By Adugna D.

Chapter Two
PROPERTY, PLANT AND EQUIPMENT, INTANGIBLE ASSETS AND
NATURAL RESOURCES

CHAPTER OVERVIEW

In Chapters 1, you saw how companies maintain control over two very important current
assets: receivables and inventories. In this chapter, we continue the discussion of internal
control with specific application to non-current assets, also called long-lived assets.
Long-lived assets include things such as equipment, buildings, natural resources, and
intangible assets.
Business assets are classified as current or long-lived (long-term) assets. Current assets
are considered to be useful for one year or less. Long-lived assets are expected to be
useful longer than a year. The three major categories of long-lived assets include:
 Plant assets are tangible assets such as land, buildings, and machinery, equipment,
furniture etc.
 Intangible assets are assets such as patents, copyrights, trademarks, franchises,
organization costs, leaseholds, and goodwill.
 Natural resources are assets such as mining properties, oil and gas reserves, and
tracts of standing timber.

Accounting for Plant Assets

Plant assets have the following nature
 They are tangible i.e. they have physical substance
 They are acquired for use in business operations,
 They are expected to be used for more than one year, and
 They are subject to depreciation.
Plant assets are sometimes reported on the balance sheet as Fixed Assets or as Property,
Plant, and Equipment.
The major accounting problems relating to plant and equipment are:
 Determining the cost of the plant asset.
 Procedures for allocating the cost of a plant asset to accounting periods.
 Recording cost (such as repairs) incurred in using plant assets.
 Recording the disposal of plant assets.

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A. Acquisition of Plant Assets

 The cost of a plant asset includes all are reasonable and necessary expenditures
incurred in acquiring the plant asset and placing it in use and should be recorded in
an asset account.
 Costs include the list price, sales taxes, freight and handling costs, installation
costs, and insurance prior to the time that the asset is placed in service.
 When a secondhand asset is purchased, the initial cost of getting it ready for use,
such as expenditures for new parts, repairs, and painting, are included to the cost of
the asset.
 Expenditures resulting from carelessness or error in installing the asset, from
vandalism, or from other unusual occurrences are not included as part of the cost of
the asset.
The cost of an existing building includes the purchase price, brokerage commission,
taxes, and any expenditure to repair or renovate the building to make it ready for use.
The cost of machinery and equipment includes the purchase price less any discounts,
plus transportation charges, transportation insurance, commissions, and installation costs.
Improvements to land are not part of the cost of land because the usefulness of the
improvement decreases over time. Such improvements include roads, paving, fencing,
driveways, parking lots, and lawn sprinkler systems. Improvements to land should be
recorded in a separate asset account. The costs of improvements to leased assets are
called leasehold improvements.
When a building is constructed by the owner, the total cost of the building includes
architect fee, all direct expenditures (labour, materials, building permit, etc.) plus a
reasonable estimate of indirect costs (overhead). Interest costs incurred during the time a
plant asset is being constructed are considered a necessary cost to “acquire” the asset and
are therefore capitalized (i.e., debited to the asset account.)
When a company purchases a group of assets for one single amount (also known as a
group purchase or a basket purchase), the total cost of the assets is allocated to
individual assets by the relative-sales-value method.

B. Nature of Depreciation
As time passes, all plant assets with the exception of land lose their capacity to yield
services. This decrease in the usefulness of plant asset is a business expense and is
reported on the income statement as Depreciation Expense.
Factors contributing to a decline in usefulness may be divided into two categories:
physical depreciation and functional depreciation. Physical depreciation includes wear
from use and deterioration from the action of the elements. Functional depreciation
includes inadequacy and obsolescence. A given plant assts become inadequate if its

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capacity is not sufficient to meet the demands of increased production. A plant asset is
obsolete if the commodity that it produces is no longer in demand or if a newer machine
can produce a commodity of better quality or at a greater reduction in cost.
Note, therefore, that physical depreciation arises from the actual use of a plant asset
whereas functional depreciation is due to obsolescence factors such as technological
advances and less demand for a product.
Note further that the purpose of recording depreciation is to show the decline of
usefulness of an asset, not a decline in its market value. Depreciation merely reduces the
value of plant asset accounts (it is a book adjustment), it does not reduce the cash account
or affect cash flows. This means that depreciation is based on an asset’s cost, and that
depreciation is not in any way related to cash. A contra account called Accumulated
Depreciation is used to record the total amount of a plant asset’s cost that has been
recorded as depreciation expense. The adjusting journal entry to record depreciation is:
Depreciation Expense ………………………..XX
Accumulated Depreciation……………………….XX
As accumulated depreciation increases each year, the remaining book value of the asset
(cost minus accumulated depreciation) declines. The final book value of an asset will be
its residual value.

Accounting for Depreciation

To measure depreciation, it is necessary to determine the plant assets cost, estimated
useful life, and estimated residual value (salvage value or scrap value).
 Estimated useful life is the length of service a business expects from the plant
asset. Useful life may be expressed as a length of time, units of output, or other
measures. For example, a computer may be expected to be useful for four years,
while a printing press might be expected to print one billion sheets of paper over its
useful life. Normally such factors as climate, frequency of use, maintenance, and
minimum standards of efficiency will affect the economic life of a plant affect.
Note that the useful life of an asset is an estimate of the usefulness of an asset and is
not necessarily related to the physical life. For example, an asset such as a computer
may become obsolete (not economically useful) long before it physically
deteriorates.
 Estimated residual value is the expected cash value of an asset at the end of its
useful life. It is also called scrap or salvage value or trade-in value.
 The depreciable cost of an asset is its cost minus residual value.

DEPRECIATION METHODS
1. The Straight-Line (SL) Depreciation Method
This method allocates the depreciable cost of a plant asset to depreciation expense in
equal amounts per period over the life of the asset. The formula for straight-line
depreciation is:

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Depreciation Exp. = cost - residual value

useful life
Recall that the adjusting entry to record depreciation expense is:
Depreciation Expense …………………………XX
Accumulated Depreciation………………………..XX
Note that this method is:-
 The simplest and the most widely used method of computing depreciation.
 An equal portion of the cost of the asset (less residual value) is allocated to each
period of use.
 Most appropriate when usage of an asset is fairly uniform from period to period.
Illustration - 1
Suppose, for example a business enterprise acquires a new computer (office equipment)
at a cost of Birr 6000. It is estimated that the computer has an estimated residual value of
Birr 1000 at the end of its estimated useful life of 4 years. The yearly (annual)
depreciation would be Birr 1250m computed as follows:
Annual depreciation = Cost - Salvage value
Estimated useful life
= Birr 6000 – Birr 1000 = Birr 1250
4 years
The depreciation to be reported for each of the four years would be as follows:
Depreciation Method- Straight-Line Method
Year Cost Yearly Accumulated Carrying value
Depreciation Depreciation (Book Value)
Beginning of first year Br. 6000 - - Br. 6000.00
End of first year 6000 Br. 1250.00 Br. 1250.00 4750.00
End of second year 6000 1250.00 2500.00 3500.00
End of third year 6000 1250.00 3750.00 2250.00
End of fourth year 6000 1250.00 5000.00 1000.00

NB. There are three important points to note from the depreciation schedule for the
straight-line depreciation method. First, the depreciation is the same each year. Second,
the accumulated depreciation increases uniformly. Third, the carrying (Book) value
decreases uniformly until it reach the estimated residual value.
2. Units-Of-Production (UOP) Depreciation Method
This method allocates the cost of an asset to depreciation expense based on the output
that the asset is expected to produce.
Units of usage can be expressed in quantity of goods produced, hours used, number of
cuttings, miles driven or tons hauled.
The formula for units-of-production depreciation is:
UOP depreciation per = cost - residual value

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unit of output useful life in units

With UOP, the total depreciation expense in a period is:
Depreciation Expense = UOP depreciation per unit of output × units of output in the
period
While the straight-line method could be used for any plant asset, the UOP method is not
appropriate for all assets. Rather, it is used for assets where the life is a function of use
rather than time (for example, an airplane where flying hours is a more accurate measure
of life compared with years).
Example- 2
If we assume that the office equipment from the previous illustration has an estimated
useful life of 10,000 hours, the depreciation cost per hour would be determined as
follows:
Hourly depreciation = Cost – Salvage value = Br. 6000.00 – 1000 = Br. 0.50
Rate Estimated units of useful life 10,000 operating hrs.
If we assume that the use of the equipment was 2800 hours for the first year, 3600 hours
for the second, 2400 hours for the third, and 1200 hours for the fourth, the depreciation
schedule for the office equipment would appear as follows:
Depreciation Schedule Production Method
Year Cost Hours Depreciation Yearly Accum. Carrying value
Per Hour Depr. Depr. (Book value)
Beginning of the Br. 6,000 - Br. 0.50 - - Br. 6,000.00
First year
End of first year 6,000 2,800 0.50 Br. 1,400.00 Br. 1,400.00 4,600.00
End of second year 6,000 3,600 0.50 1,800.00 3,200.00 2,800.00
End of third year 6,000 2,400 0.50 1,200.00 4,400.00 1,600.00
End of fourth year 6,000 1,200 0.50 600.00 5,000.00 1,000.00
3. Double-Declining-Balance (DDB) Method
It is an accelerated depreciation method. Accelerated depreciation simply means that a
larger portion of an assets cost is allocated to depreciation expense in the early years of
an assets life, and a smaller portion is allocated to depreciation expense toward the end of
the assets useful life.
To compute double-declining-balance depreciation:
a) Compute the straight-line depreciation rate per year:
(1 / Useful life in years) = X%
b) Multiply the straight-line depreciation rate per year by 2 (double it) to obtain the
double-declining-balance rate:
DDB rate = (1/Useful life in years) × 2
c) Multiply the assets beginning book value for a period (remember that book value
equals cost minus accumulated depreciation) times the DDB rate. Book value will

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decrease each period, therefore depreciation expense will decrease each period.
Note that the residual value of the asset is ignored until the net book value of the
asset approaches the assets residual value.
Depreciation Expense = DDB rate × book value
d) When the net book value of the asset approaches the assets residual value, adjust
the year’s depreciation so that the remaining book value of the asset is equal to the
residual value. The final year’s depreciation amount will be equal to:
Book value at the beginning of the year - Residual value
Example - 3
Referring to the previous example, the equipment had an estimated useful life of four
years. Consequently, under the straight-line method, the depreciation rate for each year
was 25 percent, (100/ estimated useful life of the asset for 100/ 4 years).

Therefore, under the double-declining balance method, the fixed rate is 50 percent (2X 25
percent). This fixed rate of 50 percent is applied to the remaining carrying value at the
end of each year. Estimated residual value is not taken into account in computing
depreciation except in the last year of an assets useful life, when depreciation is limited to
the amount necessary to bring the carrying value down to the estimated residual value.
The depreciation schedule for this method is as follows:
Depreciation Schedule, Double-Declining Balance Method
Year Cost Fixed Depr. Yearly Accumulated Carrying Value
Rate Depreciation Depreciation (BV)
Date of purchase Br. 6000 50% - - Br. 6000
End of first year 6000 50% Br. 3000 Br. 3000 3000
End of Second year 6000 50% 1500 4500 1500
End of third year 6000 50% 750 5250 750
End of fourth year 6000 50% 250 550 500
NB. The fixed rate of 50% is always applied to the Book value at the end of the previous year.
The depreciation is greatest in the first year and declines each year after that. Finally, the
depreciation in the last year is limited to the amount necessary to reduce book value to residual
value, Br. 250 = Br. 750 Br. 500 (i.e. Previous book value minus residual value).
4. Sum-Of-The-Years-Digits Method
The sum-of-the-years-digits (SYD) method is another form of accelerated depreciation.
The annual depreciation is calculated by subtracting salvage value from original cost, and
multiplying this figure by a fractional rate of depreciation. The denominator of the
fraction is the sum of the years of useful life; for a life of 5 years, the denominator is = 1
+ 2 + 3 + 4 + 5 = 15. The numerator is the year in reverse order. For the first year, the
numerator is 5 and the fraction is 5/15.

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Example- 4
For example, for a plant asset with an estimated life of 4 years, the denominator of the
fraction is 4+3+2+1 = 10. The depreciation schedule for this method is as follows:
Depreciation Schedule- Sum - of - the - Years - Digits Method
Year Depreciable Rate Yearly Accumulated Book Value
Cost Depreciation Depreciation
Date of purchase Br6000 - - - Br. 6000
End of first year 6000 4/10 Br. 2200 Br. 2200 3800
End of second year 6000 3/10 1650 3850 2150
End of third year 6000 2/10 1100 4950 1050
End of fourth year 6000 1/10 550 5500 500
NB. The above illustration for the sum of years digit method is based on the assumption
that the first use of the asset concide with the beginning of the fiscal period. When the
first use of the asset does not concide with the beginning of a fiscal year, it is necessary to
allocate each full year’s depreciation b/n the two fiscal years benefited. Assuming that the
asset in the example was placed in service after four months of the fiscal year had been
elapsed, the depreciation for that fiscal year would be Br. 1466.67 computed as follows:

First year depreciation = 4/10 X (6000 – 500) X 8/12…………………. Br. 1466.67

Therefore, the depreciation for the second year would be ….Br. 1833.33
Computed as follows:
= 4/10 X (6000 – 500) X 4/12……………….. Br. 733.33
= 3/10 X (6000 – 500) X 8/12……………………. 1100.00

Total, second fiscal year depreciation…………………………… Br. 1833.33

Some important points to remember:
 You never depreciate below the estimated salvage value.
 Units-of-production ignores time.
 Double-declining-balance ignores salvage value initially.
 Double-declining-balance uses book value, while the other methods use depreciable
cost.
 The straight line method provides for uniform periodic charges to depreciation
expense over the life of the asset.
 The units of production method provides for periodic charges to depreciation expense
that may vary considerably, depending upon the amount of usage of the asset.
 Both the declining-balance and the sum-of-the-years-digits methods provide for a
higher depreciation charge in the first year of use of the asset and gradually declining
periodic charge thereafter. For this reason they are frequently referred to as
accelerated depreciation methods. These methods are most appropriate for situations

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in which the decline in productivity or earning power of the asset is appropriately

greater in the early years of its use than in later years. Further justification for their
use is based on the tendency of repairs to increase with the age of an asset. The
reduced amounts of depreciation in later years are therefore offset to some extent by
increased maintenance expenses.
 If an asset becomes fully depreciated (i.e., book value = residual value) but remains in
use, both the asset and contra asset account should remain in the ledger until the
business disposes of the asset. That means Depreciation is no longer recorded after
the book value of the asset is reduced to the residual value, even if the asset is still in
use.
Study Tip: The method used does not determine the total amount of the assets cost
to recognize as depreciation expense over the assets life. Rather, the method
determines the amount of the total to allocate each accounting period. Regardless of
method, accumulated depreciation will be the same when the asset is fully
depreciated.
Depreciation Method for Income Tax Purposes

Although depreciation is a noncash expense, the amount of depreciation recorded affects

the amount of income tax a business pays. Higher depreciation expense will reduce
taxable income, and therefore income tax payments. Using an accelerated depreciation
method will increase depreciation expense in the early years of an assets life. This will
decrease taxable income and income taxes, but only initially. The cash available to the
business increases because tax payments are reduced.
The Ethiopian income tax law doesn’t allow the use of the declining-balance,
sum-of-the-years-digits, and units-of-production methods of depreciation for income tax
purpose. According to proclamation number 286/89 in Ethiopia for tax purpose
depreciation is computed as follows: -
 The acquisition or construction cost, and the cost of improvement, renewal and
reconstruction, of buildings and constructions shall be depreciated individually on a
straight-line basis at five percent (5%).
 The acquisition or construction cost, and the cost of improvement, renewal and
reconstruction, of intangible assets shall be depreciated individually on a straight-
line basis at ten percent (10%).
 The following two categories of business assets shall be depreciated according to a
pooling system at the following rates:
(a) Computers, information systems, software products and data storage
Equipment: twenty-five (25%).
(b) All other business assets: twenty percent (20%).

Revision of Periodic Depreciation

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Remember that depreciation is computed based on two estimates-useful life and residual
value. These estimates are made at the time an asset is acquired. One, or both, of these
initial estimates may have to be revised as experience with the asset accumulates. When
it is clear that either estimates should be revised, the un depreciated asset balance at that
date should be apportioned, based on the new estimates, over the remaining estimated
life.
Example
Assume the following for a machine
On Jan 1, 1992 ABC Co. purchased a machine for Br 33,000. This machine has estimated
economic life of 10 years with an estimated salvage value of Br 3,000. The Company
uses straight line method of depreciation. Thus annual depreciation will be:-
Annual Depreciation= 33,000-3000= 3,000
10
Further assume that at the beginning of 1998 the initial estimated life was changed to 14
years while the salvage value was changed to Br 1,000. Thus the revised annual
depreciation would be:-
Undepreciated balance at the beginning of 1998 is computed as follows:-
Acquisition Cost……………………………....…33,000
Accumulated Depreciation, 1992-1997………….18,000
Undepreciated Balance………………………15,000
The revised annual depreciation for the remaining life of the machine is computed as
follows:-
Annual Depreciation= 15,000-1000= 1,750
8
Note the following
 The correction of error in estimates used in the determination of depreciation
does not affect the amounts of depreciation expense recorded in previous years.
 Revision of estimates affects only future depreciation expense amounts
Recording Depreciation
Depreciation is recorded by debiting Depreciation Expense and by crediting Accumulated
Depreciation account of each plant asset. Accumulated depreciation is a contra asset
account. It permits the original cost to remain unchanged in the plant asset account. This
facilitates the computation of periodic depreciation and the listing of both original cost
and accumulated depreciation on the balance sheet.
When to record depreciation?
 Monthly or yearly
 When the asset is sold, traded in, or scarped.
Consideration
 Depreciate for a full month all assets acquired before the 15 th of the month. There
is no depreciation for the month on the assets acquired after the 15th.
 Depreciate for a full year all assets acquired before July 1 st. There is no
depreciation for the year on assets acquired after July 1st.
Reading assignment
 Depreciation of plant assets of low unit costs
 Composite-rate depreciation method
Capital and Revenue Expenditure

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Subsequent to the acquisition of plant assets expenditures may be made for ordinary
repairs and maintenance, major repairs, replacement, and additions. These expenditures
made after the acquisition date are called either capital expenditure or capital
expenditures.
Capital expenditures are expenditures that significantly affect an asset by 1) increasing
the assets productive capacity, 2) increasing the assets efficiency, or 3) extending the
assets useful life. Examples are:-
 Additions to plant assets: - Expenditures for addition to existing plant assets would
be debited to the assets account.
 Betterments: - are expenditures that increase operating efficiency or capacity for the
remaining useful life of a plant asset. They are debited to the plant asset account.
 Extraordinary Repairs: - are expenditures that increase the useful life of an asset
beyond the original estimates. They are debited to the accumulated depreciation
account to restore a portion of the depreciation accumulated in prior years. In
addition, the periodic depreciation for future periods would be predetermined on the
basis of the revised estimate of the remaining useful life.
Revenue expenditures are those that maintain the existing condition of an asset or
restore an asset to good working order. Revenue expenditures are debited to an expense
account:
Most expenditure related to plant assets are repairs to the assets. Extraordinary repairs are
capital expenditures, while ordinary repairs are revenue expenditures.
C. Disposal of Plant Asset
With the possible exception of land, eventually a plant asset will no longer serve the
needs of the business. The business will generally dispose of the asset by discarding it,
selling it, or exchanging it.
Discarding Plant Assets
The simplest accounting entry occurs when a company discards an asset. If the asset is
fully depreciated with no residual value, the entry to record its disposal is:
Accumulated Depreciation-Asset…………………..XX
Plant Asset………………………………………….XX
If the asset is not fully depreciated, a loss is recorded for the remaining book value:
Accumulated Depreciation-Asset……………………….XX
Loss on Disposal of Asset...……………………………..XX
Plant Asset………………………………………………..XX
These entries have the effect of removing the asset from the books.
Sale of Plant Assets
When an asset is sold, the first step is to update depreciation for the partial year of
service. Depreciation is recorded from the beginning of the accounting period to the date
of the sale:
Depreciation Expense ………………………..XX
Accumulated Depreciation-Asset………………XX
The second step is to compute the remaining book value:
Book Value = Cost - Accumulated Depreciation
* If cash received is greater than the remaining book value, a gain is recorded:
Cash…………………………………………XX

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Accumulated Depreciation-Asset……………XX
Plant Asset………………………..………………..XX
Gain on Sale of Asset ……………………………...XX
* If cash received is less than the remaining book value, a loss is recorded:
Cash…………………………………………XX
Loss on Sale of Asset………………………..XX
Accumulated Depreciation-Asset……………XX
Plant Asset…………………………………………XX
Note that gains will increase income and losses will decrease income. Therefore, both
gains and losses are listed on the income statement.
Exchange of Plant Assets
When plant assets are exchanged or traded in, the balance for the old asset must be
removed from the books and the replacement asset must be recorded. When the old asset
is exchanged for similar new asset the trade-in allowance (i.e., the deduction from the
purchase price of the new asset) may be below or above the book value of the book value
of the old asset.
 When the trade-in allowance is above the book value of the old asset, the cost of
the new asset is equal to the book value of the old asset plus the amount paid
(called the boot) and no gain is recognized.
 When the trade-in allowance is below the book value of the old asset, the cost of
the new asset is equal to the price of the new asset and loss will be recognized.
Example
Old Equipment
Cost……………………………………………………...40,000
Accumulated Depreciation at date of exchange…………35,000
Book value…………………………………………… 5,000
Price of the new equipment………………………Br 60,000
1. Record the exchange transaction if the old equipment is exchanged for the new
equipment with the trade-in allowance of Br 6,000
Accumulated Depreciation-Equipment………………..35,000
Equipment……………………………………………..59,000
Equipment……………………………………………..40,000
Cash…………………………………………………...54,000
2. Record the exchange transaction if the old equipment is exchanged for the new
equipment with the trade-in allowance of Br 3,000
Accumulated Depreciation-Equipment………………..35,000
Equipment……………………………………………..60,000
Loss on Disposal of Plant Asset………………………..2,000
Equipment……………………………………………..40,000
Cash…………………………………………………...57,000
LEASING PLANT ASSETS
A business can rent a property for a specified period of time under a contract known as a
lease. The lessor is the owner of the property, and the lessee is the party that has the right
to use the property. The lease may be capital or operating. Leases which extent over most
of the asset life, and which transfer ownership to the lessee at the end of the lease are
called capital leases. Assets held under capital lease must be shown on the balance sheet,

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and therefore, the Plant Assets is debited and a lease liability account is credited.
Operating leases tend to be more short-term, and the lessee does not acquire the leased
property at the end of the lease.
SUBSIDIARY LEDGERS FOR PLANT ASSETS
When a business has a large number of plant assets to keep track of, the use of a
subsidiary ledger is recommended. Detailed information on each plant asset is maintained
in the subsidiary ledger. All plant assets can be specifically identified by an assigned
number. The first part of the number corresponds to the general ledger account, while the
second part of the number represents the identification assigned to the asset. Periodically,
it is advisable to compare balances of the subsidiary ledger with the controlling
accounts in the general ledger. Subsidiary ledgers are very useful in: -
 determining the periodic depreciation expense
 recording the disposal of individual items
 preparing tax returns
 Preparing insurance claims in the event of insured losses.
Internal control dictates that plant assets be safeguarded by:
1) Assigning responsibility for custody of the assets.
2) Separating custody of assets from accounting for the assets. (This item is a
cornerstone of internal control in almost every area.)
3) Setting up security measures; for instance, armed guards and restricted access to
plant assets to prevent theft.
4) Protecting assets from the elements (rain, snow, and so on).
5) Having adequate insurance against fire, storm, and other casualty losses.
6) Training operating personnel in the proper use of the asset.
7) Keeping a regular maintenance schedule.

DEPLETION OF NATURAL RESOURCES

The periodic allocation of the use of natural resources is a called depletion. Mineral
deposits, coal, timber, natural gas, and petroleum are all subject to depletion. Depletion
Expense is debited and Accumulated Depletion is credited for the amount of usage during
the period. The usage is based on current year production as a fraction of total capacity,
and the determination is essentially identical to the unit-of-production depreciation
method.

Example
ABC Co acquired certain mineral right for Br 600,000. The deposit is estimated at
2,400,000 tons of ore of uniform grade. During the year the Company mined 200,000
tons. Record the depletion.
The Depletion Rate= 600,000/ 2,400,000 = Br 0.25 a ton
Depletion expense for the period= 0.25 x 200,000= Br 50,000
Depletion Expense……………………………50,000

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Accumulated Depletion……. ………………………..50,000

INTANGIBLE ASSETS
Intangible assets are assets that do not have physical substance. They are not held for
sale, and they are usually highly valuable to the business. They include patents,
copyrights, trademarks, goodwill, and franchises. Except for goodwill, most intangible
assets receive legal protection of exclusive use. The cost of obtaining legal protection for
the intangible asset should be debited to the intangible asset account. The periodic loss of
value of the intangible asset is called amortization, and is expensed annually.
The acquisition cost of an intangible asset is recorded as:
Intangible Asset……………………….XX
Cash……………………………………XX
The cost of intangible assets is expensed through amortization over the asset’s useful
life. Amortization is usually computed on a straight-line basis, similar to straight-line
depreciation. Amortization is recorded as:
Amortization Expense ……………………XX
Intangible Asset…………………………..XX
Note that the book value of the intangible asset is reduced directly. There is no
Accumulated Amortization account. Additionally, the residual value of most intangible
assets is zero. Finally, the useful life of many amortizable assets is much shorter than the
legal life of such assets-for example, copyrights.
One important type of intangible asset is goodwill. Goodwill is recorded only when
another company is acquired. The amount of goodwill, if any, is equal to the difference
between the price paid for the acquired company and the market value of the acquired
company’s net assets (assets - liabilities):
Goodwill = Price Paid - Market Value of Net Assets
If the purchase price paid is less than the market value of the acquired company’s net
assets, there is no goodwill.

TEST YOURSELF
I) Matching Match each numbered term with its lettered definition.

_____ 1. accelerated depreciation _____ 10. depletion

_____ 2. copyright _____ 11. goodwill
_____ 3. double-declining-balance method _____ 12. leasehold improvements
_____ 4. franchises and licenses _____ 13. capital lease
_____ 5. relative-sales-value method _____ 14. intangible assets
_____ 6. straight-line depreciation _____ 15. revenue expenditure
_____ 7. capitalize _____ 16. patent
_____ 8. units-of-production _____ 17. trademarks
_____ 9. amortization

A) the exclusive right to reproduce and sell a book, musical composition, film, or other
work of art

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B) that portion of a natural resource’s cost that is used up in a particular period

C) an accelerated method of depreciation that computes annual depreciation by
multiplying the asset’s decreasing book value by a constant percentage, which is two
times the straight-line rate
D) privileges granted by a private business or a government to sell a product or service in
accordance with specified conditions
E) excess of the cost of an acquired company over the sum of the market value of its net
assets
F) assets with no physical form
G) costs incurred to maintain an asset in good condition
H) a grant from the government giving the holder the exclusive right to produce and sell
an invention
I) an allocation technique for identifying the cost of each asset purchased in a group for
a single amount
J) a depreciation method that writes off a relatively large amount of an asset’s cost
nearer the start of its useful life than does the straight-line method
K) an allocation of cost that applies to intangible assets
L) a lease which covers an extended period of time
M) depreciation method in which an equal amount of depreciation expense is assigned to
each year (or period) of asset use
N) distinctive identifications of a product or service
O) a depreciation method in which a fixed amount of depreciation is assigned to each
unit of output produced by the plant asset
P) to include a related cost as part of an assets cost

II. True/False For each of the following statements, circle T for true or F for false.

1 T F Accelerated depreciation results in higher book value when plant assets are newer.
2. T F The amount of depreciation expense over the life of an asset will be greater if a
company uses accelerated depreciation.
3. T F Capital leases are reported as assets.
4. T F Revenue expenditures are debited to assets accounts.
5. T F Depreciable cost equals cost less accumulated depreciation.
6. T F Using accelerated depreciation results in increasing amounts of depreciation
expense as the asset ages.
7. T F Double-declining-balance initially ignores residual value.
8. T F Straight line depreciation is calculated by dividing useful life into depreciable cost.
9. T F When calculating depreciation based on a revised life estimate, the formula is book
value divided by remaining life estimate.
10. T F Residual value, scrap value, and salvage value are synonymous terms.
III. Exercises

1. ABC Company buys Machines X, Y, and Z for Br 360,000. The market values of the
machines are Br 120,000, Br 144,000, and Br 216,000, respectively. What cost will
be allocated to each machine?

2. Shalom’s Machine Co. purchased a machine for Br 72,000 on January 2, 1998. Marie
expects the machine to produce 50,000 units over five years and then expects to sell
the machine for Br 22,000. Marie produced 14,000 units the first year, 18,000 units

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the second year and 10,000 units the third year. Compute the depreciation expense for
1998, 1999 and 2000. Round your answer to the nearest birr

1998 1999 2000

Straight-line
Units-of-production
Double-declining-balance
Sum-of-the-years’-digits

3. On January 2, 1997, Fast Company purchased used equipment for Br 25,000. Fast
expected the equipment to remain in service for 4 years. It depreciated the equipment
on a straight-line basis with Br 1,000 salvage value. The Company’s accounting
period ends on December 31. On April 30, 1999, Fast sold the equipment for Br
4,000. Record depreciation expense for the equipment for the four months ended
April 30, 19X9, and also record the sale of the equipment.

4. On October 2, 2001, Band Ltd purchased new equipment that carried an invoice price
of Br 19,400 plus a 5% sales tax. In addition, the purchaser was responsible for Br
500 of freight charges. The sale was subject to 3/15, n/45 discount/credit terms. Upon
receipt of the new equipment, Band Ltd paid Br 1850 to have the equipment installed
and connected. To finance this purchase, Band Ltd borrowed Br 22,000 from the bank
for 60 days at 12% interest. Band Ltd paid the invoice within 15 days, earning the 3%
discount.
Required: - Calculate the fully capitalized cost of the new equipment.
Problem #1
On January 1, 19X1, Bravo Inc. purchased three pieces of equipment. Details of the cost,
economic life, residual value, and method of depreciation are shown below:

Cost Useful Life Residual Depreciation Method

Equipment Value
A Br 24,000 6 yrs Br 3,000 straight-line
B 16,000 40,000 units 1,000 units-of-production
C 18,000 5 yrs 4,000 double-declining-balance
D 26,000 4 yrs 1,000 Sum-of-the-years’-digits

Units produced: - 1st year 10,000, 2nd year 8,000, 3rd year 9,000, 4th year 7,000 and 5th year
6,000
Required:
1) Prepare a schedule computing the depreciation expense for each piece of
equipment over its useful life.
2) Prepare the journal entry to record the discarding of Equipment A at the end of its
life.
3) Prepare the journal entry to record the sale of Equipment B for Br 1,000 at the end
of its life.
4) Prepare the journal entry to record the sale of Equipment C for Br 5,000 at the end
of 4th year.
5) Prepare the journal entry to record the exchange of Equipment D at the end of 3 rd
year. for new equipment with purchase price of Br 45,000 and trade-in allowance

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of Br 4,000
Problem #2
On March 20, 1995, Bewket Trading purchased a machine for Br 36,000. Its estimated
useful life was 10 years with no salvage value. Additional expenses were made for
transportation, Br 1,000; and installation costs, Br 1,800. On January 10, 1997, repairs
costing Br 16,000 were made, extending its useful life to 4 years beyond the original
estimate. On December 1, 1998, some worn-out parts were replaced for Br 600. The
company closes its books on December 31 and uses the straight-line method.
Required:
Present journal entries to record the following:
1) the purchase of the machine
2) payment of transportation and installation costs
3) depreciation for 1995
4) the repair on January 10, 1997
5) depreciation for 1997
6) the repair on December 1, 1998
7) depreciation for 1998
Problem # 3
On April 1, 2003, Saba Engineering acquired a patent for Br 60,000 and mineral rights
for Br 400,000. The patent, which expires in 10 years, is expected to have economic
value for 6 years. The mineral deposit, on the other hand, is estimated to have a potential
of 900,000 tons of ore of uniform grade. During the year 2003, 150,000 tons were mined.
The company’s accounting period ends on December 31.
Required: - Make journal entries on December 31, 2003 to record
a) Amortization of the patent
b) Depletion for the year

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