Operating Assets

Operating assets constitute the major productive assets of many companies. Current assets are important to a company’s short-term liquidity; operating assets are absolutely essential to its long-term future. These assets must be used to produce the goods or services the company sells to customers. The amount of money invested in operating assets may be very large, as is the case with most manufacturing companies. On the other hand, operating assets on the balance sheet may be insignificant to a company’s value, as is the case with a computer software firm. Users of financial statements must assess the operating assets to make important decisions. For example, lenders are interested in the value of the operating assets as collateral when making lending decisions. Investors must evaluate whether the operating assets indicate long-term potential and can provide a return to the stockholders.

The terms used to describe the operating assets and the balance sheet presentation of those assets vary somewhat by company. Some firms refer to this category of assets as fixed or plant assets. Other firms prefer to present operating assets in two categories: tangible assets and intangible assets.

The acquisition costs of the land, buildings, machinery and equipment, capitalized leases and leasehold improvements are stated and the amount of acumulated depreciation is deducted to determine the net amount.

Acquisition of Property, Plant and Equipment. Assets classified as property, plant and equipment are initially recorded at aquisiton cost (also referred to as historical cost). These assets are normally presentet on the balance sheet at original acquisition cost minus acumulated depreciation. Acquisition cost (also known as orginal cost) should include all of the costs that are normal and necessary to aquire the asset and prepare it for its intended use. Items included in acquisition would generally include the following: purchase price, taxes paid st time of purchase (for example, sales tax), transportation charges, installation costs.

An accountant must exercise careful judgement to determine which costs are “normal” and “necessary” and should be included in the calculation of the acquisition cost of operating assets. Acquisition cost should not include expenditures unrelated to the acquisition (for example, repair costs if an assets is damaged during installation) or costs incurred after the asset was installed and use begun.

Group purchase. Quite often a firm purchases several assets as a group and pays a lump-sum amount. This is most common when a company purcases land and building situated on it and pays a lump-sum amount for both. It is important to measure separately the acquisition cost of the land and of the building. Land is not a depreciable asset, but the amount allocated to the building is subject to depreciation. In the cases such as this, the purchase price should be allocated between land and building on the basis of the proportion of the fair market values of each.

For example, assume that on January 1, Bussa Company purchased a building and the land that it is situated on for $100,000. The accountant was able to establish that the fair market valuees of the two assets on January 1, were as follows:

Land $ 30,000

Building 90,000

Total $120,000

On the basis of the estimated market values, the purchase price should be allocated as follows:

To land: $100,000 x $30,000/$120,000 = $25,000

To building: $100,000 x $90,000/$120,000 = $75,000

The journal entry to record the purchase would be as follows:

Jan.1 Land 25,000

Building 75,000

Cash 100,000

To record the purchase of the land and building for a lump-sum amount:

Assets=Liabilities+Owner’s Equity

+25,000

+75,000

-100,000

Market value is best established by an independent appraisal of the property. If such appraisal is not possible, the accountant must rely on the market value of other similar assets, on the value of the assets in tax records, or on other available evidence.

Capitalization of Interest. The interest on borrowed money should be treated as an expense of the period. If a company buys an asset and borrows money to finance the purchase, the interest on the borrowed money is not considered part of the asset’s cost. Financial statements generally treat investing and financing as separate decisions. Purchase of an asset, an investing activity, is treated as a business decision that is separate from the decision concerning the financing of the asset. Therefore, interest is treated as a period cost and should appear on the income statement as interest expense in the period incurred.

If a company constructs