Accounting for property, plant, and equipment

The accounting for property, plant, and equipment is primarily concerned with determining the cost used up in any given period (depreciation expense) and the dollar amount to report as an asset on the balance sheet at the end of the period. The process through which these amounts are determined will be examined in the following paragraphs.

Determining the dollar amount of property, plant, and equipment resources The dollar amount reported as property, plant, and equipment resources (assets) consists of all costs providing benefits for more than one year and required to get the assets ready to be used.

For example, assume on January 2, a company buys $27,300 of new display equipment on account. In return for promising to pay $27,300, the company obtains the following.
 

Equipment sales price

$26,500

Equipment delivery 

$500

Equipment 9-month extended warranty

$300

Total

$27,300

The company predicts that after six years the display equipment will be too inefficient to use. Although the equipment may still be in working condition after six years, the company expects to replace it with more modern equipment. The company predicts that it will be able to sell the equipment to some other company for $3,000 at the end of the equipment's six-year useful life.

The dollar amount to report as a resource is the cost of getting the resource into usable condition. In the case of the display equipment, the cost is $27,000, which includes the $26,500 sales price and the $500 cost of delivery. The delivery cost is included in the asset account because the equipment is not usable to the company unless it is delivered from the supplier. The $300 cost of the extended warranty would not be included in the equipment cost, but would be recorded as an asset, possibly called Equipment Warranties. The warranty is necessary to protect the company against certain equipment problems, but it is not necessary just for the company to be able to use the equipment. The Equipment Warranties account would be considered a current asset because its benefits will be used up within the next twelve months. If the warranty were for 18 months, 12 months' cost would be considered a current asset and 6 months' cost would be a long-term asset. The $27,300 purchase of equipment affects the company's resources and sources of resources as follows.
 

Total
Resources

=

Sources of
Borrowed
Resources

+

Sources of
Owner Invested
Resources

+

Sources of
Management Generated
Resources

Assets

=

Liabilities

+

Stockholders' Equity

+ $300
equipment warranties

+ $27,000
display equipment

=

+ $27,300
accounts payable

 

 

 

 

As a result of buying the display equipment on account, the company's resources and sources of resources both increase by $27,300. Only $27,000 would be included in the display equipment account because the $300 warranty cost is not necessary to get the equipment into usable condition.

Remembering that assets increase with debits and debits equal credits, prepare the journal entry to record the equipment purchase.
 

Date

Description

Post.
Ref.

Debits

Credits

Jan. 2

Equipment Warranties

 

300

 

 

Display Equipment

 

27,000

 

 

    Accounts Payable

 

 

27,300

 

Display equipment purchase

 

 

 


 

** You now have the background to do text exercise 9.4.
 

Determining the total dollar amount of property, plant, and equipment to report as an expense Just like all resources, the dollar amount of property, plant, and equipment to report as an expense is the dollar amount of the resource used up. Since the company purchased the equipment for $27,000 and expects to be able to sell it for $3,000 at the end of its useful life, the company's expense for the display equipment will be $24,000 over its useful life of six years ($27,000 cost - $3,000 residual value).

Show the effects on the company's resources and sources of resources of using up $24,000 of display equipment.
 

Total
Resources

=

Sources of
Borrowed
Resources

+

Sources of
Owner Invested
Resources

+

Sources of
Management Generated
Resources

Assets

=

Liabilities

+

Stockholders' Equity

- $24,000
accumulated depreciation, display equipment

=

 

 

 

 

- $24,000
depreciation expense,
display equipment

Over six years, the using up of equipment reduces the company's resources by $24,000 and reduces the company's stockholders' equity by $24,000. The decrease in resources is not shown directly in the display equipment account, but is recorded in a separate contra asset account called accumulated depreciation, display equipment. As the equipment is used up, the expense is called depreciation expense, display equipment.

Remembering that assets increase with debits and debits equal credits, prepare the journal entry to record the using up of $24,000 of equipment over six years.
 

Date

Description

Post.
Ref.

Debits

Credits

"over

Depreciation Expense, Display Equipment

 

24,000

 

six

    Accumulated Depreciation, Display Equipment

 

 

24,000

years"

Six-year depreciation

 

 

 

By the end of six years, the company would report the following amounts in its general ledger accounts.
 

Display Equipment 

 

Accumulated Depreciation, 
Display Equipment 

 

Depreciation Expense, 
Display Equipment 

$27,000

(Cost of getting equipment
into usable condition)

 

 

 

$24,000

(Cost of equipment used up)

 

$24,000

(Cost of equipment used up)

$24,000

(Closed to income summary)

The company's accounts show the display equipment was originally purchased for $27,000 (display equipment account) and had been used up a total of $24,000 (accumulated depreciation, display equipment account and depreciation expense, display equipment account). The $3,000 difference between the display equipment account and the accumulated depreciation, display equipment account represents the dollar amount of the display equipment that was not used up by the end of year six. If the company's estimates are accurate, the $3,000 difference will be equal to the display equipment's residual value at the end of six years.
 

** You now have the background to do text exercise 9.5.
 

Determining the periods in which to report the property, plant, and equipment depreciation expense Like all assets, the periods in which to report the property, plant, and equipment depreciation expense are the periods during which the assets are used. In the case of the display equipment, it should be depreciated (expensed) over its useful life of six years.

Determining the dollar amount of depreciation expense to report in any specific year of the property, plant, and equipment's useful life Based on the display equipment's $27,000 original cost and estimated residual value of $3,000, the company knows its six-year depreciation expense will be $24,000, as calculated earlier. The question facing management each year is: how much of the $24,000 depreciation expense should be recorded during each of the six years of the equipment's life? The logical answer is that the depreciation expense to record in each year is the amount of the equipment used up during each year. Unfortunately, it is virtually impossible to measure how much of the display equipment was used up in any one year. Except for a few scratches or dents, the display equipment probably looks the same year after year. To overcome the difficulty of measuring the amount of property, plant, and equipment used up during each year, managers rely on two general methods of calculating depreciation expense: the straight-line method and accelerated methods.

Straight-line depreciation Many assets are used at approximately the same rate each year. For example, buildings can be used 365 days a year for 40 years or more. For assets that are used at approximately the same rate each year, it is reasonable to record the same amount of depreciation expense each year. Remember depreciation expense is the cost of the assets used up. To record the same amount of depreciation expense for each year of an asset's life, managers use the straight-line depreciation method. For the display equipment, the straight-line depreciation method would calculate annual depreciation expense as follows.

Straight-line annual depreciation = (cost residual value) / useful life

Straight-line annual depreciation = ($27,000 - $3,000) / 6 years = $4,000 per year

Over its six-year life the display equipment's depreciation expense would total $24,000, with each year's expense being $4,000.
 

Year

Depreciation

1

$4,000

2

$4,000

3

$4,000

4

$4,000

5

$4,000

6

$4,000

Total

$24,000

Show the effects on the company's resources and sources of resources of using up $4,000 of display equipment during year 1.
 

Total
Resources

=

Sources of
Borrowed
Resources

+

Sources of
Owner Invested
Resources

+

Sources of
Management Generated
Resources

Assets

=

Liabilities

+

Stockholders' Equity

- $4,000
accumulated depreciation, display equipment

=

 

 

 

 

- $4,000
depreciation expense,
display equipment

The use of equipment in year 1 reduces the company's resources by $4,000 and reduces the company's stockholders' equity by $4,000. The decrease in display equipment is recorded in a separate contra asset account called accumulated depreciation, display equipment and the expense is called depreciation expense, display equipment.

Remembering that assets increase with debits and debits equal credits, prepare the journal entry to record the using up of $4,000 of equipment in the first year.
 

 Date

Description

Post.
Ref.

Debits

Credits

Dec. 31

Depreciation Expense, Display Equipment

 

4,000

 

 

    Accumulated Depreciation, Display Equipment

 

 

4,000

 

Year 1 depreciation

 

 

 

By the end of six years, the effects of using up the display equipment would be as follows.

 

Total
Resources

=

Sources of
Borrowed
Resources

+

Sources of
Owner Invested
Resources

+

Sources of
Management Generated
Resources

Year

Assets

=

Liabilities

+

Stockholders' Equity

1

- $4,000

=

 

 

 

 

- $4,000

2

- $4,000

=

 

 

 

 

- $4,000

3

- $4,000

=

 

 

 

 

- $4,000

4

- $4,000

=

 

 

 

 

- $4,000

5

- $4,000

=

 

 

 

 

- $4,000

6

- $4,000

=

 

 

 

 

- $4,000

Totals

- $24,000

=

 

 

 

 

- $24,000

Over six years, the company's using up $24,000 of display equipment reduces the company's resources and sources of resources by $24,000. The straight-line depreciation method results in a $4,000 reduction of resources and sources of resources each year.

At the end of six years, the following information would appear in the company's general ledger.
 

Display Equipment

 

Accumulated Depreciation, 
Display Equipment 

 

Depreciation Expense, 
Display Equipment 

$27,000

 

 

 

$4,000
$4,000
$4,000
$4,000
$4,000
$4,000

 

$4,000
$4,000
$4,000
$4,000
$4,000
$4,000

$4,000
$4,000
$4,000
$4,000
$4,000
$4,000

$27,000

 

 

 

$24,000

 

$0

 

The equipment's $27,000 cost appears in the display equipment account. The $24,000 of equipment used up over six years appears in the accumulated depreciation, display equipment account. The amount of equipment used up each year is first recorded in the depreciation expense, display equipment account, which is closed to the income summary account at the end of each year.
 

Practice Exercise

On January 2, the Christopher Corporation purchased equipment by paying $9,000 cash to a supplier. To have the equipment delivered, the Christopher Corporation paid $200 cash to a local trucking company. The equipment will be used for the next 10 years, after which it will be sold for $1,000.

1. Determine the total dollar amount the Christopher Corporation will record in its equipment account on January 2.

The equipment account includes all costs of getting the equipment in usable condition. It would include the $9,000 price from the supplier and the $200 delivery cost. The equipment cannot be used unless it is purchased and delivered to the company. The total dollar amount in the equipment account would be $9,200.

2. Determine the total depreciation expense the company will have over the 10-year life of the equipment.

The total 10-year depreciation expense would be $8,200, the equipment's $9,200 cost less its $1,000 residual value.

3. Determine the straight-line depreciation expense for the equipment in year 1.

Annual straight-line depreciation = (cost residual value) / useful life = ($9,200 - $1,000) / 10 = $820.
 

** You now have the background to do text exercise 9.6.

 

 

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