Difficulty: Introductory to Intermediate | Prerequisites: Basic financial accounting (debits, credits, journal entries, the accounting equation).
Unit 8 is where accounting moves from recording transactions to tracking the long-term assets a business actually operates with: trucks, buildings, equipment, land. You need to understand how companies measure what these assets cost up front, how they spread that cost across the years the asset is in use (depreciation), and what happens when the asset is sold or scrapped. The unit also introduces how businesses account for borrowing money, both short-term notes and long-term instalment loans. If you are comfortable with debits, credits, and journal entries from earlier units, you have what you need.
Plant assets (property, equipment, buildings) are recorded at their full acquisition cost and then depreciated over their useful lives using one of three methods: straight-line, units-of-production, or double-declining-balance. Maintenance costs are expensed immediately; improvements are capitalised and change future depreciation. When an asset is sold, you compare the cash received to the asset's book value to record a gain or loss. The unit also covers short-term loans (interest calculated on a prorated annual rate) and long-term instalment loans where each fixed payment splits between interest and principal.
Plant assets (property, plant, and equipment / fixed assets / PP&E)
Resources with physical substance, used in business operations, and not intended for sale to customers. They provide service over multiple years.
In simple terms: the big, tangible things a company owns and uses to run the business, like trucks, machinery, and buildings.
Capitalise
To record an expenditure as an asset on the balance sheet rather than as an expense on the income statement.
Think of it as: instead of writing off the cost straight away, you park it on the balance sheet and spread it out over time.
Depreciation
The process of allocating the capitalised cost of a plant asset across the accounting periods that benefit from its use.
In simple terms: spreading the cost of an asset over the years you use it, so each year's income statement bears a fair share.
Salvage value (residual value)
The estimated value of a plant asset at the end of its useful life.
Think of it as: what you expect to get for the asset when you are done with it.
Depreciable base
The asset's cost minus its salvage value. This is the total amount that will be depreciated over the asset's life.
Accumulated depreciation
A contra-asset account (XA) that holds the total depreciation recorded against an asset since it was acquired. It is credited each period; the asset account itself is not touched.
Net book value (carrying value)
Asset cost minus accumulated depreciation. This is the value reported on the balance sheet.
Contra-asset account (XA)
An account that offsets an asset account. Accumulated depreciation is the most common example: it carries a credit balance that reduces the reported value of the related asset.
Maintenance expenditures
Costs of keeping an asset in its current operating condition, such as fuel, tyres, or routine servicing. Expensed in the current period.
Improvement expenditures (capital expenditures)
Costs that extend an asset's useful life or add functionality. Capitalised (added to the asset's value) and depreciated over the remaining life.
Mortgage
A legal agreement where a lender provides money at interest in exchange for taking title to the borrower's property; the title transfers back once the debt is repaid.
Think of it as: a loan backed by a specific piece of property that the bank can claim if you stop paying.
Expenses are recorded in three ways: product costs (matched to revenue when the product is sold), period costs (expensed in the period incurred), and allocated costs spread over multiple periods (depreciation of long-lived assets).
Plant assets share three characteristics: they have physical substance, they are used in business operations, and they are not intended for resale. Except for land, every plant asset loses service potential over time and must be depreciated.
The cost of any plant asset includes all expenditures necessary to acquire the asset and make it ready for its intended use.
Cash purchase price
Closing costs (title fees, solicitor's fees)
Real estate broker's commissions
Accrued property taxes and other liens assumed by the purchaser
Costs to make the land ready for use (demolition of old structures, removal costs, net of any salvage proceeds)
Land itself is never depreciated. Land improvements (fencing, paving, lighting) are depreciated over their useful lives.
Cash purchase price
Sales tax
Freight and delivery charges
Expenditures for assembling, installing, and testing the unit
The cost depends on how the building is obtained.
Purchased: purchase price, closing costs, broker's commission
Made ready for intended use: remodelling, replacing, and repair expenditures
Constructed: contract price plus architect fees, building permits, and excavation costs
Once construction is complete, subsequent interest payments on funds borrowed for construction are debited to Interest Expense (they are no longer capitalised).
Depreciation allocates the depreciable base (cost minus salvage value) across the periods that benefit from the asset. Three methods appear in this course.
Spreads the depreciable base evenly over the asset's useful life.
\text{Annual Depreciation} = \frac{\text{Cost} - \text{Salvage Value}}{\text{Useful Life}}Worked example: A truck costs $30,000, has a 5-year useful life, and a $4,000 salvage value.
Depreciable base: 30,000 - 4,000 = $26,000
Annual depreciation: 26,000 / 5 = $5,200
Journal entry each year: debit Depreciation Expense $5,200, credit Accumulated Depreciation $5,200. The Truck account stays at $30,000; accumulated depreciation builds in the contra account.
After year 1 the balance sheet shows Truck $30,000 less Accumulated Depreciation $5,200, giving a net book value of $24,800.
Spreads the depreciable base over expected total output or operating hours rather than calendar time.
\text{Depreciation for Period} = \frac{\text{Cost} - \text{Salvage Value}}{\text{Total Estimated Units}} \times \text{Units Produced in Period}Worked example: Same $30,000 truck, $4,000 salvage, expected to drive 150,000 miles total.
Year 1 (40,000 miles): (26,000) x (40,000 / 150,000) = $6,933
Year 2 (35,000 miles): (26,000) x (35,000 / 150,000) = $6,067
Subsequent years follow the same pattern.
Front-loads depreciation: higher expense in early years, lower in later years. The rate is double the straight-line rate, applied to the declining book value (not the depreciable base).
\text{DDB Rate} = \frac{2}{\text{Useful Life}}\text{Depreciation for Year} = \text{Beginning Book Value} \times \text{DDB Rate}Salvage value is not subtracted from the cost upfront. Instead, you stop depreciating once the book value reaches the salvage value.
Worked example: Truck $30,000, 5-year life, $4,000 salvage. DDB rate = 2/5.
Year 1: 30,000 x 2/5 = $12,000
Year 2: (30,000 - 12,000) x 2/5 = $7,200
Year 3: (30,000 - 12,000 - 7,200) x 2/5 = $4,320
Remaining book value after year 3: 30,000 - 12,000 - 7,200 - 4,320 = $6,480
Continuing at the DDB rate would push below the $4,000 salvage value, so you switch: (6,480 - 4,000) = 2,480, spread evenly over the two remaining years.
Year 4: $1,240
Year 5: $1,240
The switchover rule: once applying the DDB rate would take book value below salvage, stop. Go back to the last year that was still above salvage, subtract the salvage value from the remaining book value, and divide evenly among the leftover years.
Maintenance (revenue expenditure): costs to keep the asset running in its current condition (fuel, tyres, routine repairs). These are expensed immediately.
Journal entry: debit Expense, credit Cash.
Improvement (capital expenditure): costs that extend the asset's useful life or enhance its functionality (e.g. adding a GPS system to a truck). These are capitalised, added to the asset's carrying value, and depreciated over the remaining useful life.
Journal entry: debit the asset account, credit Cash.
The test: if the expenditure extends the life or adds functionality, capitalise it. If it merely maintains existing performance, expense it.
Worked example of revised depreciation after an improvement:
A truck was purchased for $30,000 with a 5-year life, $4,000 salvage, and $5,200 annual straight-line depreciation. In year 2 a $1,000 GPS is added (improvement).
New truck value on the books: $31,000
Net book value at start of year 2: 30,000 - 5,200 = $24,800
Add the improvement: 24,800 + 1,000 = $25,800
Revised year 2 depreciation: (25,800 - 4,000) / 4 remaining years = $5,450
When a plant asset is sold, retired, or scrapped, the company removes both the asset's cost and its accumulated depreciation from the books. The difference between the cash received and the asset's net book value at the date of disposal produces a gain or a loss.
Worked example:
The truck (cost $31,000 after improvement) is sold at the end of year 2 for $15,000. Accumulated depreciation at that point is $10,650 (year 1: $5,200 + year 2: $5,450).
Net book value: 31,000 - 10,650 = $20,350
Cash received: $15,000
Loss on disposal: 20,350 - 15,000 = $5,350
Journal entry for the sale:
Debit Cash $15,000
Debit Accumulated Depreciation $10,650
Debit Loss on Disposal $5,350
Credit Truck $31,000
If the cash received had been greater than the net book value, the entry would record a gain (credit) rather than a loss (debit).
Borrowing money from a bank and repaying it within one year, with interest. Interest rates are always quoted on an annual basis, so you prorate for the actual loan period.
Worked example: A company borrows $10,000 for 6 months at 6% annual interest.
Interest = 10,000 x 6% x 6/12 = $300. Total repayment: $10,300.
Equal payments made at equal intervals over a period longer than one year. Each payment consists of an interest portion and a principal portion.
Early payments are mostly interest (because the outstanding balance is high). Later payments are mostly principal (because the balance has fallen).
Worked example: A company borrows $100,000 for 5 years at 6%, with annual payments of $23,740.
Year 1: Interest = 100,000 x 6% = $6,000. Principal reduction = 23,740 - 6,000 = $17,740.
Year 2: Interest = (100,000 - 17,740) x 6% = $4,936. Principal reduction = 23,740 - 4,936 = $18,804.
The pattern continues, with interest falling and principal rising each year.
A mortgage is a long-term loan secured by property. The lender takes title to the property as collateral; the title reverts to the borrower when the debt is repaid.
Long-term loans may carry a fixed interest rate (constant over the loan's life) or an adjustable rate (reset periodically to reflect market conditions).
Each mortgage payment consists of interest on the unpaid balance plus a reduction of principal. While total payments stay constant, the interest portion decreases each period and the principal portion increases.
Amortisation schedule columns:
Column | Description | Calculation |
|---|---|---|
A: Cash Payment | Fixed periodic payment | Given |
B: Interest Expense | Interest on opening balance | Principal Balance x Rate x Portion of Year |
C: Reduction of Principal | Amount applied to the loan balance | A - B |
D: Principal Balance | Outstanding loan balance after payment | Previous D - C |
\text{Straight-Line Depreciation} = \frac{\text{Cost} - \text{Salvage Value}}{\text{Useful Life}}\text{Units-of-Production Depreciation} = \frac{\text{Cost} - \text{Salvage Value}}{\text{Total Estimated Units}} \times \text{Units in Period}\text{DDB Rate} = \frac{2}{\text{Useful Life}}\text{DDB Depreciation} = \text{Beginning Book Value} \times \text{DDB Rate}\text{Net Book Value} = \text{Cost} - \text{Accumulated Depreciation}\text{Revised Depreciation (after improvement)} = \frac{\text{Net Book Value} + \text{Improvement} - \text{Salvage Value}}{\text{Remaining Useful Life}}\text{Gain or Loss on Disposal} = \text{Cash Received} - \text{Net Book Value at Disposal}\text{Short-Term Interest} = \text{Principal} \times \text{Annual Rate} \times \frac{\text{Loan Period}}{12}\text{Instalment Interest (per period)} = \text{Outstanding Balance} \times \text{Annual Rate}\text{Principal Reduction} = \text{Payment} - \text{Interest}Students often think land is depreciated like other plant assets. It is not. Land has an unlimited useful life and is never depreciated. Land improvements (parking lots, fences) are a separate account and are depreciated.
Students sometimes credit the asset account directly when recording depreciation. You do not. The credit goes to Accumulated Depreciation, a contra-asset account. The asset account keeps its original cost until the asset is disposed of.
In double-declining-balance, students frequently subtract salvage value before applying the DDB rate. Salvage value is not subtracted from cost upfront in DDB. You apply the rate to the full beginning book value and only worry about salvage when the calculation would push the book value below it.
Students often confuse maintenance and improvement. The distinction is whether the expenditure extends the asset's life or functionality (capitalise it) or merely keeps it running at its current level (expense it).
⚠️ Be ready to calculate depreciation under all three methods for the same asset. Exams frequently give one scenario and ask for straight-line, units-of-production, and DDB.
⚠️ Know the journal entries: Depreciation Expense (debit) and Accumulated Depreciation (credit). Never credit the asset account.
⚠️ The DDB switchover rule is a favourite exam question. Practice identifying the year where the method would push below salvage, and splitting the remainder evenly.
⚠️ Gains and losses on disposal require you to update depreciation to the date of sale before computing book value. Do not forget this step.
⚠️ Instalment loan amortisation tables: you may be asked to compute the interest and principal split for a given year, or to identify how the split changes over time.
True or False: Land is depreciated over its useful life. (False. Land is never depreciated.)
Fill in the blank: The depreciable base equals ________ minus ________. (Cost minus Salvage Value)
True or False: Under DDB, you subtract salvage value from the asset's cost before applying the depreciation rate. (False. You apply the rate to beginning book value and stop when you reach salvage.)
Fill in the blank: An expenditure that extends an asset's life is called a(n) ________, while routine upkeep is called ________. (Improvement; Maintenance)
True or False: In a long-term instalment loan, the interest portion of each payment increases over time. (False. Interest decreases because the outstanding balance falls.)
Q: A company purchases equipment for $50,000. The equipment has a useful life of 8 years and a salvage value of $2,000. What is the annual straight-line depreciation expense?
A: (50,000 - 2,000) / 8 = $6,000 per year.
Q: A machine costs $40,000, has a salvage value of $5,000, and is expected to produce 100,000 units over its life. In year 1 it produces 22,000 units. What is the depreciation expense for year 1?
A: (40,000 - 5,000) x (22,000 / 100,000) = $7,700.
Q: Using DDB, a $60,000 asset has a 4-year useful life and $8,000 salvage value. What is year 1 depreciation?
A: DDB rate = 2/4 = 50%. Year 1: 60,000 x 50% = $30,000.
Q: A truck with a cost of $25,000 and accumulated depreciation of $18,000 is sold for $5,000. Is there a gain or a loss, and how much?
A: Net book value = 25,000 - 18,000 = $7,000. Cash received = $5,000. Loss = 7,000 - 5,000 = $2,000.
Q: A company borrows $20,000 for 9 months at an annual interest rate of 8%. How much interest will it owe?
A: 20,000 x 8% x 9/12 = $1,200.
Q: In year 1 of a $200,000 instalment loan at 5% with annual payments of $46,100, how much of the first payment is interest and how much is principal?
A: Interest = 200,000 x 5% = $10,000. Principal = 46,100 - 10,000 = $36,100.
Depreciation connects directly to the statement of cash flows (Unit 12). Because depreciation is a non-cash expense, it is added back to net income when computing cash from operations under the indirect method.
The concept of capitalising vs expensing reappears in budgeting (Unit 10), where capital expenditure budgets cover long-lived asset purchases separately from operating budgets.
Gains and losses on disposal affect the income statement and therefore feed into variance analysis (Unit 13) when comparing actual results to budget.
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