Buildings, machinery, equipment, furniture, fixtures, computers, cars and trucks are examples of assets that will last for more than one year, but will not last indefinitely. These are some examples of long-lived non-monetary assets. When these assets were acquired, the company has made an expenditure. If the company will benefit in the curret period, the cost of the goods are expenses. If the benefits are expected in future periods, the costs are assets during the current period and the expenditures are capitalized. The cost of these non-monetary assets should be matched with the revenues that are obtained from its use in the future periods.
In general there are two types of long-lived assets: the tangible assets and the intangible assets. A tangible asset is an asset that has physical substance. Examples are land, plant and equipment and natural resources. An intangible asset has no physical substance. These will include good will, patent rights and copyrights. Land is not normally amortized because its useful life is assumed to be indefinitely long. Depreciation is process of converting the original cost of plant and equipment assets to expense. Depletion on the other hand is the process of converting the cost of the natural resource assets to expense. If the intangible assets are converted to expense, it is called amortization.
With plant and equipment, betterments or repairs and maintenance can be done. To differentiate, maintenance will keep the asset in good condition but not in a better condition than when it was purchased. On the other hand, betterment makes the asset better or extends its useful life beyond the original estimate of useful life. Thus, betterment is added to the cost of the asset while repair and maintenance costs are considered period costs.
What are the items to be included in the cost of an asset? The cost of a property, plant or equipment includes all expenditures that are necessary to make the asset ready for its intended use. In general, non-monetary assets are recorded at cost. However there are certain exceptions to this. If the entity receives an asset by donation or pays less than the market value of the asset, the asset is recorded at its fair value.
Plant and equipment undergo depreciation compared to land that does not have a limited useful life. Therefore, a portion of the cost of the asset is charged as an expense in each of the accounting periods in which the asset provides benefits to the entity. Depreciation is considered to be an expense since costs of goods and services consumed by an entity are expenses. Generally, long-lived tangible assets’ useful life is limited by either deterioration or obsolescence. Deterioration is the physical wearing out of an asset. Physical life is the time until an asset wears out. Obsolescence is the loss of usefulness of an asset not related to its physical condition. Service life is the time until the asset becomes obsolete.
To make an estimate of the depreciation expense, we need to estimate the service life of the asset, the residual value at the end of its service life and the method of depreciation to be used. The service life is the estimate of how long the asset will be used. The residual value is the estimated amount that a company will receive when it disposes of an asset at the end of the asset’s service life. This value is often estimated to be zero. There are three conceptual methods of depreciation to be used. The straight line method views a fixed assets as providing its services in a level stream and charges as an expense an equal fraction of the net cost of the asset each year. The most common method of depreciating assets for financial statement purposes is the straight-line method. Accelerated depreciation is an alternative to the straight-line method. Compared to the straight-line method, accelerated depreciation methods provide for more depreciation in...