Chapter 9 REPORTING AND ANALYZING LONG- LIVED ASSETS

Chapter 9Chapter 9

REPORTING AND REPORTING AND ANALYZING LONG-ANALYZING LONG-

LIVED ASSETSLIVED ASSETS

Property, Plant, and Equipment Intangible Assets Natural Resources

Long-term, or non-current, assets acquired for use in a business rather than for resale. Examples include

Property, Plant, and Equipment--Tangible, long-lived assets acquired for business operations. Depreciation is the process of allocating the costs of these assets over their estimated useful lives.

• Property, Plant, and Equipment• Intangible Assets--Intangible long-lived

assets without physical substance that are used in business. Amortization is the process of allocating the costs of these assets over their estimated useful lives.

Nature of Operating AssetsNature of Operating Assets

• Property, Plant, and Equipment• Intangible Assets• Natural Resources--Assets that are

physically consumed or waste away in the course of business. Depletion is the process of allocating costs of natural resources as they are mined or extracted.

Nature of Operating AssetsNature of Operating Assets

Recording asset acquisition. Allocating the cost of an asset over its useful

life, or depreciation. Accounting for maintenance, repairs, and

improvements made to the asset. Accounting for sale or disposal of the asset.

John Doe purchased a delivery truck to use in his business. The cost of the truck was $50,000. What entry will John make if he paid cash for the truck?

Assets Acquired by PurchaseAssets Acquired by Purchase

John Doe purchased a delivery truck to use in his business. The cost of the truck was $50,000. What entry will John make if he paid cash for the truck?

Delivery Truck................................ 50,000 Cash........................................ 50,000

Purchased a delivery truck for $50,000.


John Doe purchased a delivery truck to use in his business. The cost of the truck was $50,000. What entry will John make if he purchased the truck with $10,000 cash and then borrowed the remaining $40,000?


John Doe purchased a delivery truck to use in his business. The cost of the truck was $50,000. What entry will John make if he purchased the truck with $10,000 cash and then borrowed the remaining $40,000?

Delivery Truck................................ 50,000 Cash........................................ 10,000 Notes Payable.......................... 40,000



John Doe purchased a delivery truck to use in his business. The cost of the truck was $50,000. What entry will John make if he traded a piece of land worth $50,000 for the truck?


John Doe purchased a delivery truck to use in his business. The cost of the truck was $50,000. What entry will John make if he traded a piece of land worth $50,000 for the truck?

Delivery Truck................................ 50,000 Land......................................... 50,000



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Cost is measured by• the cash paid in a cash transaction, or • the cash equivalent price paid when noncash

assets are used in payment.

The cash equivalent price is equal to• the fair market value of the asset given up, or • the fair market value of the asset received,

whichever is more clearly determinable.

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If a building is purchased, but needs to be readied for its intended use, cost includes• expenditures for remodeling rooms

or offices• replacing or repairing

o roofo floorso electrical wiringo plumbing

1155

All necessary expenditures relating to the purchase or construction of a building.

When a building is purchased such costs include the• purchase price• closing costs (attorney's fees title

insurance)• real estate broker's commissions

1166

Cost of land includes Cash price, closing costs, brokers’

commissions, accrued property taxes, etc. Can also include costs to raze a building,

drain and fill the land Proceeds from sale of salvaged materials

are deducted from the cost

1177

All expenditures necessary to make the improvements ready for their intended use• Drive ways• Parking lots• Fences• Underground sprinklers

Basket Purchase--The purchase of two or more assets acquired together at a single price.

Relative Fair Market Value Method--A way of allocating a basket purchase price to the individual assets acquired based on their respective market values.


When two or more assets are acquired at a single price. The prices are allocated on a “relative fair market value method.”

In the example below, on Oct 31 we purchased land and building for a total of $360,000.

Basket PurchaseBasket Purchase


In the example below, we purchased land and building for a total of $360,000.

Asset FMV Total Value Cost `Land $100,000 25% .25 x 360,000 = $ 90,000Building $300,000 75% .75 x 360,000 = $ 270,000

$400,000 100% $ 360,000


Asset FMV Total Value Cost `Land $100,000 25% .25 x 360,000 = $ 90,000Building $300,000 75% .75 x 360,000 = $ 270,000

$400,000 100% $ 360,000

Journal Entry: Land............. 90,000 Building........ 270,000

Cash..... 360,000


In the example below, we purchased land and building for a total of $360,000.

Unless, of course, the intent of purchasing the building was to demolish it and build a new one.


In which case, the whole cost, plus the demolition cost, is the cost of the land.

Depreciation--A systematic write-off each period of the original cost assigned to the asset.

Useful Life--The length of time a company expects to use an asset.

Salvage or Residual Value--What the asset will be worth at the end of its useful life (net of disposal costs). C

AS

CA

SHH

Accumulated Depreciation--The total depreciation recorded on an asset since its acquisition. It is a contra-asset account that is offset against the cost of the asset on the balance sheet.

Book Value--Equal to the original cost of the asset less accumulated depreciation.

The original cost. The estimated useful life. The salvage or residual value.

Calculating Depreciation Expense

In order to calculate depreciation In order to calculate depreciation expense, the following information is expense, the following information is needed:needed:

Allocate the expenses (cost) of the asset –

– to the periods it contributes to revenue

Depreciation Expense

$24,000$24,000

The depreciation method in which the cost of an asset is allocated equally over each period of the asset’s estimated useful life.

The asset is assumed to benefit all periods equally.

Straight-Line--Recognizes equal periodic depreciation charges of the asset’s useful life. The formula for Straight-Line is:

Depreciation = Cost - Salvage Value Expense Useful Life (years)

Straight-Line--Recognizes equal periodic depreciation charges of the asset’s useful life. The formula for Straight-Line is:

The following information will be used to provide an example of calculating depreciation:◦ Acquisition Cost $24,000◦ Estimated Residual Value $ 2,000◦ Estimated Useful Life 4 years◦ This is the second year the asset has been in use.


Depreciation = $24,000 - $2,000 Expense 4

Depreciation = $5,500 per year Expense


Depreciation Expense..................... 5,500 Accumulated Depreciation........ 5,500

To record depreciation expense for the asset.

The journal entry to record depreciation for 2005 would be:

$0

$2,000

$4,000

$6,000

$8,000

$10,000

$12,000

2004 2005 2006 2007


1 Straight Line2 Units-of-production3 Sum-of-the-years’ digits4 Declining Balance

$0

$2,000

$4,000

$6,000

$8,000

$10,000

$12,000

2004 2005 2006 2007


$0

$2,000

$4,000

$6,000

$8,000

$10,000

$12,000

2004 2005 2006 2007


$0

$2,000

$4,000

$6,000

$8,000

$10,000

$12,000

2004 2005 2006 2007


Comparison of MethodsComparison of Methods

$0

$2,000

$4,000

$6,000

$8,000

$10,000

$12,000

2004 2005 2006 2007

Sum-of-the-Years' Digits

Double-Declining Balance

Straight-Line

Depreciation ExpenseDepreciation Expense

If the asset was not purchased at the beginning or end of the year, then depreciation should only be recorded for the months the asset was in use.

To simplify the process, some companies take a full year depreciation in the year of purchase, but take no depreciation expense in the year the asset is sold.

The following information will be used to provide an example of calculating depreciation:◦ Acquisition Cost $24,000◦ Estimated Residual Value $ 2,000◦ Estimated Useful Life 4 years◦ This is the first year the asset has been in use


= $24,000 - $2,000 = $5,500 4

Depreciation = $5,500 x .5 = $2,750 Expense 1st yr


Depreciation Expense..................... 2,750 Accumulated Depreciation........ 2,750

To record depreciation expense for the asset.

The journal entry to record depreciation for 2005 would be:

Depreciation for tax purposes must be computed in accordance with federal income tax law.

Modified Accelerated Cost Recovery System (MACRS).

Due to MACRS depreciation calculations, the depreciation expense for federal income tax will differ from the depreciation computed for financial reporting purposes.

Ordinary Expenditures--Expenditures for repairs, maintenance, and minor improvements which benefit the period in which they are made.

Capital Expenditure--Expenditures that lengthen an asset’s useful life, increases its capacity, or changes its use.

1 The amount must be significant.2 It should benefit the company for several

periods.3 It should increase the productive life or

capacity of the asset.

In order to classify as a capital expenditure, three criteria should be met:

Tool Time paid $3,000 during the year to maintain the company truck. What entry needs to be made?

Tool Time paid $3,000 during the year to maintain the company truck. What entry needs to be made?

Maintenance Expense........... 3,000 Cash................................ 3,000

Spent $3,000 to maintain truck.

Tool Time paid $10,000 to rebuild the engine in the company truck. It is expected that the new engine will add 2 years to the useful life of the truck.

Tool Time paid $10,000 to rebuild the engine in the company truck. It is expected that the new engine will add 2 years to the useful life of the truck.

Company Truck.................. 10,000 Cash............................. 10,000

Spent $10,000 to rebuild truck engine.

Example: Capital Example: Capital ExpenditureExpenditure

DiscardingSellingExchanging for another asset

John Doe decided to scrap a truck at the end of its useful life of 10 years. The original cost of the truck was $20,000. What entry will John make to scrap the truck?

Example: DisposalExample: Disposal

Ignore John’s legal

fees

John Doe decided to scrap a truck at the end of its useful life of 10 years. The original cost of the truck was $20,000. What entry will John make to scrap the truck?

Accumulated Depreciation....... 20,000 Truck…............................... 20,000

Scrapped $20,000 truck.

John Doe decided to scrap a truck after using it for only 9 years of its useful life of 10 years. The original cost of the truck was $20,000. What entry will John make to scrap the truck?


John Doe decided to scrap a truck after using it for only 9 years of its useful life of 10 years. The original cost of the truck was $20,000. What entry will John make to scrap the truck?

Accumulated Depreciation............ 18,000Loss on Disposal........................... 2,000 Truck...................................... 20,000

Scrapped $20,000 truck.


John Doe decided to sell the truck after using it for its useful life of 10 years. The original cost of the truck was $20,000. What entry will John make if he sells the truck for $3,000?

Example: SaleExample: Sale

Cash….......................................... 3,000Accumulated Depreciation............ 20,000 Truck….................................... 20,000 Gain on Sale…........................ 3,000

Sold a $20,000 truck for $3,000.

John Doe decided to sell the truck after using it for its useful life of 10 years. The original cost of the truck was $20,000. What entry will John make if he sells the truck for $3,000?

John Doe decided to sell the truck after using it for 8 years of its useful life of 10 years. The original cost of the truck was $20,000. What’s the entry if he sells the truck for $3,000?


Cash............................................. 3,000Accumulated Depreciation............ 16,000Loss on Sale................................. 1,000 Truck....................................... 20,000

Sold a $20,000 truck for $3,000.


John Doe decided to sell the truck after using it for 8 years of its useful life of 10 years. The original cost of the truck was $20,000. What’s the entry if he sells the truck for $3,000?

A contract that specifies the terms under which the owner of an asset transfers the right to use the asset to another party.

Depending on the lease provisions, a lease may resemble a purchase or a rental agreement.

Lessee--The party granted the right to use the property under the terms of a lease.

Lessor--The owner of the property that is rented (leased) to another party.

Operating Lease--A simple rental agreement. Capital Lease--A leasing transaction that is

recorded as a purchase by the lessee.

Cancellation Cancellation ClauseClause

Specifies under whatSpecifies under whatcircumstances the leasecircumstances the leasemay be canceled.may be canceled.


TermTerm


Delineates time period theDelineates time period thelease is to be in force.lease is to be in force.


TermTerm

Bargain Purchase Bargain Purchase OptionOption


Delineates time period theDelineates time period thelease is to be in force.lease is to be in force.

Grants lessee the right toGrants lessee the right topurchase the asset at the purchase the asset at the end of the lease term for end of the lease term for less than the residual less than the residual value.value.

Rental payment requiredRental payment requiredover lease term plus anyover lease term plus anypayment for residual value.payment for residual value.

Minimum LeasePayment

Minimum Lease Minimum Lease PaymentPayment

Rental payment requiredover lease term plus anypayment for residual value.

Minimum LeasePayment

Residual ValueResidual Value Market value of leasedMarket value of leasedasset at end of lease term.asset at end of lease term.

Minimum Lease Minimum Lease PaymentPayment

Lease classification can have a major impact on the financial statements.

◦A lease is classified an operating lease if the criteria for a capital lease are not met.

◦A lease is classified as a capital lease if it is non-cancelable and meets any one of the following four criteria.

1 The lease transfers ownership of the leased asset to the lessee by the end of the lease term.

2 The lease contains an option allowing the lessee to purchase the asset at the end of the lease term at a bargain price.

3 The lease term is equal to 75 percent or more of the estimated economic life of the asset.

4 The present value of the lease payments at the beginning of the lease is 90 percent or more of the fair market value of the leased asset.

Transfer of Ownership?Transfer of Ownership?Transfer of Ownership?Transfer of Ownership?

Bargain PurchaseBargain PurchaseOption?Option?

Bargain PurchaseBargain PurchaseOption?Option?

Term Term 75% of 75% ofUseful Life?Useful Life?

Term Term 75% of 75% ofUseful Life?Useful Life?

PV Payment PV Payment 90%90%of FMV?of FMV?

PV Payment PV Payment 90%90%of FMV?of FMV?

CapitalCapitalLeaseLease

CapitalCapitalLeaseLease

OperatingOperatingLeaseLease

OperatingOperatingLeaseLease

Yes

No

No

No

NoNo

Yes

Yes

Yes

Bob Jones signed a two-year lease which requires a monthly payment of $1,000. When the lease expires, Bob will either move out or negotiate a new lease. The journal entry is the following:

Example: Operating Lease

Bob Jones signed a two-year lease which requires a monthly payment of $1,000. When the lease expires, Bob will either move out or negotiate a new lease. The journal entry is the following:

Rent (or Lease) Expense......... 1,000

Cash.................................. 1,000

To record monthly rent on office building.

Example: Capital LeaseDreams Inc. leased a hotel for lease payments of $100,000 for 20 years. Since at the end of 20 years Dreams will own the property, the lease is treated as a purchase. The journal entries are as follows:


Leased Property.................. 851,360 Lease Liability................ 851,360 To record hotel acquired under a 20-year lease.


Leased Property.................. 851,360 Lease Liability................ 851,360 To record hotel acquired under a 20-year lease.

Lease Liability...................... 14,864 Interest Expense.................. 85,136 Cash.............................. 100,000 To record annual capital lease payments.

Rights and privileges that are long-lived, are not held for resale, have no physical substance, and usually provide their owner with a competitive advantage.

Patent--An exclusive right granted for 17 years by the government to manufacture and sell an invention.

Franchise--An exclusive right to sell a product or offer a service in a certain geographical area.

Goodwill--An intangible asset that shows a business is worth more than the net value of its assets.

The periodic allocation to expense of an intangible asset’s cost. The straight-line method is used most frequently.

Uncle Buck purchased a patent for $100,000. The useful life was 5 years. What entry is needed to record the purchase?

Example: PatentExample: Patent

Uncle Buck purchased a patent for $100,000. The useful life was 5 years. What entry is needed to record the purchase?

Patent.......................................... 100,000 Cash...................................... 100,000

Purchased a patent for $100,000.

Uncle Buck purchased a patent for $100,000. The useful life was 5 years. What entry is needed to record the patent’s amortization after the first year?


Uncle Buck purchased a patent for $100,000. The useful life was 5 years. What entry is needed to record the patent’s amortization after the first year?

Amortization Expense, Patent......... 20,000 Patent...................................... 20,000

To amortize patent for 1/5 of the cost.


An intangible asset that exists when a business is valued at more than the fair market value of its net assets.

Goodwill should be recorded only if its value can be objectively determined.

Goodwill is never written up above its original cost.

Bob, Inc. purchased a company for $200,000. The fair market value was determined to be $150,000. What amount of goodwill is recorded?

Example: GoodwillExample: Goodwill

Bob, Inc. purchased a company for $200,000. The fair market value was determined to be $150,000. What amount of goodwill is recorded?

Purchase Price............................... 200,000Fair Market Value........................... 150,000

Goodwill 50,000

Bob, Inc. purchased a company for $200,000. The fair market value was determined to be $150,000. If goodwill is amortized over 40 years, what is the journal entry for goodwill expenses after the first year?


Bob, Inc. purchased a company for $200,000. The fair market value was determined to be $150,000. If goodwill is amortized over 40 years, what is the journal entry for goodwill expenses after the first year? Amortization Expense, Goodwill........ 1,250 Goodwill...................................... 1,250

To amortize Goodwill for 1/40 of the cost.


Depletion--The process of cost allocation that assigns the original costs of a natural resource to the periods benefited.

Involves the calculation of a depletion rate for each unit of the natural resource.

Coal Time paid $1,000,000 for a coal mine. The mine contained an estimated 250,000 tons of coal. What entry is made for the purchase of the coal mine?

Coal Time paid $1,000,000 for a coal mine. The mine contained an estimated 250,000 tons of coal. What entry is made for the purchase of the coal mine?

Coal Mine................... 1,000,000 Cash..................... 1,000,000

Purchased coal mine for $1,000,000.

Coal Time paid $1,000,000 for a coal mine. The mine contained an estimated 250,000 tons of coal. During 2005, 30,000 tons of coal were mined. What is the depletion expense for 2005?

Coal Time paid $1,000,000 for a coal mine. The mine contained an estimated 250,000 tons of coal. During 2005, 30,000 tons of coal were mined. What is the depletion expense for 2005?

Depletion Expense........... 120,000 Coal Mine................... 120,000

Mined 30,000 tons at $4.00 per ton.

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Chapter 9 REPORTING AND ANALYZING LONG- LIVED ASSETS