Plant Asset Disposals, Natural Resources, and Intangible Assets

This chapter details the events that need to be dealt with when disposing assets. There are balance sheet and income statement entries that must be recorded when getting rid of equipment by scrapping it or selling it. It also discusses intangible assets, how to record them, and how to account for their diminishing value. Many business entities will eventually have to dispose of a plant asset. When this happens, the company will either have a loss or show a gain depending on the difference between the asset's sale price and its book value. You will learn the journal entries for a variety of situations, including a gain on the sale of an asset, a loss on the sale of an asset, how to realize loss, and what to do when a fire or flood that destroys an asset.

Analyzing and using the financial results - Total assets turnover

Understanding the learning objectives

  • By comparing an asset's book value (cost less up-to-date accumulated depreciation) with its sales price, the company may show either a gain or a loss. If sales price is greater than book value, the company shows a gain. If sales price is less than book value, the company shows a loss. If sales price equals book value, no gain or loss results.
  • When a plant asset is retired from service, the asset's cost and accumulated depreciation must be removed from the plant asset accounts.
  • Plant assets are sometimes wrecked in accidents or destroyed by fire, flood, storm, and other causes. If the asset was not insured, the loss is equal to the book value. If the asset was insured, only the amount of the loss exceeding the amount to be recovered from the insurance company would be debited to a loss account.
  • In exchanges of nonmonetary assets having commercial substance, the firm records the asset received at either (1) the stated cash price of the new asset or (if the cash price is not stated) (2) the known fair market value of the asset given up plus any cash paid.
  • In exchanges of nonmonetary assets not having commercial substance, the firm records the new asset at the book value of the old asset plus the cash paid.

 

An ethical perspective:

ABC corporation

In 2010, prior to the tax law change permitting the amortization of goodwill for tax purposes, ABC Corporation acquired XYZ Company for USD 10,000,000 cash. ABC acquired the following assets:

Accounts receivable

 

$80,000

 

Old Book Value

Fair Market Value

Merchandise inventory

$ 200,000

$ 300,000

Buildings

3,000,000

4,000,000

Land

1,000,000

3,000,000

Equipment

500,000

700,000

 

An experienced appraiser with an excellent reputation established the fair market value of the assets. ABC also assumed the liability for paying XYZ's USD 50,000 of accounts payable.

John Gilbert, ABC's accountant, prepared the following journal entry to record the purchase: In explaining the entry to ABC's president, Gilbert said that the assets had to be recorded at their fair market values. He also stated that the goodwill could not be amortized for accounting purposes or tax purposes.

Accounts Receivable (+A)

80,000

 

Merchandise Inventory (+A)

300,000

 

Buildings (+A)

4,000,000

 

Land (+A)

3,000,000

 

Equipment (+A)

700,000

 

Goodwill (+A)

1,970,000

 

Accounts Payable (+L)

 

50,000

Cash (-A)

  10,000,000

 

To record the purchase of XYZ Company.

 

The president reacted with, "It is not fair that we are prohibited from amortizing goodwill when it is a part of the cost of the purchase. Besides, appraisals are very inexact, and maybe some of our other assets are worth more than the one appraiser indicated. I want you to reduce goodwill down to USD 470,000 and assign the other USD 1,500,000 to the buildings and equipment. Then, we can benefit from the depreciation on these assets. If I need to find an appraiser who will support the new allocations, I will".

When Gilbert protested, the president stated, "If you are going to have a future with us, you need to be a team player. We just cannot afford to lose those tax deductions". Gilbert feared that if he did not go along, he would soon be unemployed.

  • Depletion charges usually are computed by the units-of-production method. Total cost is divided by the estimated number of units that are economically extractable from the property. This calculation provides a per unit depletion cost that is multiplied by the units extracted each year to obtain the depletion cost for that year.
  • Depreciable assets located on extractive industry property should be depreciated over the shorter of the (1) physical life of the asset or (2) life of the natural resource. The periodic depreciation charges usually are computed using the units-of-production method. Using this method matches the life of the plant asset with the life of the natural resource.
  • Only outright purchase costs are included in the acquisition cost of an intangible asset. If an intangible asset is internally generated, its cost is immediately expensed.
  • Intangibles should be amortized over their finite useful lives. The method of amortization should be based upon the pattern in which the economic benefits are used up. If no pattern is apparent, straight-line amortization should be used.
  • \\text { Total assets turnover }=\frac{\text { Net sales }}{\text { Average total assets }}
  • This ratio indicates the efficiency with which a company uses its assets to generate sales.