Chapter 8

Operating Assets: Property, Plant, and

Equipment, Natural Resources & Intangibles
Operating Assets
Operating assets are also called long-lived assets.
Long-lived assets are those which have a useful
life of more than one year.
Are intended for the use of the business, not
acquired for resale purposes.
Operating assets consist of two types:
 Tangible assets include property, plant, and equipment.
 Intangible assets have no physical substance.
 Sometimes classified with “other assets”.

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Property, Plant & Equipment
Tangible assets that are used in the
production of goods and services the
company sells to customers.
 Also called fixed assets or plant assets.

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Johnson Controls, Inc.
Property, Plant, and Equipment
Buildings and improvement $ 1,242.9
Machinery and equipment 3,191.1
Construction in progress 310.7
At
$ 4,744.7
Land 223.8 Cost
$ 4,968.5
Less accumulated depreciation (2,588.7)
Property, plant, and equipment (net) $ 2,379.8
Book Value

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Acquisition of Property, Plant & Equipment
When a plant is purchased, it should be recorded in
the balance sheet at acquisition cost (original cost).
Acquisition cost includes all expenditures normal
and necessary to acquire an asset and prepare it for
its intended use, such as:
 Purchase price.
 Taxes (paid at the time of purchase).
 Transportation charges.
 Installation cost.
 Repairs needed to prepare the asset for its intended use.

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 Depreciation of P,P & E
 All property, plant, and equipment, except land, have a
limited life and decline in usefulness over time.
 Usefulness declines because of physical deterioration,
obsolescence, passage of time, exposure to the elements, or
inadequate maintenance.
 A proper matching of expenses and revenue is required to
accurately measure income.
 The process of allocating and charging the cost of the
usefulness to the accounting periods that benefit from the
asset’s use is called depreciation.

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Allocating Depreciation

Many depreciation methods are used to allocate

the original cost to the periods benefited.
All methods are based on the asset’s original cost.
All methods require two estimates
The asset’s useful life (service life): the length of time
the asset will be used in the operations of the business.
The asset’s salvage value (residual value): the amount
that could be received from selling or disposing the
asset at the end of its useful life.

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Allocating Depreciation

 Straight-line method.
 Units-of-production method.
 Accelerated depreciation methods

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Straight-Line Method
 Allocates the cost of asset evenly (equally) over its useful life.
In other words, it charges each year in the asset’s life with the
same amount of expense.

$9,000
3-year life

$3,000 $3,000 $3,000

Year 1 Year 2 Year 3
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 Straight-Line Method

 Depreciation each year is computed as follows:

Acquisition Cost - Residual Value
Life of Asset
 The book value of asset is the cost of the asset minus
its total accumulated depreciation to date.
 Simplest method and most popular for annual reports
to stockholders.

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Straight-Line Method: Example

 On January 1, Kemp Company purchases a

machine for $20,000. The life of the machine
is estimated at five years, after which it is
expected to be sold for $2,000.

$20,000 cost - $2,000 residual value =

$18,000 to be depreciated

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 Straight-Line Depreciation
Depreciation = Cost - Residual Value

Life
= $20,000 -
$2,000
$18,000
5 years
5-year life = $3,600

$3,600 $3,600 $3,600 $3,600 $3,600

Year 1 Year 2 Year 3 Year 4 Year 5
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Units-of-Production Method

This method relates depreciation directly to the

wear and tear of the asset as it relates to its use.
It allocates the asset cost based on number of
units produced over its useful life.
 Expense for the year is calculated based on actual
units produced (used) during that year.
 Units in asset’s life are any measure of wear, including
miles, machine hours, tons mined.

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Units-of-Production Method
 Depreciation per unit is computed as follows:
Acquisition Cost - Residual Value
Total number of units in asset’s life

 The annual depreciation for a given year can be

calculated based on the number of units produced
during that year, as follows:
Depreciation per unit * units produced in current
year
 Depreciate until all expected units have been produced.
 This method should only be used if output over the
useful life can be estimated with reasonable accuracy.
NOTE: Do not depreciate an asset below its expected residual value.
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Units-of-Production Depreciation
 Kemp’s estimated machine production:
Yr. 1 3,600 units
Yr. 2 3,600 units
Yr. 3 3,600 units
Yr. 4 3,600 units
Yr. 5 3,600 units
Total 18,000 units

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Units-of-Production Depreciation

 Depreciation = Cost – Residual Value

per unit Life in Units
= $20,000 - $2,000
18,000
= $ 1.00
 Kemp’s depreciation in year 1:
4,000 units x $1/unit = $ 4,000

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Accelerated Depreciation Methods
Double-Declining-Balance Method

 Accelerated methods assume assets decline in value

more in the earlier years of life, so more expense is
recorded in earlier years of life than in later ones.
 Double declining-balance is the most common
accelerated method.
 Depreciation expense is calculated at twice the straight-
line rate applied to the declining net book value over
the asset’s life:
1. Calculate the straight line rate: 100% / asset’s life.
2. Double it.
3. Multiply this rate each year by the asset’s net book value
at the beginning of that year.

NOTE: For this method, unlike the others, residual value is not deducted from the
cost before multiplying by the depreciation rate.
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 Double-Declining-Balance Depreciation

DDB rate = (100% / useful life) x 2 = (100% / 5 years) x 2 = 40%

Year 1 Depreciation = Beginning book value x rate
= $20,000 x 40%
= $8,000

Beginning Ending
Year Rate Book Value Depreciation Book Value
1 40% $20,000 $8,000 $12,000

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Double-Declining-Balance Depreciation

Year 2 Depreciation = Beginning book value x rate

= $12,000 x 40%
= $4,800

Beginning Ending
Year Rate Book Value Depreciation Book Value
1 40% $20,000 $8,000 $12,000
2 40% $12,000 4,800 7,200

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Double declining-balance Depreciation

Beginning Ending
Year Rate Book Value Depreciation Book Value
1 40% $20,000 $8,000 $12,000
2 40% 12,000 4,800 7,200
3 40% 7,200 2,880 4,320
4 40% 4,320 1,728 2,592
5 40% 2,592 592 2,000
$18,000
Final year’s depreciation =
amount needed to equate book = Residual
value with salvage value Value
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 Straight-line vs. DDB Depreciation
$8,000

$7,000

$6,000

$5,000

$4,000 Straight-line
DDB
$3,000

$2,000

$1,000

$0
Year 1 Year 2 Year 3 Year 4 Year 5
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Capital versus Revenue Expenditures

 Capital Expenditure: a cost added to the acquisition

or capitalized cost of the asset on the balance sheet.
 To be depreciated over a period of time
 Provide economic benefit that do not fully expire before
the current period.
 Revenue Expenditure: recorded as an expense in the
income statement in the period in which it is incurred
and not part of the cost of the asset.
 Do not provide benefit in the future periods.

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Capital versus Revenue Expenditures
Distinction is based on management’s judgment.
 If the asset’s life or productivity is increased, the
expenditure is capitalized.
 If it maintains the asset in normal operating

condition, the expenditure is expensed.

 Materiality is a factor, but a material expenditure

should not be capitalized only because it is

material.
 Generally, the smaller the dollar amount, the more

likely it will be specified as a revenue expenditure.

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Capital Expenditures
Example:
$20,000 machine originally expected to be
depreciated over 5 years. After 2 years, overhaul
machine at cost of $3,000. Machine life is
increased by 3 years.
planned
$3,600 $3,600 $3,600

Yr. 1 Yr. 2 Yr. 3 Yr. 4 Yr. 5

replace
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Capital Expenditures
Example:
 $12,800 remaining book value + $3,000 capital
expenditure depreciated prospectively over remaining
life

$3,600 $3,600 $2,300 $2,300 …… $2,300

Yr. 1 Yr. 2 Yr. 3 Yr. 4 ….. Yr. 8

replace
engine
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Disposal of Property, Plant & Equipment

Disposing of an asset occurs when the asset is sold,

traded, or discarded.
 Requires two operations:
 Update depreciation to date of sale.
 Calculate gain or loss on disposal by:

 First, determining the book value of the property

being disposed of by subtracting the accumulated

depreciation from the acquisition cost;
 And then computing the difference between the book

value of the disposal asset and the value of the asset

received (this may be cash or an other asset);
 The gain or loss appears in the “other
income/expense” section of income statement.

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 Disposal of Property, Plant & Equipment
Example:

 Sell truck (cost $20,000; accumulated depreciation

$9,000) for $12,400

Cash $ 12,400
Accumulated depreciation 9,000
Gain on sale 1,400
Truck 20,000

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Natural Resources
Natural resources are tangible assets consumed
as they are used and cannot be replenished in
the near future.
Natural resources are recorded on the balance
sheet in the property, plant, and equipment
category at acquisition cost.
Like the cost of plant assets, the cost of natural
resources is allocated to the periods in which
they are consumed.
The cost created by consuming the usefulness
of natural resources is called depletion.

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Natural Resources

 Depletion for each year is computed as follows:

(Acquired Cost - Residual Value)

* Actual Amount
Extracted
Estimated Extracted

Note: Either the asset account may be reduced directly or

a contra account may be used.

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Boise Cascade Corporation
Partial Balance Sheet
(in thousands)
Property and Equipment:
Land and land improvements $ 68,482
Buildings and improvements 675,905
Machinery and equipment 4,606,102
Less: accumulated depreciation (2,742,650)
2,607,839
Timber, timberlands, and
timber deposits 322,132
$2,929,971
Natural Resources
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Intangible Assets
Intangible assets are long-lived assets, with
no physical existence.
Examples are patents, copyrights, trademarks,
brand names, logos and goodwill.
They have future economic benefit.
Balance sheet reflects their cost, but may not
reflect the true value of these assets.
Intangible assets should be listed on the
balance sheet separately from plant,
property, and equipment.

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Intangible Assets

 Intangible assets are amortized rather than

depreciated, essentially the same process with a
different name.
 An intangible asset is amortized only if it has a
finite life.
 If an intangible asset is amortized, most companies
use the straight-line method of amortization.
 Amortization should be recorded over the legal or
useful life, whichever is shorter.

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AOL Time Warner, Inc. : Partial Balance Sheet

Operating Assets: (in millions)

Property, plant and equipment, net $ 12,684
Music catalogues and copyrights 2,927
Film library 3,363
Cable television and sports franchises 27,109
Brands, trademarks, and other 10,684
Goodwill and other intangibles 128,338

g i bl e
Intan s
Asset
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Amortization of Intangibles

Example:
ML Company developed a patent for $10,000.
The patent’s legal life is 20 years, but its
anticipated useful life is 5 years.
ML Company’s annual amortization:
Patent approval costs $10,000
Divide by:
Lesser of legal or useful life 5 years
Annual amortization $ 2,000

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Amortization of Intangibles
ML Company’s Balance Sheet Presentation:

Upon End of acquisition Yr. 1 Yr. 5

Long-term Assets:
Intangible assets,
Patent $10,000 $10,000 $10,000
Less: accum.
amortization $2,000 $10,000

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Analyzing Long-term Assets
Average Life = Property, Plant & Equipment
Depreciation
Expense

What is the average depreciable period (or life) of

the company’s assets?

Average Age = Accumulated Depreciation

Depreciation Expense

Are assets old or new?

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Analyzing Long-term Assets

Asset Turnover = Net Sales

Average Total Assets

How productive are the company’s assets?

This is a profitability ratio which measures how many dollars of sales

for every dollar of assets.

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