Reading: Lesson 2 - Nature of plant assets

To be classified as a plant asset, an asset must: (1) be tangible, that is, capable of being seen and touched; (2) have a useful service life of more than one year; and (3) be used in business operations rather than held for resale. Common plant assets are buildings, machines, tools, and office equipment. On the balance sheet, these assets appear under the heading "Property, plant, and equipment". Plant assets include all long-lived tangible assets used to generate the principal revenues of the business. Inventory is a tangible asset but not a plant asset because inventory is usually not long-lived and it is held for sale rather than for use. What represents a plant asset to one company may be inventory to another. For example, a business such as a retail appliance store may classify a delivery truck as a plant asset because the truck is used to deliver merchandise. A business such as a truck dealership would classify the same delivery truck as inventory because the truck is held for sale. Also, land held for speculation or not yet put into service is a long-term investment rather than a plant asset because the land is not being used by the business. However, standby equipment used only in peak or emergency periods is a plant asset because it is used in the operations of the business.

Accountants view plant assets as a collection of service potentials that are consumed over a long time. For example, over several years, a delivery truck may provide 100,000 miles of delivery services to an appliance business. A new building may provide 40 years of shelter, while a machine may perform a particular operation on 400,000 parts. In each instance, purchase of the plant asset actually represents the advance payment or prepayment for expected services. Plant asset costs are a form of prepaid expense. As with short-term prepayments, the accountant must allocate the cost of these services to the accounting periods benefited. 

Accounting for plant assets involves the following four steps:

• Record the acquisition cost of the asset.
  
• Record the allocation of the asset's original cost to periods of its useful life through depreciation.
  
• Record subsequent expenditures on the asset.
  
• Account for the disposal of the asset.
  

In Exhibit 4, note how the asset's life begins with its procurement and the recording of its acquisition cost, which is usually in the form of a dollar purchase. Then, as the asset provides services through time, accountants record the asset's depreciation and any subsequent expenditures related to the asset. Finally, accountants record the disposal of the asset. We discuss the first three steps in this chapter and the disposal of an asset in Chapter 11. The last section in this chapter explains how accountants use subsidiary ledgers to control assets.

Remember that in recording the life history of an asset, accountants match expenses related to the asset with the revenues generated by it. Because measuring the periodic expense of plant assets affects net income, accounting for property, plant, and equipment is important to financial statement users.