Plant Assets, Intangible Assets, & Natural Resources - BVT Publishing
Chapter 6Plant Assets, IntangibleAssets, & Natural ResourcesLEARNING OBJECTIVESDistinguish between capital expenditures and revenue expenditures.Understand what costs should be capitalized as a part of the cost of plantassets, including buildings, equipment, land, land improvements and leaseholdimprovements.Understand accounting and reporting for leasehold improvement costs.Understand the nature of depreciation as cost allocation (not asset valuation) and thedepreciation methods available for use (straight-line method, accelerated methods,units-of-output method, half-year convention).Understand federal tax implications of different depreciation methods.Be aware of the relationship between the consistency principle and depreciationmethods used.Understand the impact of changes in estimated asset service lives or salvage valueson depreciation.Understand the impact of changes in depreciation methods used on financialreporting.Understand basic reporting rules regarding plant asset impairment.Be aware of major differences between U.S. GAAP and international financialreporting standards (IFRS) regarding plant assets, intangible assets, research anddevelopment costs, and organization costs.Understand accounting for disposal of plant assets when scrapped, sold, orexchanged.Be aware of the nature and types of intangible assets that exist.Understand basic accounting and reporting rules for intangible assets.Understand U.S. GAAP for research and development costs.Understand basic accounting and reporting for natural resources.143
6.1Financial Accounting Chapter 6Plant Assets1446.1a Capital Expenditures versus Revenue ExpendituresPlant assets include buildings, equipment, land, land improvements, and leasehold improvements. In previous chapters, we discussed certain plant assets such as buildings and equipment with related depreciation,as well as land that is not subject to depreciation. Now, we’ll discuss plant asset acquisition, depreciation, anddisposal in greater depth. First, let’s differentiate capital expenditures from revenue expenditures.Capital expenditures are material expenditures that will benefit future accounting periods, and are therefore initially recorded as assets. Revenue expenditures are expenditures that either benefit only the currentperiod or are immaterial, and are therefore initially recorded as expenses. Acquisitions of buildings or equipment are capital expenditures. Major improvements or betterments of plant assets extending their life or output,such as building additions or major equipment renovations, are capital expenditures. Expenditures for routinerepairs and maintenance of plant assets or for fuel to operate plant assets are revenue expenditures. Someexpenditures may meet the “future period benefit” requirement of capital expenditures but may be too small(immaterial) to be worth capitalizing as assets when purchased. For example, an electronic pencil sharpenerpurchase for 30 is an expenditure for an item that will benefit future accounting periods; however, it is so small(immaterial) a purchase that the cost of recording it as an asset and depreciating it over say 10 years at 3 peryear outweighs any benefit that might be gained in terms of financial statement accuracy. For this reason, somecompanies create policy making all expenditures under certain minimum dollar amounts revenue expenditures.This amount will vary in terms of what is considered to be material for a company. A larger company may have a 5,000 dollar threshold while a smaller company may have a 500 threshold.6.1b Plant Asset Acquisition CostsAll normal costs to get plant assets into condition and position for use are capital expenditures representing a part of the asset’s cost, referred to as reasonable and necessary costs. Obviously, a plant asset’spurchase price is a capital expenditure but so are costs that one may otherwise view as expenses in a differentcontext such as installation costs (labor, material, etc.), sales taxes, and delivery costs.Interest on borrowing to purchase a plant asset after the plant asset has been placed in service is notpart of the asset’s cost but rather it is interest expense. However, under U.S. generally accepted accountingprinciples, interest during an asset’s construction period prior to its use is a part of the cost of the asset (seeFinancial Accounting Standards Board Statement No. 34, Capitalization of Interest Costs, 1979).When acquiring land, all of the following costs are capitalized as a part of the land cost: purchase priceof the land, real estate or legal fees associated with the purchase, accrued taxes that must be paid, net costof removing old buildings from the land, and costs of grading and landscaping. Note that these are all normalcosts to get the land in condition and position for use. If, after land is purchased and placed in service, additional improvements are made such as the additions of driveways, fences, or parking areas, these costs aregenerally part of the cost of an asset called land improvements, rather than the account land. And, unlikeland, land improvements are subject to depreciation.List prices are only relevant to the extent they represent the actual plant asset’s cost. If a discount is givenoff the list price, then the discounted price, not the list price, is the asset’s cost.Example: ABC Manufacturing Co. purchased factory equipment with a list price of 100,000 on June 1, 20X7.As a regular customer of the seller of the equipment, the manufacturer qualified for a 4% discount off the listprice. The manufacturer paid 36,000 down to the seller and signed a 3 month note payable at a 5% annualrate due to the vendor, with interest of 250 due to the vendor at the end of each of the next three monthsand the note principal of 60,000 due on September 1, 20X7. In addition, the manufacturer paid the following costs in cash: sales tax on the equipment purchase of 4,800, equipment delivery costs of 1,200, andinstallation labor and material costs of 3,000. When the equipment was delivered, it fell off the delivery truckand cost the manufacturer an added 500 for repairs. As a result, the manufacturer’s factory equipment costwould be determined as follows:
Note: The 500 paid to repair the equipment after it fell off the delivery truck is an expense and not part of the asset cost since it is clearly not anormal cost of getting the plant asset into position and condition for use.The entry to record the plant asset acquisition would have been as follows:6/1/X7 Factory equipment 105,000Cash 45,000*Note payable 60,000**To record acquisition of factory equipment.* Down payment to seller of equipment of 36,000 plus sales tax of 4,800 plus deliverycosts of 1,200 plus installation costs of 3,000 equal 45,000.** Net amount due to seller after 4% discount of 96,000 less 36,000 down payment equals 60,000 note payable.Note: (a) The factory equipment will be depreciated using one of the methods that will be described shortly. (b) Interest on the note payable of 250 per month ( 60,000 principal 5% interest 1 month/12 months) will paid on June 30, July 31, and August 31 and will be recorded as interest expense (not as part of the plant asset cost). The 60,000 principal will be paid on September 1, 20X7.Example: Custom Designs, Inc. purchased land for 300,000 and paid real estate fees of 18,000, legal feesof 2,000, 30,000 to have an old building on the land removed, and 5,000 for grading and clearing the land.As a result of the sale of antique staircases and woodwork from the old building before demolition, Customdesigns, Inc. received 9,000 in salvage value. The cost of the land would be determined as follows:Purchase price 300,000Real estate fees 18,000Legal fees 2,000Old building demolition costs 30,000Less: Salvage value 9,00021,000Grading and clearing costs 5,000Total land cost 346,000 Allocation of Plant Asset Acquisition Costs in Lump-Sum PurchasesSometimes plant assets are acquired in bundles or groups. For example, land, building, and equipment housedin the building might be purchased for a single price. If the price paid equals the fair value of the plant assetsacquired, then the recording of the acquisition will be straight forward, involving the recording of the assets attheir individual fair values in consideration of the purchase price. But if the price paid for the plant asset groupdiffers from the sum of the fair values of those assets, then the purchase price should be allocated among theplant assets acquired based on their fair values.Example: Custom Designs, Inc. purchased land, building, and equipment with fair market values on the purchase date of 150,000, 800,000, and 50,000 respectively and paid a total price of 950,000 for these assets.The 950,000 price paid will be allocated among the assets acquired as follows:% to TotalPrice PaidFair ValuesFair ValueAllocationLand 150,00015% 142,500Building 800,00080%760,000Equipment 50,0005%47,500Totals 1,000,000100% 950,000145Plant Assets, Intangible Assets, & Natural ResourcesList price 100,000Less: 4% discount off list price 4,000Subtotal 96,000Sales tax 4,800Delivery costs 1,200Installation costs 3,000Total cost of equipment 105,000
Financial Accounting Chapter 6146The entry to record the acquisition of these plant assets is as follows:Land 142,500Building 760,000Equipment 47,500Cash 950,0006.1c Leasehold ImprovementsSometimes a lessee of property will make improvements to leased property such as adding new carpets, lightsfixtures, or even walls which will become the property of the lessor (property owner) at the end of the lease.Therefore, the lessee of the property should amortize leasehold improvement costs over the shorter of theirestimated service life or the lease life.Example: Davis Co. leased building space for an 8 year period on January 1, 20X1, from BIG Leases, Inc.Davis Co. invested 80,000 in improvements to the office space, including carpets, light fixtures, and dry wall.These leasehold improvements are estimated to have a 10 year service life and no salvage value. The entriesDavis Co. would make relative to the leasehold improvements are:During 20X1:Leasehold improvements 80,000Cash 80,000To record cost of leasehold improvements.December 31, 20X1: Amortization expense: leasehold improvements 10,000Leasehold improvements 10,000To record amortization of leasehold improvements as follows: 80,000 divided by 8 year lease life 10,000 per year. This entry will be repeatedeach year from 20X1 through 20X8, the end of the lease life.Note that it did not matter that the leasehold improvement life was estimated at 10 years since the lesseewill no longer have access to the leased property or related improvements when the lease end in 8 years. Inshort, the leasehold improvement costs should be amortized over their useful life to the lessee.6.1d Plant Asset Depreciation MethodsAs mentioned in an earlier chapter, depreciation is the allocation of the cost of plant assets to the futureperiods benefiting from their use. It is not valuation of plant assets. We will discuss straight-line depreciation,units-of-output (or production) depreciation, and accelerated depreciation methods. All examples will bebased on the following information:Equipment cost (acquired January 1, 20X1) 19,000Salvage value 1,000Estimated useful life 3 yearsStraight-line DepreciationThe straight-line method of depreciation provides the same total dollar amount of deprecation each year asfollows:Asset Cost – Salvage Value Annual depreciation expenseEstimated useful life 19,000 – 1,000 6,000 annual decpreciation expense(or, if monthly, 500 per month)3 years
Straight-Line Depreciation MethodYear20X120X220X3Cost lessSalvage Value 18,000 18,000 18,000Annual RateAnnualof Depreciation Depreciation Expense 1/3 6,000 1/3 6,000 1/3 6,000AccumulatedDepreciation 6,000 12,000 18,000BookValue* 13,000 7,000 1,000*Book value 19,000 original cost less accumulated depreciation.The annual entry for depreciation expense is:Depreciation expense – equipment 6,000Accumulated depreciation – equipment 6,000So, for example, at the end of year 20X2, the statement of financial position would appear as follows:Equipment 19,000Less: Accumulated depreciation 12,000Equipment (net) 7,000Straight-line Depreciation for Partial YearSuppose, however, that the equipment described in the previous example had been acquired on March 20,20X1 (not January 1, 20X1). In this case, depreciation need not be calculated on a daily basis since this wouldimply more accuracy than actually exists. In fact, any systematic and rational approach to depreciation isacceptable under generally accepted accounting principles and depreciation could be based on: a) roundingto the nearest whole month or, b) the half-year convention.a) Straight-Line Method Rounding to the Nearest Whole Month (April 1 to December 31, 20X1 9Months/12 Months; January 1 to March 31, 20X4 3 Months/12 Months)Year20X120X220X320X4Cost lessSalvage Value 18,000 18,000 18,000 18,000 Annual RatePartialAnnualAccumulatedof DepreciationYearDepreciation Expense Depreciation1/3 9/12 4,500 4,5001/3 6,000 10,5001/3 6,000 16,5001/3 3/12 1,500 18,000BookValue* 14,500 8,500 2,500 1,000*Book value 19,000 original cost less accumulated depreciation.b) Straight-Line Method Applying the Half-Year Convention(depreciate for one-half year in year of acquisition)Year20X120X220X320X4Cost lessSalvage Value 18,000 18,000 18,000 18,000 Annual RatePartialAnnualAccumulatedof DepreciationYearDepreciation Expense Depreciation1/3 1/2 3,000 3,0001/3 6,000 9,0001/3 6,000 15,0001/3 1/2 3,000 18,000BookValue* 16,000 10,000 4,000 1,000*Book value 19,000 original cost less accumulated depreciation.When the half-year convention is used, accounting efficiencies may be gained since all plant assets of equallife acquired during any given year may be depreciated as a group, rather than being depreciated separatelybased on different months of purchase.Note: Under any depreciation method (straight-line or accelerated), when the half-year convention isused, it applies to all plant assets acquired, regardless of the date during the year on which they were acquired.147Plant Assets, Intangible Assets, & Natural ResourcesDepreciation may be expressed as a fraction (or as a percentage) and in this case depreciation would be 1/3(or thirty-three and one-third percent) of the asset’s cost less salvage value. Over the equipment’s life, depreciationwill be determined as follows:
Financial Accounting Chapter 6148Accelerated DepreciationAccelerated depreciation provides for a larger total dollar amount of deprecation in the early years of anasset’s life and a lower total amount of depreciation in the later years of an asset’s life. One of the ways inwhich accelerated depreciation may be implemented is by developing an accelerated depreciation rate andmultiplying that rate by the asset’s declining balance (or book value). The accelerated depreciation rate is aspecified percentage of the straight-line depreciation rate, such as 200% or 150%. For example, if the specifiedpercentage is 200% for an asset with an estimated three-year life and therefore a straight-line depreciationrate of 1/3, then the accelerated depreciation rate is 2/3 (or 200% times 1/3). Or, if the specified percentageis 150% for an asset with estimated three-year life and therefore a straight-line depreciation rate of 1/3, thenthe accelerated depreciation rate is 1/2 (or 150% times 1/3). This accelerated depreciation rate is multipliedby the asset’s declining balance (or book value) to determine depreciation expense. The declining balance(book value) will begin at the asset’s full cost, not reduced by an estimated salvage value. However, unlessusing an accelerated depreciation method for federal income tax purposes as will be demonstrated, the bookvalue of the asset should not fall below its salvage value. The 200% and 150% declining balance accelerateddepreciation methods will be illustrated shortly. While there are other accelerated depreciation methods thatwill not be illustrated here, these other methods are either variants of the declining balance methods that willbe illustrated or they are methods not heavily used in financial or tax accounting.Accelerated Depreciation Using the Double-Declining-Balance(DDB) Method (also called the 200% DDB method)The DDB method involves doubling the straight-line rate of depreciation and multiplying the resulting accelerated depreciation rate times the asset’s declining balance (or book value). The declining balance initiallyequals the asset’s cost but is reduced each year by that year’s depreciation. There is no reduction for salvagevalue when the depreciation process begins but the asset’s book value (cost less accumulated depreciation)may not fall below salvage value. Using our original case facts (equipment cost 19,000, estimated 3 year-life, 1,000 salvage value), the equipment will be depreciated as follows:200% DDB MethodYear20X120X220X3DecliningAnnual Rate ofAnnualBalanceDepreciation*Depreciation Expense 19,000*** 2/3 12,667 6,333 2/3 4,222 2,111 – 1,000 salvage value 1,111****AccumulatedDepreciation 12,667 16,889 18,000BookValue** 6,333 2,111 1,000* DDB rate 2 straight-line rate 2 1/3 2/3 (this is the accelerated depreciation rate).** Book value 19,000 original cost less accumulated depreciation.*** Original cost.**** Note: While there is no initial reduction for salvage value, do not bring the declining balance (book value) below salvage value. That is, 2/3 of 2,111 or 1,407 would have been too much depreciation.200% DDB Depreciation for Partial YearAgain, if the equipment described in the previous example had been acquired on March 20, 20X1 (not January1, 20X1), any systematic and rational approach to depreciation is acceptable under generally acceptedaccounting principles. Depreciation could be based on: a) rounding to the nearest whole month or, b) thehalf-year convention.
149a) 200% DDB Depreciation Method Rounding to the Nearest Whole Month(April 1 to December 31, 20X1 9 Months/12 Months)DecliningAnnual Rate ofBalanceDepreciation* 19,000*** 1/2**** 9,500 2/3 3,167 2/3 1,056 – 1,000 salvage value AnnualDepreciation Expense 9,500 6,333 2,111 56*****AccumulatedDepreciation 9,500 15,833 17,944 18,000BookValue** 9,500 3,167 1,056 1,000*DDB rate 2 straight-line rate 2 1/3 2/3 (this is the accelerated depreciation rate).**Book value 19,000 original cost less accumulated depreciation.***Original cost.****20X1 (first year) rate 2/3 accelerated depreciation rate 9 months/12 months 1/2.***** Note: While there is no initial reduction for salvage value, do not bring the declining balance (book value) below salvage value. That is,2/3 of 1,056 or 704 would have been too much depreciation.Note: Other systematic and rational approaches could be used. For example, in this case, depreciation expense could have calculated by taking: 9/12 of a full first year 12,667 DDB depreciation expense in 20X1 ( 9,500), 3/12 of a full first year 12,667 DDB depreciation expense plus 9/12 of a full second year 4,222 DDB depreciation expense in20X2 ( 6,334), 3/12 of a full second year 4,222 DDB depreciation expense plus 9/12 of a full third year 1,111 DDB depreciation expense in20X3 ( 1,888), and 3/12 of a full third year 1,111 DDB depreciation expense in 20X4 ( 278), equaling accumulated depreciation of 18,000 ( 9,500 6,334 1,888 278).b) 200% DDB Method Applying the Half-Year ConventionYear20X120X220X320X4DecliningAnnual Rate ofBalanceDepreciation* 19,000*** 1/3**** 12,667 2/3 4,222 2/3 1,407 – 1,000 salvage value AnnualDepreciation Expense 6,333 8,445 2,815 407*****AccumulatedDepreciation 6,333 14,778 17,593 18,000BookValue** 12,667 4,222 1,407 1,000* DDB rate 2 x straight-line rate 2 x 1/3 2/3 (this is the accelerated depreciation rate).** Book value 19,000 original cost less accumulated depreciation.*** Original cost.**** 2 0X1 (first year) rate 2/3 accelerated depreciation rate x 1/2 (for half-year convention) 1/3.***** Note: While there is no initial reduction for salvage value, do not bring the declining balance (book value) below salvage value. That is, 2/3 of 1,407 or 938 would have been too much depreciation.Accelerated Depreciation Using the 150% Declining-Balance Method (1.5 DB Method)The 1.5 DB method involves multiplying the straight-line rate of depreciation by 1.5 and then multiplying theresulting accelerated depreciation rate times the asset’s declining balance (or book value). As stated earlier,the declining balance initially equals the asset’s cost but is reduced each year by that year’s depreciation. Also,recall that there is no reduction for salvage value when the depreciation process begins but the asset’s bookvalue (cost less accumulated depreciation) may not fall below salvage value. Again using the original information, 150% declining-balance depreciation would be as follows:Plant Assets, Intangible Assets, & Natural ResourcesYear20X120X220X320X4
Financial Accounting Chapter 6150150% DB Depreciation MethodYear20X120X220X3DecliningAnnual Rate ofAnnualBalanceDepreciation* Depreciation Expense 19,000*** 1/2 9,500 9,500 1/2 4,750 4,750 – 1,000 salvage value 3,750****AccumulatedDepreciation 9,500 14,250 18,000BookValue** 9,500 4,750 1,000* 1.5 DB rate 1.5 straight-line rate 1.5 1/3 1/2 (this is the accelerated depreciation rate).** Book value 19,000 original cost less accumulated depreciation.*** Original cost.**** Note: While there is no initial reduction for salvage value, bring the declining balance (book value) to salvage value.150% DB Depreciation for Partial YearAgain, if the equipment described in the previous example had been acquired on March 20, 20X1 (not January1, 20X1), any systematic and rational approach to depreciation is acceptable under generally acceptedaccounting principles. Depreciation could be based on: a) rounding to the nearest whole month or, b) thehalf-year convention.a) 150% DB Depreciation Method Rounding to the Nearest Whole Month(April 1 to December 31, 20X1 9 Months/12 Months)Year20X120X220X320X4DecliningAnnual Rate ofBalanceDepreciation* 19,000*** 3/8**** 11,875 1/2 5,937 1/2 2,968 – 1,000 salvage value AnnualDepreciation Expense 7,125 5,938 2,969 1,968*****AccumulatedDepreciation 7,125 13,063 16,032 18,000BookValue** 11,875 5,937 2,968 1,000* 1.5 DB rate 1.5 straight-line rate 1.5 1/3 1/2 (this is the accelerated depreciation rate).** Book value 19,000 original cost less accumulated depreciation.*** Original cost.**** 20X1 (first year) rate 1/2 accelerated depreciation rate 9 months/12 months 3/8.***** Note: While there is no initial reduction for salvage value, bring the declining balance (book value) to salvage value.Note: Other systematic and rational approaches could be used. For example, in this case, depreciation expense could have been calculated by taking: 9/12 of a full first year 9,500 150% DB depreciation expense in 20X1 ( 7,125), 3/12 of a full first year 9,500 150% DB depreciation expense plus 9/12 of a full second year 4,750 150% DB depreciationexpense in 20X2 ( 5,938), 3/12 of a full second year 4,750 150% DB depreciation expense plus 9/12 of a full third year 3,750 150% DB depreciationexpense in 20X3 ( 4,000), and 3/12 of a full third year 3,750 150% DB depreciation expense in 20X4 ( 937), equaling accumulated depreciation of 18,000( 7,125 5,938 4,000 937).b) 150% DB Depreciation Method Applying the Half-Year ConventionYear20X120X220X320X4DecliningAnnual Rate ofBalanceDepreciation* 19,000*** 1/4**** 14,250 1/2 7,125 1/2 3,562 – 1,000 salvage value AnnualDepreciation Expense 4,750 7,125 3,563 2,562*****AccumulatedDepreciation 4,750 11,875 15,438 18,000* 1.5 DB rate 1.5 straight-line rate 1.5 1/3 1/2 (this is the accelerated depreciation rate).** Book value 19,000 original cost less accumulated depreciation.*** Original cost.**** 2 0X1 (first year) rate 1/2 accelerated depreciation rate 1/2 (for half-year convention) 1/4.***** Note: While there is no initial reduction for salvage value, bring the declining balance (book value) to salvage value.BookValue** 14,250 7,125 3,562 1,000
Special Point: Accelerated Depreciation Adjustment151Example: On April 18, 20X3, equipment was purchased for 100,000 with a salvage value of 8,000 and auseful life of 5 years. The 150% DB depreciation method is used as l Rate ofAnnualBalanceDepreciation*Depreciation Expense 100,000*** 3/20**** 15,000 85,000 3/10 25,500 59,500 3/10 17,850 41,650 3/10 12,495Switch to straight-line***** 10,578Switch to straight-line***** 10,577AccumulatedDepreciation 15,000 40,500 58,350 70,845 81,423 92,000BookValue** 85,000 59,500 41,650 29,155 18,577 8,000* 1.5 DB rate 1.5 straight-line rate 1.5 1/5 3/10 (this is the accelerated depreciation rate).** Book value 100,000 original cost less accumulated depreciation.*** Original cost.**** 2 0X3 (first year) rate 3/10 accelerated depreciation rate 1/2 (for half-year convention) 3/20.***** T he remaining depreciable amount at January 1, 20X7 is 21,155 ( 29,155 book value at December 31, 20X6 less 8,000 salvage). Usinga switch to straight line depreciation for 20X7 and 20X8, depreciation expense each year is 10,577.50 (rounded to 10, 578 for 20X7 and 10,577 for 20X8).Note: If the switch to straight-line depreciation had not been made, 20X7 depreciation expense would havebeen 8,747 (3/10 29,155) and the 20X8 depreciation would have been higher at 12,408. To avoid a situation in which an accelerated depreciation method results in higher depreciation expense in a later year thanin a previous year, a switch to the straight-line method is made. This change to the straight-line method is notconsidered to be an accounting change since the goal of accelerated depreciation is maintained – earlier yearshave higher depreciation expense and later years have lower depreciation expense.Straight-line Depreciation versus Accelerated DepreciationThe straight-line method, which results in a constant dollar amount of depreciation each year over the lifeof the asset, makes sense particularly when an asset has equal utility over its life, that is, when it providesnet cash flows that are roughly equal each year, has equal annual productive capacity over its life, and hasrelatively constant maintenance costs over its life. The accelerated method, which results in a higher dollaramount of depreciation in the early years and in a lower dollar amount of depreciation in the later years of anasset’s life, makes sense particularly when an asset has declining utility over its life, that is, when it providesnet cash flows that are higher in the early years of its life and lower in the later years of its life, has greaterproductive capacity in its early years than in its later years, and has rising maintenance costs. So, for example,if straight line depreciation is used for an asset that has equal utility and maintenance costs over its life, constant annual depreciation expense and constant annual maintenance expense may be viewed as follows: Total depreciation& maintenanceexpenses/year Maintenanceexpense/year Depreciationexpense/year1 2 3Years1 2 3Years1 2 3YearsIf accelerated depreciation is used for an asset that has declining utility and rising maintenance costsover its life, decreasing depreciation expense and increasing maintenance expense may be viewed as follows:Plant Assets, Intangible Assets, & Natural ResourcesSometimes when declining balance accelerated depreciation methods are used, a special adjustment is neededinvolving a switch from the accelerated method to the straight-line method.
Financial Accounting Chapter 6152 Total depreciation& maintenanceexpenses/year Maintenanceexpense/year Depreciationexpense/year1 2 3Years1 2 3Years1 2 3YearsNote that, in theory, because the straight-line method yields relatively lower depreciation expense andhigher maintenance expense than the accelerated method in the early years of the asset’s life while the reverseis true for the later years of the asset’s life, total annual depreciation and maintenance expenses are relativelysimilar under straight-line and accelerated methods as depicted in the graphs above, resulting in a “leveling” oftotal annual expenses. As a practical matter, however, a firm may simply wish to use accelerated depreciation,for all depreciable assets for tax purposes to lower current tax burden as described previously. Also, an argument can be made in favor of the use of accelerated depreciation in any case for financial reporting purposessince it results in lower net income and therefore is in conformity with the principle of conservatism describedin an earlier chapter.Units of Output (Production Based) Depreciation MethodSo far, the straight-line and accelerated depreciation methods we have discussed have resulted in therecording of depreciation expense based simply on the passage of time. That is, once determined by thesemethods, depreciation cost is a fixed cost which will occur no m
Chapter 6 Plant Assets, Intangible Assets, & Natural Resources LEARNING OBJECTIVES Distinguish between capital expenditures and revenue expenditures. Understand what costs should be capitalized as a part of the cost of plant assets, including buildings, equipment, land, land improvements and leasehold improvements.
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