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

Understanding the learning objectives

To be classified as a plant asset, an asset must: (1) be tangible; (2) have a useful service life of more than one year; and (3) be used in business operations rather than held for resale.
In accounting for plant assets, accountants must: (a)Record the acquisition cost of the asset. (b)Record the allocation of the asset's original cost to periods of its useful life through depreciation.
(c)Record subsequent expenditures on the asset. (d)Account for the disposal of the asset.
Accountants consider four major factors in computing depreciation: (1) cost of the asset; (2) estimated salvage value of the asset; (3) estimated useful life of the asset; and (4) depreciation method to use in depreciating the asset.

Straight-line method: Assigns an equal amount of depreciation to each period. The formula for calculating straight-line depreciation is:

$\text { Depreciation per period }=\dfrac{\text { Asset cost }-\text { Estimated salvage value }}{\text { Number of accounting periods } \in \text { estimated useful life }}$

Units-of-production method: Assigns an equal amount of depreciation to each unit of product manufactured by an asset. The units-of-production depreciation formulas are:

$\text{Depreciation per period} = \dfrac{\text { Asset cost - Estimated salvage value }}{\text { units of production (service) during useful life of asset }}$
$\text { Depreciation per period }=\text { Depreciation per unit } \times \text { Number of units of goods } / \text { services produced }$

Double-declining-balance method: DDB is an accelerated depreciation method. Salvage value is ignored in making annual calculations. The formula for DDB depreciation is:

$\text { Depreciation per period }=(2 \times \text { straight }-\text { line rate }) \times(\text { Asset cost }-\text { Accumulated depreciation })$

Capital expenditures are debited to an asset account or an accumulated depreciation account and increase the book value of plant assets. Expenditures that increase the quality of services or extend the quantity of services beyond the original estimate are capital expenditures.
Revenue expenditures are expensed immediately and reported in the income statement as expenses. Recurring and or minor expenditures that neither add to the asset's quality of service-rendering abilities nor extend its quantity of services beyond the asset's original estimated useful life are expenses.
Plant asset subsidiary ledgers contain detailed information that cannot be maintained in the general ledger account about each item in a major class of depreciable plant assets.
Control over plant and equipment is enhanced by plant asset subsidiary ledgers and other detailed records. Information in a detailed record may include a description of the asset, identification or serial number, location of the asset, date of acquisition, cost, estimated salvage value, estimated useful life, annual depreciation, accumulated depreciation, insurance coverage, repairs, date of disposal, and gain or loss on final disposal of the asset. A periodic physical inventory should be taken to determine whether items in accounting records actually exist and are still being used at the proper location.
To calculate the rate of return on operating assets, divide net operating income by operating assets. This ratio helps management determine how effectively it used assets to produce a profit.