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Accounting Fundamentals II: Lesson 4 Page 1 of 7

Accounting Fundamentals II: Lesson 4 (printer-friendly version)


Your Instructor: Charlene Messier

INSTRUCTIONS:

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Chapter 1

Introduction

In this lesson, you'll learn about purchasing and recording plant assets. You'll also learn how to
calculate depreciation on plant assets and how to prepare plant asset records. After the depreciation
expense has been determined, you'll learn how to record a transaction for this expense in the General
Journal. And we'll also look into the disposition of plant assets.

Depreciation is a very important expense to keep accurate records of as businesses usually have
extensive, expensive equipment, both in the office area and in the customer area. If you look around
when you enter a business, you can see many examples of store equipment: display cases, racks and
shelving, and sometimes equipment used to serve merchandise they sell such as monogram
equipment or equipment to adjust jewelry. All of this equipment depreciates as time passes and the
equipment is used.

Each piece of equipment has its own record called a Plant Asset Record, where you'll calculate the
depreciation for that equipment. At the end of the fiscal period, the amount of depreciation
accumulated during that period is entered into an expense account so the net income of the business
for that period is an accurate figure. This also assists the business owner in determining how often the
equipment must be replaced, as the Plant Asset Record shows not only the depreciation allocated to
that piece of equipment but also the life expectancy and salvage value of it.

All of these factors are important in calculating a feasible, cost effective replacement plan for all the
equipment owned by the business. Just like you replacing your car every few years, a business must
determine and plan for replacing its plant assets.

You'll just need to print one form for this lesson—the Plant Asset Record. To do that, just click Lesson
4 Form in the Supplementary Material.

Chapter 2

Review Transactions

Let's do a few review transactions to keep your newly acquired skills sharp. These transactions were
all covered in previous lessons, so you should know in which journal to journalize them and which ones
need to be posted to the General, Accounts Payable, or Accounts Receivable Ledgers. As usual, the
solutions are located in the Supplementary Material section if you need to refer to them.

Transaction #37: December 10, Purchased supplies on account from Certain Winners,
Inc., $550.00, Purchase Invoice #7. (This would be a Debit to Supplies and a Credit to
Accounts Payable/Certain Winners in the General Journal.)

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Transaction #38: December 11, Purchased merchandise for cash, $1,500.00, Check
#12. (Purchases Debit in the General Debit column and Cash Credit in the Cash
Payments Journal.)

Transaction #39: December 11, Sold merchandise on account to William Johnson,


$400.00 plus 5% sales tax, $20.00, total $420.00, Sales Invoice #6. (This is entered in
the Sales Journal as a Debit to Accounts Receivable and Credits to Sales and Sales Tax
Payable.)

Transaction #40: December 12, Received cash on account from Barbara Sanders,
$157.50, Receipt #5.

Transaction #41: December 12, Paid cash for Advertising Expense, $250.00, Check
#13.

Transaction #42: December 12, Received cash from sales, $2,500.00 plus sales tax,
$125.00, total $2,625.00, Tape #12.

Transaction #43: December 12, Paid cash on account to Everything Sports, $500.00,
Check #14.

After you have journalized these transactions into their correct journals, go ahead and post the
amounts that should be posted immediately to the General Ledger. Don't forget to post to the Accounts
Payable and Accounts Receivable Ledgers, too.

Chapter 3

Purchasing and Recording Plant Assets

Businesses usually use two categories of assets in their operations: current


assets and plant assets. Current assets are assets that the company plans to
use up, sell or exchange in one year or less. Some examples of current assets
might be cash, accounts receivable, merchandise inventory, supplies, and
prepaid insurance.

Plant assets are items that will be used for a


number of years by Teammates, Inc. in the
day-to-day operation of its business.
Examples of plant assets might be
computers, cash registers, display cases,
and furniture. Plant assets are used in the operation of the
business and are not intended to be resold to a business's
customers.

The merchandise that Teammates, Inc. has on hand to resell to its


customers is considered a current asset as the company plans to
sell it. The equipment and supplies that Teammates, Inc. purchases to operate its business are
considered plant assets. The difference between plant assets and current assets is how the business
intends to use the asset.

Businesses have three major types of plant assets: equipment, buildings, and land. Teammates, Inc.
owns equipment such as computers, display cases, cash registers, and monogram machinery.
Because Teammates, Inc. rents the building from which it operates; there are no building or land
assets. The only plant asset the business has is equipment.

Journalizing the purchase of a plant asset is similar to journalizing the purchase of current assets, such
as supplies. The plant asset account is debited for the amount of the purchase, and Cash or Accounts

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Payable is credited (depending on whether it is a cash or charge purchase). The account in the
General Ledger might have a title like Office Equipment, Display Furniture, etc., depending on the
asset being purchased. Therefore, a purchase of office equipment for cash would be journalized in the
Cash Payments Journal with a debit to Office Equipment in the General Debit column and a credit in
the Cash Credit column. A charge purchase would be journalized in the General Journal with a debit
(to Office Equipment) in the General Debit column and a credit (in the General Credit column) to
Accounts Payable/vendor's name.

Depreciation of plant assets occurs over several years. This is referred to as the life expectancy of the
asset. All plant assets decrease in value as they become older, with the exception of land. Therefore,
all plant assets will be depreciated over the number of years they are expected to be in use. Some
plant assets may be scraped completely after their life expectancy; others may be sold and replaced
with newer equipment.

In keeping with the matching expenses with revenue concept, a calculated amount of depreciation will
be deducted from the value of each plant asset for each fiscal period. This amount will be debited to an
account titled Depreciation Expense-Office Equipment or Depreciation Expense-Store Equipment and
credited to an account titled Accumulated Depreciation-Office Equipment or Accumulated
Depreciation-Store Equipment, depending on the type of plant asset. The amount of the adjustment
(which will be entered into the expense account) depends on three things: 1) the initial cost of the
asset, 2) the life expectancy of the asset, and 3) the estimated salvage value of the asset. Salvage
value is the amount that the company can expect to receive from the sale of the plant asset after its life
expectancy.

Two factors affect the useful life of a plant asset: 1) physical depreciation caused by wear from use and
normal aging and weathering, and 2) functional depreciation, when a plant asset is inadequate or
obsolete.

Chapter 4

Calculating Depreciation Expense, Preparing Plant Asset Records

To calculate the depreciation for plant assets, you must


determine three things: the original cost of the asset, the
estimated salvage value of the asset, and the estimated
useful life of the asset.

First, subtract the salvage value from the original cost. This
gives you the total depreciation the plant asset will incur.
Next, divide the total depreciation by the number of years
the asset is estimated to last. This gives you the yearly
amount of depreciation expense. For example, a computer
costing $1,500.00 with a salvage value of $500.00 and a
life expectancy of five years would be depreciated $200.00
per year. The cost, $1,500.00 minus the salvage value of
$500.00, leaves $1,000.00 to be depreciated over five
years. The $1,000.00 divided by five equals $200.00. This
is the amount of yearly depreciation for the computer's five-
year lifespan.

Depreciating a plant asset for an equal amount over a


number of years is called the straight-line method of
depreciation.

If a plant asset is purchased during the year, you must calculate the depreciation expense for only the
part of the year it was in use, not for the total 12 months. For example, if the computer above were
purchased in late June, you would only be allowed to take half of the yearly depreciation, or $100.00,
because the equipment was owned for only six months of the current year. To calculate monthly
depreciation, simply divide the yearly depreciation by 12. Then multiply that figure by the number of

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months the plant asset was owned.

A Plant Asset Record is an accounting form that shows information pertaining to each plant asset. Let's
open up some Plant Asset Records for equipment purchased this year by Teammates, Inc. First, take
a look at the Plant Asset Record that you printed from the Supplementary Material for this lesson.
There are two forms on each page. The first form will be for display cases the company purchased for
$5,000.00.

You will be using the straight-line depreciation method. The salvage value of the cases is $500.00 and
their estimated useful life is five years. Fill in the top portion of the Plant Asset Record with this
information.

Next, you need to calculate the yearly depreciation for the display cases. The original cost is $5,000.00
and the salvage value is $500.00; therefore, the cases will depreciate $4,500.00 over the five-year
period, or $900.00 a year. I arrived at this figure by subtracting the salvage value from the original cost
and then dividing that amount by the number of years the cases are expected to last.

Enter the year in the first column of the Plant Asset Record. In the Beginning Book Value column, enter
$5,000.00. This figure represents the purchase price of the item. Under the Annual Depreciation
column, enter $900.00, and in the Ending Book Value column, enter $4,100.00. The ending book value
is simply the beginning book value minus the annual depreciation. So you can now see that these
display cases will depreciate at the rate of $900.00 per year for the next five years.

Now you need to prepare a Plant Asset Record for a new computer Teammates, Inc. purchased this
year. The original cost was $1,500.00, the estimated salvage value is $300.00, and the estimated
useful life is four years. You will still be using the straight-line method of depreciation. To find the
annual depreciation, subtract the salvage value from the original cost, and then divide that amount by
four. This will give you the annual depreciation on the computer. Go ahead and enter this year's figures
as you did for the display cases above.

You now need to journalize this year's depreciation expense for the display cases and the computer.
You will be using the General Journal page 13 labeled Adjusting Entries for these transactions.

Transaction #44: December 12, Recorded annual depreciation for office equipment,
$300.00, Memorandum #5.

On the next available line in the General Journal, page 13, enter Depreciation Expense-Office
Equipment in the Account Title column. Use M5 as the Doc. No. and put $300.00 in the Debit column.
On the next line, put Accumulated Depreciation-Office Equipment and enter $300.00 in the Credit
column. That's all there is to it. Using the next two lines in the General Journal, journalize the yearly
depreciation expense for the display cases, which would be Store Equipment rather than Office
Equipment.

Transaction #45: December 12, Recorded annual depreciation for Store Equipment,
$900.00, Memorandum #6.

You will again be using the Adjusting Entries General Journal page 13 for this transaction.

When you are finished, post these two transactions to the General Ledger.

Disposing of Plant Assets

In this exercise, you are going to learn how to journalize the disposition of a plant asset. The asset may
be sold for its book or salvage value, above that amount, or below that amount.

If the plant asset is sold for its salvage value, the transaction is entered in the Cash Receipts Journal.

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Here's how: Debit the account Accumulated Depreciation-Office Equipment for the amount of the total
depreciation realized to date, credit the account Office Equipment for the original price of the
equipment, and debit Cash for the amount received from the sale of the item. This zeros out the asset
account, Office Equipment, and the Accumulated Depreciation account for that piece of equipment and
records the sale price into the Cash account. Let's do one for the sale of some of Teammates, Inc.
Office Equipment.

Transaction #46: December 12, Received cash from the sale of office equipment for its
salvage value, $100.00, Receipt #6. The original price of this piece of office equipment
was $500.00 and the total accumulated depreciation for the last four years is $400.00.

To journalize this transaction, enter the date on the next available line of the Cash Receipts Journal.
Use R6 as the Doc. No. Enter Accumulated Depreciation-Office Equipment in the Account Title column
and put $400.00 in the General Debit column. Next, enter $100.00 in the Cash Debit column on the
same line. On the next line, put Office Equipment in the Account Title column and enter $500.00 in the
General Credit column. This will zero out the original amount of $500.00 in the Office Equipment
account where the original amount of the purchase was entered at the time of the purchase. It will also
zero out the $400.00 that has been posted to date to Accumulated Depreciation-Office Equipment.

Let's journalize one more transaction from the sale of a plant asset, only this time, Teammates, Inc.
received less than the salvage amount from its sale.

Transaction #47: December 12, Received cash from the sale of store equipment,
$50.00, Receipt #7. The original price of this piece of store equipment was $300.00, and
the total depreciation over the last six years was $240.00. The estimated salvage value
was $60.00.

To journalize this transaction, enter the date on the next available line in the Cash Receipts Journal.
Use R7 as the Doc. No. In the Account Title column, enter Accumulated Depreciation-Store Equipment
and put $240.00 in the General Debit column. On that same line, enter $50.00 in the Cash Debit
column. On the next line, enter Store Equipment and put $300.00 in the General Credit column. Then,
on the next line, enter Loss on Plant Asset and put $10.00 in the General Debit column. This will again
zero out the original price of $300.00 for the equipment and the $240.00 that has been posted to date
to Accumulated Depreciation-Store Equipment as well as record a loss on the sale of the equipment in
the amount of $10.00.

When you have finished journalizing these two transactions, post the amounts in the General Debit and
General Credit columns to the General Ledger.

Chapter 5

Conclusion

This has been a very extensive lesson with many new concepts. We have covered plant and current
assets, maintaining plant asset records, calculating and recording depreciation, and disposing of plant
assets.

Both plant and current assets exist in almost all businesses. The Plant Asset Record is important to the
business for calculating the amount of depreciation for a period of time, and also in planning for
replacement costs. Calculating the proper amount of depreciation of plant assets is important to the
success of the business, as is replacing plant assets in a timely, cost-effective manner. No business
wants to have to replace all of its equipment in one year. Rather, it is more cost effective to replace
some equipment every year. By determining the life expectancy of each piece of equipment, the
business is better able to determine what equipment should be replaced each year and devise a plan
for its equipment replacement needs.

All of this information is extremely vital to any business for accurate, complete accounting records.
Proper equipment acquisition, depreciation, and disposal is of the utmost importance and could mean

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the difference between the success or failure of the business.

As usual, when you feel ready, please take the quiz for this lesson. Good luck!

Supplementary Material

Lesson 4 Form
/crs/pix/af2/L04-Form.pdf
Here's the Plant Asset Record form that you'll need to print out and
complete for this lesson.

Lesson 4 Solutions
/crs/pix/af2/L04-Solutions.pdf
All finished? Click here to check your work against this lesson's
solution forms. You can either print them or check the amounts
online. Unfortunately, some of the wider forms can only appear
sideways, so printing may be your better option. If you don't mind
tilting your head, you'll be able to see what you need to see on the
screen while saving some printer ink and paper! Note: Only those
forms and accounts with new entries in them will appear in each
lesson's solutions. If you're curious about a transaction in a
previous lesson, you'll have to go back to that lesson's Solution
link.

Depreciation and Amortization on the Income Statement


http://beginnersinvest.about.com/library/lessons/bl-
depreciationexpense.htm
Here is a good explanation and example of calculating depreciation
expense.

Depreciation
http://www.businesstown.com/accounting/basic-depreciation.asp
This site defines depreciation and explains it in layperson's terms.

FAQs

Q: Why is the source document for journalizing depreciation expense a memorandum


rather than a check, when other expenses are paid by check?

A: The source document for journalizing depreciation expense is not a check because
the business did not actually write a check for the amount. The expense is determined by
the purchase price and life expectancy of the equipment. Then an internal form (a
memorandum) is prepared to be used as the document for journalizing the transaction.

Q: Do I need to prepare a Plant Asset Record for store or office supplies?

A: No. Only plant assets, such as equipment that will depreciate in value and have a life
expectancy greater than one year, will require a Plant Asset Record. Store and office
supplies do not depreciate in value; they are simply used up.

Q: What happens if a piece of equipment lasts longer than its life expectancy?

A: If a piece of equipment lasts longer than its expected useful life, all is well and good.
However, the business will not be able to depreciate it during that period of time. Some
businesses will sell the equipment at the end of its life expectancy and replace it with new
equipment even if it still has some useful life, rather than wait until it is completely

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useless.

Q: What is the advantage of depreciating plant assets over a period of time rather than
taking the entire purchase price during the year of purchase?

A: By depreciating plant assets over a number of years, the business has a more stable
expense record, and the net income of the business should be more stable from one year
to the next. If all of the plant assets were deducted by their original purchase prices
during the year that they were purchased, that might be an extremely large amount and
make the business show a net loss rather than a net income.

Q: Why is it important to keep track of both accumulated depreciation and depreciation


expense for the same plant asset?

A: Depreciation expense is the amount of depreciation applied to the plant asset during
the fiscal period. Accumulated depreciation is the total amount of depreciation on the
plant asset since its purchase, and will be for more than one fiscal period.

Course content © 1997-2007 by Charlene Messier. All rights reserved. Reproduction or redistribution
of any course material without prior written permission is prohibited.

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