Accounting for Long-Term Operational

Assets

Chapter Eight

McGraw-Hill/IrwinMcGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.

Tangible versus Intangible Assets

Tangible assets have a physical presence; they can be seen and touched.

Intangible assets are rights or privileges. They cannot be seen or touched.

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Tangible Long-Term Assets

1.1. Property, Plant, and EquipmentProperty, Plant, and Equipment – Sometimes called plant assets or fixed assets. We depreciate these assets over their useful life.

2.2. Natural ResourcesNatural Resources – Mineral deposits, oil and gas reserves, timber stands, coal mines, and stone quarries are some examples of natural resources. We deplete these assets over their useful life.

3.3. LandLand – Has an infinite life and is not subject to depreciation.

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Intangible Assets

1.1. Intangible Assets with Intangible Assets with IdentifiableIdentifiable Useful Useful LivesLives – patents and copyrights.

• Amortize the cost of each over its useful life.

2.2. Intangible Assets with Intangible Assets with IndefiniteIndefinite Useful Lives Useful Lives - renewable franchises, trademarks, and goodwill.

• The cost of these assets is not expensed unless it can be shown that there has been an impairment in value.

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Cost of Long-Term Assets

Buildings Buildings •Purchase pricePurchase price•Sales taxesSales taxes•Title search and transfer document Title search and transfer document costscosts•Realtor’s and attorney’s feesRealtor’s and attorney’s fees•Remodeling costsRemodeling costs

Buildings Buildings •Purchase pricePurchase price•Sales taxesSales taxes•Title search and transfer document Title search and transfer document costscosts•Realtor’s and attorney’s feesRealtor’s and attorney’s fees•Remodeling costsRemodeling costs

Equipment Equipment •Purchase price (less discounts)Purchase price (less discounts)•Sales taxesSales taxes•Delivery costsDelivery costs•Installation costsInstallation costs•Costs to adapt to intended useCosts to adapt to intended use

Equipment Equipment •Purchase price (less discounts)Purchase price (less discounts)•Sales taxesSales taxes•Delivery costsDelivery costs•Installation costsInstallation costs•Costs to adapt to intended useCosts to adapt to intended use

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Cost of Long-Term Assets

Land Land •Purchase pricePurchase price•Sales taxesSales taxes•Title search and transfer document Title search and transfer document costscosts•Realtor’s and attorney’s feesRealtor’s and attorney’s fees•Costs of removal of old buildingsCosts of removal of old buildings•Grading costsGrading costs

Land Land •Purchase pricePurchase price•Sales taxesSales taxes•Title search and transfer document Title search and transfer document costscosts•Realtor’s and attorney’s feesRealtor’s and attorney’s fees•Costs of removal of old buildingsCosts of removal of old buildings•Grading costsGrading costs

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Basket Purchase Allocation

Beatty Co. purchased land and a building for $240,000 cash. An appraiser estimated that the land has a fair market value of $90,000, and the building has a fair market value of $270,000. How will we assign the $240,000 cost between the land and building? Amount %

Fair market value of building 270,000$ 75%

Fair market value of land 90,000 25%

Total fair market value 360,000$ 100%

Cost % AllocationAssign to building 240,000$ 75% 180,000$ Assign to land 240,000 25% 60,000

100% 240,000$

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Life Cycle of Operational Assets

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Depreciation Methods

1. Straight-line method - the same - the same amount is depreciated each accounting amount is depreciated each accounting period.period.

2. Double-declining-balance – produces – produces more depreciation expense in the early more depreciation expense in the early years of an asset’s life, with a declining years of an asset’s life, with a declining amount of expense in later years.amount of expense in later years.

3. Units-of-production – produces – produces varying amounts of depreciation in varying amounts of depreciation in different accounting periods depending different accounting periods depending upon the number of units produced.upon the number of units produced.

1. Straight-line method - the same - the same amount is depreciated each accounting amount is depreciated each accounting period.period.

2. Double-declining-balance – produces – produces more depreciation expense in the early more depreciation expense in the early years of an asset’s life, with a declining years of an asset’s life, with a declining amount of expense in later years.amount of expense in later years.

3. Units-of-production – produces – produces varying amounts of depreciation in varying amounts of depreciation in different accounting periods depending different accounting periods depending upon the number of units produced.upon the number of units produced.

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Straight-Line Depreciation

= Liab. + Equity Gain – Exp. = Net Inc. Cash Flow

Cash + Book Value of Van Ret. Earn.4,500 (4,000) = NA + 500 500 – - = 500 4,500 IA

Assets

Life Cycle Phase 4On January 1, 2017, the van is sold for $4,500 cash.Cost of Asset 24,000$

Accumulated Depreciation 20,000 ($5,000 × 4 years)Book Value 4,000 Cash Proceeds 4,500 Gain on disposal 500$

Account Title Debit CreditCash 4,500 Accumulated depreciation 20,000 Van 24,000 Gain on sale of van 500

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Double-Declining-Balance Method

The double-declining-balance method is called an accelerated depreciation method because more depreciation expense is recorded in the early years than in later years. Determining the amount of depreciation expense in any year is the result of a three-step process.

1. Determine the straight-line rate of depreciation.

2. Multiply the straight-line rate times two.

3. Multiply the double-declining rate by the book value of the asset at the beginning of the period.

1. Determine the straight-line rate of depreciation.

2. Multiply the straight-line rate times two.

3. Multiply the double-declining rate by the book value of the asset at the beginning of the period.

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Double-Declining-Balance Method

See how double-declining-balance depreciation works

(1 ÷ 4) = (25% straight-line rate × 2) = 50%(1 ÷ 4) = (25% straight-line rate × 2) = 50%

YearBook Value at

Beginning of Year

Double the Straight-Line

Rate

Annual Depreciation

Expense2013 ($24,000 – $ 0) 50% 12,000$ 2014 ($24,000 – $12,000) 50% 6,000 2015 ($24,000 – $18,000) 50% 2,000 2,0002016 ($24,000 - $20,000) 50% 2,000 0

22,000$

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Units-of-Production Depreciation

Cost – Salvage valueTotal estimated units of production

=Depreciation charge per unitof production

Depreciation charge per unitof production

×Units of production in current accounting period

=PeriodicDepreciation Expense

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Units-of-Production Depreciation

Here is the depreciation charge per mile driven in our van:

$24,000 – $4,000100,000 miles

= $0.20 per mile

Here is the calculation of depreciation expense based on miles driven:

Depreciation Charge Per

MileMiles

DrivenDepreciation

Expense0.20$ × 40,000 = 8,000$ 0.20 × 20,000 = 4,000 0.20 × 30,000 = 6,000 0.20 × 15,000 = 3,000 2,000

105,000 21,000$

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Graph of Depreciation Expense

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Income Tax Considerations

The maximum depreciation currently allowed by tax law is computed using the modified accelerated cost recovery system (MACRS). The rate of depreciation depends on the class life of the asset and the period in which we are calculating depreciation. There are currently six categories for property, excluding real estate. They are 3-year, 5-year, 7-year, 10-year, 15-year, and 20-year property.

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Revision of Estimates

Estimates are revised when new information surfaces. Assume we purchased equipment on January 1, 2013, for $50,000 cash and estimated salvage value was $3,000. The equipment has an estimated useful life of eight years, and we use straight-line depreciation.

($26,500 – $3,000) ($26,500 – $3,000) ÷ 10 = $2,350 depreciation per year÷ 10 = $2,350 depreciation per year($26,500 – $3,000) ($26,500 – $3,000) ÷ 10 = $2,350 depreciation per year÷ 10 = $2,350 depreciation per year

On January 1, 2017, after four years of depreciation, it was determined that the machine has a useful life of fourteen years.

($50,000 – $3,000) ($50,000 – $3,000) ÷ 8 = $5,875 depreciation per year÷ 8 = $5,875 depreciation per year($50,000 – $3,000) ($50,000 – $3,000) ÷ 8 = $5,875 depreciation per year÷ 8 = $5,875 depreciation per year

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Continuing Expenditures for Plant Assets

Costs that Are ExpensedCosts that Are ExpensedThe cost of routine maintenance and minor repairs that are incurred to keep an asset in good working order are expensed as incurred. Assume the company spent $500 cash for routine maintenance on machinery.

Account Title Debit CreditRepairs Expense 500 Cash 500

Assets = Liab. + Equity Rev. – Exp. = Net Inc. Cash Flow

Cash Ret. Earn.(500) = NA + (500) NA – 500 = (500) (500) OA

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Continuing Expenditures for Plant Assets

Costs That Are CapitalizedCosts That Are CapitalizedExpenditures that improve the quality of an asset are capitalized as part of the cost of that asset. Assume the company spent $4,000 cash for a major overall of equipment to improve efficiency.

= Liab. + Equity Rev. – Exp. = Net Inc. Cash Flow

Cash + Equip. - A. Depr(4,000) 4,000 NA = NA + NA NA – NA = NA (4,000) IA

Assets

Account Title Debit CreditEquipment 4,000 Cash 4,000

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Continuing Expenditures for Plant Assets

Costs That Extend the Life of an AssetCosts That Extend the Life of an AssetThe amount of the expenditure should reduce the balance in the Accumulated Depreciation account. Assume the company spent $4,000 cash for improvements that extended the life of equipment four years.

= Liab. + Equity Rev. – Exp. = Net Inc. Cash Flow

Cash + Equip. - A. Depr(4,000) NA (4,000) = NA + NA NA – NA = NA (4,000) IA

Assets

Account Title Debit CreditAccumulated Depreciation - Equipment 4,000 Cash 4,000

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Natural Resources

Cost – Salvage valueTotal estimated units recoverable

=Depletion charge per unitof resource

Depletion charge per unitof resource

×Number of units extracted and sold this period

=PeriodicDepletion Expense

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Intangible Assets

TrademarksA name or symbol that

identifies a company or a product. The cost of a trademark may include design, purchase, or

defense of the trademark.

TrademarksA name or symbol that

identifies a company or a product. The cost of a trademark may include design, purchase, or

defense of the trademark.

PatentsThe exclusive legal right to produce and sell a product

that has one or more unique features. The legal life of a patent is 20 years.

PatentsThe exclusive legal right to produce and sell a product

that has one or more unique features. The legal life of a patent is 20 years.

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Intangible Assets

CopyrightsCopyrightsProtection of writings, musical Protection of writings, musical

composition, work of art, or other composition, work of art, or other intellectual property. The intellectual property. The

protection extends for the life of protection extends for the life of the creator plus 70 years.the creator plus 70 years.

CopyrightsCopyrightsProtection of writings, musical Protection of writings, musical

composition, work of art, or other composition, work of art, or other intellectual property. The intellectual property. The

protection extends for the life of protection extends for the life of the creator plus 70 years.the creator plus 70 years.

FranchiseThe exclusive

right to sell products or

perform services in certain

geographic areas.

FranchiseThe exclusive

right to sell products or

perform services in certain

geographic areas.GoodwillGoodwill

The excess of cost over fair The excess of cost over fair value of net tangible assets value of net tangible assets

acquired in a business acquired in a business acquisition.acquisition.

GoodwillGoodwillThe excess of cost over fair The excess of cost over fair value of net tangible assets value of net tangible assets

acquired in a business acquired in a business acquisition.acquisition.

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End of Chapter Eight

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