UnitVIIPlantPropertyEquipment.doc

Unit VIIPlant, Property and Equipment

Overview

Background Property, plant and equipment are assets used in the operation of business and often constitute the largest single asset category of a firm. For accounting purposes, these so called plant assets or tangible assets are grouped into three sub classifications: (Dyckman, T., Dukes, R., Davis, C., 1998).

1. Assets subject to depreciation, e.g., buildings, equipment, etc.2. Assets subject to depletion, e.g., mineral deposits, timber tracts, etc.3. Land, which is not subject to depreciation or depletion.

Purpose The purpose of Unit VII “Plant, Property and Equipment” is to illustrate how

the acquisition and disposal of fixed assets may be recorded in the books of the company.

Nature of Property, Plant & Equipment

The term plant, property and equipment is used to describe long lived assets that meet the following criteria: (Pefianco, E., Mercado, R., 1983)

1. they must possess physical existence; 2. they must be more or less permanent in nature; 3. they must not be held for sale; 4. they must be intended for use in operations; and 5. must undergo depreciation (except land)

In this unit This unit contains the

following topics:

Topics See PageKinds of Expenditures

2 of G

Purchase of Land

3 of G

Purchase of Property, Furniture or Equipment

4 of G

Cash Purchase 5 of G

Marivic D. Valenzuela-Manalo of G

of Property, Plant & EquipmentCredit Purchase of Property, Plant & Equipment

6 of G

Returns & Allowances on Plant Assets Acquired

8 of G

Partial Payments on Plant Assets Acquired

10 of G

Full Payment of Outstanding Liability

11 of G

Recording Incidental Charges

13 of G

Recording Sale of Property and Equipment

14 of G

Review Questions

16 of G


Kinds of Expenditures

Overview Expenditures related to the acquisition and use of operational assets is

either capital expenditures or revenue expenditures. The charge to an expense account is based on the assumption that the benefits from the expenditure will be used up in the current period, and the cost should therefore be deducted from the revenue of the period in determining the net income.

Capital Expenditure

Expenditures for the purchase or expansion of plant assets are called capital expenditures and are recorded as asset accounts.

Revenue Expenditure

Expenditures for ordinary repairs, maintenance, fuel and other items necessary to the ownership and use of plant and equipment are called revenue expenditures and are recorded by debiting expense accounts.

Exceptions to the rule

There are items on the other hand that businesses purchase which will benefit several accounting periods but whose amounts are relatively low, e.g., wastebaskets, pencil sharpeners, etc. These are not capitalized in order not to be burdened by the yearly computation of the assets’ depreciation. Thus, for reasons of convenience and economy, expenditures that are not material in peso amount are treated in accounting records as expenses of the current period. In short, any material expenditure that will benefit only the current period or that is not material in amount is treated as revenue expenditure.


Purchase of Land

Overview Acquiring a piece of land which will be used as a site where an office

building or a factory may be constructed will be recorded in the books of the buyer as “Land” not to be subjected to depletion, i.e., the gradual decrease in the value of land due to mining or oil extraction purposes.

Terms of Payment

Purchase of land will cause an increase in assets and the corresponding credit varies depending on the terms under which the purchase was made. The purchase may be on 4. cash basis, 5. on credit terms, 6. on credit terms with down payment, or 7. by signing a mortgage contract for the plant assets. Land is unique. Its cost is not depreciated/expensed overtime because its usefulness does not decrease like that of other assets.

Land xxxx Cash or Mortgage PayablexxxxPurchased land to be used in the business operation

Land Improvements

Improvements to real estate such as driveways, fences, parking lots, etc. have limited life and are therefore subject to depreciation. For this reason, they should be recorded in separate account called Land Improvements


Purchase of Property, Furniture or Equipment

Overview Every business organization would need different types of fixed assets

to function efficiently and effectively. In this part, we shall be dealing on how to record acquisition of different properties of the firm, e.g., land, equipment, furniture and fixtures. We would also show how to record the eventual sale of this used plant assets.

Nature of depreciable assets

All assets except land decline in usefulness as they age. These depreciable assets are of useful to the company for only a limited number of years. Depreciation, as the term is used in accounting, is the allocation of the cost of a plant asset to expense in the periods in which services are received from the asset. This is being done for the basic purpose of achieving the matching principle, i.e., to offset the revenue of an accounting period with the cost of goods and services being consumed in the effort to generate that revenue

Rule on acquisition

When property, furniture or equipment is acquired, the purchase may be made on cash basis, on credit terms with down payment, or by issuing a promissory note. If the purchase is made under credit terms, the said purchase must be recorded net of cash discount, if the seller is giving such discount.


Cash Purchase of Property, Plant & Equipment

Overview Plant assets may be acquired under different purchase terms. In the

case of cash purchase, assets are acquired and fully paid on the date of acquisition.

Effect of cash purchase

When property, furniture or equipment is acquired by cash purchase, there is an increase in the asset property and equipment and a decrease in the asset cash.

Illustration For example, Labrador Trading purchased one IBM computer for

P40,000, cash basis. The entry to record the transaction is:

Office Equipment CashPurchased one IBM computer.

40,000 40,000


Credit Purchase of Property, Plant & Equipment

Overview A purchase on credit terms of any type of plant assets will either

require a down payment or purely on account basis. At the same time, the seller may or may not give a cash discount.

Purely credit without cash discount

Assuming the purchase made was purely on account basis without any discounts, this will cause an increase in asset and increase in liability.

Office equipment Accounts PayablePurchased IBM computer on account.

40,000 40,000

With downpayment without cash discount

Credit purchase with down payment but without any discounts given will be recorded by using the following entry:

Office equipment Accounts Payable CashPurchased IBM computer. Terms: with

40,000 20,000 20,000


50%down, balance on account.

Credit purchase with cash discount

When a credit purchase is with a cash discount, the property acquired must be recorded net of cash discount.

To illustrate, Labrador Trading purchased a cash register from Omron Marketing for P30,000. Terms: 2/10, n/30. The entry to record the transaction is:

Store Equipment Accounts PayablePurchased cash register. Terms: 2/10, n/30

29,400 29,400

COMPUTATION: Since there was a cash discount given by the seller, the applicable amount should be deducted from the liability to be recorded.

Invoice Price P 30,000 Less: 2% cash discount(30,000*2%) 600 Accounts Payable to be recorded P 29,400

=======Continued on next page


Credit Purchase of Property, Plant & Equipment, Continued

Downpayment and Cash discount

Recording net of cash discount will also be applied under credit purchase with down payment and cash discount.

To illustrate, Labrador Trading purchased a cash register from OMRON Marketing for P30,000. Terms: P10,000 down payment; balance, 2/10, n/30. The entry to record the transaction is:

Store Equipment Cash Accounts payablePurchased cash register.Terms: with down; balance, 2/10, n/30.

29,600 10,000 19,600

COMPUTATION: Since the down payment is not to be subjected to the cash discount, only the liability portion must be recorded at an amount net of cash discount.

Invoice PriceLess: Down paymentAccounts Payable should beLess: Cash discount (20,000x2%)Accounts Payable to be recordedAdd: Down paymentCost of Store Equipment to be recorded

P 30,000 10,000 20,000 400 19,600 10,000P 29,600=======

Reminder It is important to note that the computation started with invoice price,

thus, trade discounts will be treated in the same way it was used in the purchase of merchandise.


Returns and Allowances on Plant Assets Acquired

Overview When property, furniture or equipment purchased turns out to be

defective, damaged, or of the wrong specification, the buyer either returns the asset bought or bargains for a reduction in the acquisition cost of such asset. When asset bought is returned, there is a decrease in asset and a decrease in liability, if the asset was originally acquired on credit terms. And the said reduction must also be recorded net of cash discount if there was a cash discount given in the term of purchase since returns and allowances are normally treated as part of the amount subjected to the cash discount. But when property is purchased on cash basis, allowance granted will be made by way of cash refunds. This will cause an increase in asset cash and a decrease in asset property.

Illustration Assume that on July 1, Labrador Trading purchased store shelves and

cabinets from Mansion Inc. for P40,000 less 5. Terms: P10,000 down; balance; 2/10, n/30. The entry to record the transaction is:

Jul. 1 Store Furniture and Fixture Cash Accounts PayablePurchased cabinet and shelves. Terms: 10,000 down, balance 2/10, n/30.

37,440 10,000 27,440

COMPUTATION:

List PriceLess: Trade Discount (40,000 x 5%)Invoice PriceLess: Down paymentAccounts Payable should beLess: Cash discount (28,000 x 2%)Accounts Payable to be recordedAdd: Down paymentCost of Furniture and Fixture to be recorded

P 40,000 2,000 38,000 10,000 28,000 560 27,440 10,000P 37,440========

Continued on next page


Returns and Allowances on Plant Assets Acquired, Continued

Illustration, con’t

If one of the shelves is subsequently returned by Labrador to Mansion, Inc. because of some defects, there will be a decrease in liability and also a decrease in the asset.

Assume that on July 3, Labrador returned one of the cabinets worth P5,000 due to some major defects. The entry to record the transaction is:

July 3 Accounts Payable Store Furniture and FixtureReturned one cabinet.

4,900 4,900

COMPUTATION:

Since the original purchase was recorded net of cash discount, subsequent returns made by the buyer will also be recorded as net of cash discount.

Amount of returned assetLess: Applicable cash discount(5,000 x 2%)Decrease in the liability of the buyer

P5,000 100P4,900=====

Defective items

It is not uncommon for a seller to replace defective items sold with a new unit. When this happens, no entry need be made of the return.


Partial Payments on Plant Assets Acquired

Overview The buyer has the option to make a partial payment of his account to

decrease the amount of his liability prior to his full payment. Partial payment will reduce liability and asset, cash.

Illustration Assume that on July 5, Labrador Trading made a partial payment of

P10,000. The entry to record the transaction is:

July 5 Accounts Payable CashMade a partial payment.

10,000 10,000

Note: Partial payments, unlike returns, are not recorded net of cash discount since it will not affect computation of the discount account on the date payment is made. Partial payments on the other hand will reduce existing liability of the buyer.


Full Payment of Outstanding Liability

Overview The buyer can pay his outstanding account within or after the discount

period. If full settlement is made within the discount period, the entry will only reflect a decrease in liability and cash

Illustration Assume on July 11, Labrador Trading settled his account with

Mansion, Inc. in full. The entry to record this transaction is:

July 11 Accounts Payable CashFull payment of account.

12,540 12,540

COMPUTATION:

Accounts Payable initially recordedLess: Return of one table Partial PaymentAccount to be paid

P 4,900 10,000

P 27,440 14,900P 12,540=======

Reminder It is important to note that the acquisition of property was recorded net

of cash discount on the date asset was bought. Therefore, if the buyer pays his liability within the discount period, the accounts payable reflected on his books would be the amount that must be actually paid with the cash discount already deducted. The cash discount reduces the cost of the property acquired and not to be recorded in a separate account title such as purchase discount (as in the case of merchandise)



Full Payment of Outstanding Liability, Continued

Illustration Assume that instead of paying on July 11, Labrador paid his account in full with Mansion, Inc. on July 20. The entry to record the transaction is:

July 20 Accounts PayableDiscount Lost CashPaid account in full.

12,540 460

13,000

COMPUTATION:

Accounts Payable initially recordedLess: Return of one table Partial PaymentAccounts Payable balance in the books of the buyerAdd: Discount lost due to paying after discount period Original amount of Accounts Payable P28,000 Less: Actual amount of return 5,000 Basis for computing cash discount 23,000 Cash discount percentage x 2%Cash to be paid by the buyer

P 27,440 4,900 10,000 P 12,540

460P 13,000=========

Reminder The “Discount Lost” account is to be included in the other expenses

category in the multiple statement since this expense was incurred due to the failure of the company to take advantage of the discount given to them by the seller.


Recording Incidental Charges

Overview The purchase of property, furniture, or equipment may involve

additional expenditures for freight, insurance while asset is in transit, brokerage fees, arrastre, handling, storage, customs duties, test runs, installation costs, etc. These expenditures are usually paid by the buyer and are necessary in order to put the property in a place and condition ready for use. These expenditures become part of the cost of acquiring the property, furniture or equipment. In short, incidental charges are capitalized, i.e., debited to the asset account and not to an expense account

Illustration Assume that on July 20, 20X1, Labrador Trading bought a delivery

van from Toyota, Inc., Japan for P950,000. Terms: P300,000 down payment; balance, 2/10, n/30. F.O.B. shipping point, collect P3,000. The entries to record the transaction are:

July 20 Delivery Equipment Cash Accounts PayablePurchased delivery van. Terms: with down, balance, 2/10, n/30

937,000 300,000 637,000

July 20 Delivery Equipment CashFreight cost of the van purchased.

3,000 3,000

Assume further that Labrador Trading paid for the following incidental charges for the delivery van bought.

Customs dutiesInsurance while in transit

P 20,000 15,000

The entry to record this is:

July 20 Delivery Equipment CashTaxes and insurance paid for the van.

35,000 35,000


Recording Sale of Property and Equipment

Overview Although property and equipment are not originally intended for sale,

these assets may eventually be sold when they become worn out or obsolete. The proceeds of the sale will be used to replace old units with new units.

Disposal of property and equipment could be for an amount just sufficient to recover the book value of the asset at the date of sale or for an amount, which results in either a gain on the sale or a loss on the sale. A comparison is made between the selling price and the net book value of the asset sold. Net book value is the difference between the acquisition cost of the asset and any depreciation accumulated to date.

Illustration Assume that on July 25, Labrador Trading sold its old typewriter being

used in the office. The said asset was acquired at P20,000 with an accumulated depreciation to date amounting to P12,000.

Case 1: Assume that the typewriter was sold at P8,000. The entry to record the transaction is:

July 25 CashAccumulated depreciation-Office Equipment Office EquipmentSold old typewriter.

8,000 12,000

20,000

COMPUTATION:

Acquisition costLess: Accumulated depreciationNet Book valueResale priceNo gain or loss

P 20,000 12,000 8,000 8,000 -=======



Recording Sale of Property and Equipment, Continued

Illustration, con’t


CashAccumulated depreciation-Office Equipment Office Equipment Gain on sale of Office EquipmentSold old typewriter.

10,000 12,000

20,000 2,000

COMPUTATION:

Resale PriceLess: Net Book Value Acquisition Cost Less: Accumulated DepreciationGain on sale of office equipment

20,000 12,000

10,000

8,000P 2,000=======


CashAccumulated Depreciation-Office EquipmentLoss on sale of Office Equipment Office EquipmentSold old typewriter

7,000 12,000 1,000

20,000

COMPUTATION:

Resale PriceLess: Net Book Value Acquisition Cost Less: Accumulated DepreciationLoss on sale of office equipment

20,000 12,000

7,000

8,000 (P 1,000)========

Reminder Any gain on the sale of property and equipment is classified as other

income because it is an income from a source which is not from the ordinary course of business operations. Any loss on the sale is classified as other expense in the multiple step income statement.


Review Questions

Overview The following questions will encourage the students to review the

different topics included in this unit.

Questions The following are the review questions:

1. Differentiate capital expenditures from revenue expenditures.

2. What are the different characteristics of plant, property and

equipment?

3. Enumerate and describe at least three types of plat assets.

4. How do we value plant, property and equipment in the balance

sheet?

5. What is the meaning of recording plant assets using the net method

approach?

6. What are incidental charges?

7. Give examples of expenses treated as incidental charges.

8. What is discount lost? How will it be presented in the multiple

step income statement?

9. What is the objective of the company in selling used plant assets?

10. What is the formula for computing net book value of an asset being sold?


UnitVIIPlantPropertyEquipment.doc

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