of natural resources is shown by units-of-

production method. For taxation, percentage of revenue
is taken
 Accounting for Intangible Assets

• For intangible assets having limited useful life,

amortization is done –Patents and copyrights
– They should be amortized according to legal provisions

• If the intangible asset has indefinite useful life, periodic

impairment is done – Goodwill

• Improvements in lease occupations should be amortized by

the end of probable lease life
 Accounting for Intangible Assets

• Deferred charges for long-lived intangibles are expensed.

If capitalized, amortization is done in a short period

• R&D expenses are treated as period costs – expensed

because future benefits are very uncertain (matching and
conservatism concepts)

• If R&D is done for a client, it is treated as revenue- costs

are charged as expense

• In case of Software development, costs are capitalized

when product feasibility is assured