Property, Plant, and Equipment
This chapter introduces how organizations categorize and account for fixed assets. Assets are recorded at cost, not necessarily market value. It also covers the various methods of depreciation, why each method is used, and the "rate of return" expected by an organization when they purchase an asset. You should be able to explain fair market value, acquisition costs, historical costs, and which costs are capitalized. This chapter addresses the reality that all assets with the exception of land have a useful life. A business should expect some wear and tear on assets as a direct result of using them to support business activity. Depreciation is an allocation process that ensures the useful life of an asset is properly identified from accounting and company valuation.
Analyzing and using the financial results - Rate of return on operating assets
Analyzing the ratios of income statement and balance sheet items from one year to the next can reveal important trends. Management uses these ratios to measure performance by establishing targets and evaluating results. As an example, look at Exhibit 16. Analysts use these figures to calculate the ratios and to explain the importance of this information to management and investors.
To determine the rate of return on operating assets for Dement & Peery for 2009 and 2010, use the following formula:
Net operating income is also called net operating earnings or income before interest and taxes. In calculating Dement & Peery's ratio, we have assumed that all assets are operating assets used in producing operating revenues.
This ratio measures the profitability of the company in carrying out its primary business function. For Dement & Peery, these figures indicate a slight increase in the earning power of the company in 2010. Net operating income increased more than proportionately compared to the increase in operating assets. Perhaps this performance justifies the increase in operating assets.
In this chapter, you learned how to account for the acquisition of plant assets and depreciation. The next chapter discusses how to record the disposal of plant assets and how to account for natural resources and intangible assets.