Chapter08

© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin

Chapter 8

Reporting and Analyzing Long-Term Assets


Conceptual Learning Objectives

C1: Describe plant assets and issues in accounting for them.

C2: Explain depreciation and the factors affecting its computation.

C3: Explain depreciation for partial years and changes in estimates.


Analytical Learning Objectives

A1: Compare and analyze alternative depreciation methods.

A2: Compute total asset turnover and apply it to analyze a company’s use of assets.


Procedural Learning Objectives

P1: Apply the cost principle to compute the cost of plant assets.

P2: Compute and record depreciation using the straight-line, units-of-production, and declining-balance methods.

P3: Distinguish between revenue and capital expenditures, and account for them.

P4: Account for asset disposal through discarding or selling an asset.

P5: Account for natural resource assets and their depletion.

P6: Account for intangible assets.P7: Appendix 10A: Account for asset exchanges


Called Property, Plant, & EquipmentCalled Property, Plant, & Equipment

Plant Assets

Expected to Benefit Future PeriodsExpected to Benefit Future Periods

Actively Used in OperationsActively Used in Operations

Tangible in NatureTangible in Nature

C 1


Plant Assets

Plant Assets as a Percent of Total Assets

9%

54% 55%

74%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

eBay Wal-Mart Anheuser-Busch

McDonald's

C 1


Decline in asset value over its useful life

Use2. Allocate cost to periods benefited.3. Account for subsequent expenditures.

Use2. Allocate cost to periods benefited.3. Account for subsequent expenditures.

Disposal 4. Record disposal. Disposal 4. Record disposal.

Plant Assets

Acquisition1. Compute cost. Acquisition1. Compute cost.

C 1


AcquisitionCost

AcquisitionCost

Acquisition cost excludes financing charges and

cash discounts.

Acquisition cost excludes financing charges and

cash discounts.

All expenditures

needed to prepare the asset for its intended use

All expenditures

needed to prepare the asset for its intended use

Purchaseprice

Purchaseprice

Cost DeterminationP1


Land is not depreciable.Land is not depreciable.

Purchaseprice

Purchaseprice

Real estatecommissionsReal estate

commissions

Title insurance premiumsTitle insurance premiums

Delinquenttaxes

Delinquenttaxes

Surveyingfees

Surveyingfees

Title search and transfer feesTitle search and transfer fees

LandP1


Land Improvements

Parking lots, driveways, fences, walks, shrubs, and lighting systems.

Parking lots, driveways, fences, walks, shrubs, and lighting systems.

Depreciate over useful life of

improvements.

P1


Cost of purchase or construction

Cost of purchase or construction

Brokeragefees

Brokeragefees

TaxesTaxes

Title feesTitle fees

Attorney feesAttorney fees

BuildingsP1


Purchaseprice

Purchaseprice

Installing,assembling, and

testing

Installing,assembling, and

testing

Insurance whilein transit

Insurance whilein transit

TaxesTaxes

Transportationcharges

Transportationcharges

Machinery and EquipmentP1


On January 1, Matrix, Inc. purchased land and building for $200,000 cash. The appraised values are building, $162,500, and land, $87,500.

How much of the $200,000 purchase price will be charged to the building and land accounts?

On January 1, Matrix, Inc. purchased land and building for $200,000 cash. The appraised values are building, $162,500, and land, $87,500.

How much of the $200,000 purchase price will be charged to the building and land accounts?

Lump-Sum Asset Purchase

The total cost of a combined purchase of land and building is separated on the basis of their relative market values.

The total cost of a combined purchase of land and building is separated on the basis of their relative market values.

P1


Appraised % of Purchase ApportionedAsset Value Value Price Cost

a b* c b × c

Land 87,500$ 35% × 200,000$ = 70,000$ Building 162,500 65% × 200,000 = 130,000 Total 250,000$ 100% 200,000$

* $87,500 ÷ $250,000 = 35%

$162,500 ÷ $250,000 = 65%

Appraised % of Purchase ApportionedAsset Value Value Price Cost

a b* c b × c

Land 87,500$ 35% × 200,000$ = 70,000$ Building 162,500 65% × 200,000 = 130,000 Total 250,000$ 100% 200,000$

* $87,500 ÷ $250,000 = 35%

$162,500 ÷ $250,000 = 65%

Lump-Sum Asset PurchaseP1


Depreciation is the process of allocating the cost of a plant asset to expense in the accounting periods benefiting from its use.

Depreciation is the process of allocating the cost of a plant asset to expense in the accounting periods benefiting from its use.

Cost

AllocationAcquisition

CostAcquisition

Cost

(Unused)

Balance Sheet

(Used)

Income Statement

ExpenseExpense

DepreciationC2


The calculation of depreciation requires three amounts for each asset:

1. Cost

2. Salvage Value

3. Useful Life

Factors in Computing Depreciation

C 2


1. Straight-line

2. Units-of-production

3. Declining-balance

Depreciation MethodsC 2


On January 1, 2007, equipment was purchased for $50,000 cash. The equipment has an estimated useful life of five years and an estimated residual value of $5,000.

Cost - Salvage Value

Useful life

Depreciation

Expense for Period=

Straight-Line MethodP2


Straight-Line Method

Cost - Salvage Value

Useful life

Depreciation

Expense for Period=

$9,000 Depreciation

Expense per Year=

$50,000 - $5,000

5 years=

Dr. Cr.Depreciation Expense 9,000

Accumulated Depreciation - Equipment 9,000 To record annual depreciation

P2


Depreciation AccumulatedExpense Depreciation Accumulated Book

Year (debit) (credit) Depreciation Value50,000$

2007 9,000$ 9,000$ 9,000$ 41,000 2008 9,000 9,000 18,000 32,000 2009 9,000 9,000 27,000 23,000 2010 9,000 9,000 36,000 14,000 2011 9,000 9,000 45,000 5,000

45,000$ 45,000$

Salvage ValueSalvage Value

Straight-Line Method

DepreciationRate

= (100% ÷ 5 years) = 20% per year

P2

Dep

reci

atio

n

Exp

ense Depreciation Expense

reported on theIncome Statement.

$0$1,000

$3,000

$5,000

$7,000

$9,000

2007 2008 2009 2010 2011

For the year ended December 31

Book Valuereported on theBalance Sheet.

$41,000

$32,000

$23,000

$14,000

$5,000

$-

$5,000

$10,000

$15,000

$20,000

$25,000

$30,000

$35,000

$40,000

$45,000

2007 2008 2009 2010 2011

For the year ended December 31

Bo

ok

Val

ue

P2


Units-of-Production Method

Step 2:Depreciation Expense =

DepreciationPer Unit

×Number of

Units Producedin the Period

DepreciationPer Unit

= Cost - Salvage Value Total Units of Production

Step 1:

P2


On December 31, 2007, equipment was purchased for $50,000 cash. The equipment is expected to produce 100,000 units during its useful life and has an estimated salvage value of $5,000.

If 22,000 units were produced in 2008, whatis the amount of depreciation expense?

On December 31, 2007, equipment was purchased for $50,000 cash. The equipment is expected to produce 100,000 units during its useful life and has an estimated salvage value of $5,000.

If 22,000 units were produced in 2008, whatis the amount of depreciation expense?

Units-of-Production MethodP2


Step 2:Depreciation Expense = $.45 per unit × 22,000 units = $9,900

Step 1:Depreciation

Per Unit= $50,000 - $5,000

100,000 units = $.45 per unit



Depreciation Accumulated BookYear Units Expense Depreciation Value

50,000$ 2008 22,000 9,900$ 9,900$ 40,100 2009 28,000 12,600 22,500 27,500 2010 - - 22,500 27,500 2011 32,000 14,400 36,900 13,100 2012 18,000 8,100 45,000 5,000

100,000 45,000$

No depreciation expense if the equipment is idle.



Depreciation RepairExpense Expense

Early Years High Low

Later Years Low High

Early years’ total expense approximates later years’ total expense.

Declining Balance MethodP2


Double-Declining-Balance Method

Step 2:

Double-declining-balance rate = 2 × Straight-line rate = 2 × 20% =

40%

Step 1:

Straight-linerate

= 100 % ÷ Useful life = 100% ÷ 5 = 20%

Step 3:Depreciation

expense =Double-declining-

balance rate ×Beginning period

book value

40% × $50,000 = $20,000 for 2008

P2


2008 Depreciation: 40% × $50,000 = $20,000

Double-Declining-Balance Method

2009 Depreciation: 40% × ($50,000 - $20,000) = $12,000

P2


Depreciation Accumulated BookYear Expense Depreciation Value

50,000$ 2008 20,000$ 20,000$ 30,000 2009 12,000 32,000 18,000 2010 7,200 39,200 10,800 2011 4,320 43,520 6,480 2012 2,592 46,112 3,888

46,112$ Below salvage value

Double-Declining-Balance MethodP2


Depreciation Accumulated BookYear Expense Depreciation Value

50,000$ 2008 20,000$ 20,000$ 30,000 2009 12,000 32,000 18,000 2010 7,200 39,200 10,800 2011 4,320 43,520 6,480 2012 1,480 45,000 5,000

45,000$

We usually must force depreciation expense in the

last year so that book value equals salvage value.We usually must force depreciation expense in the

last year so that book value equals salvage value.

Double-Declining-Balance MethodP2


Comparing Depreciation Methods

An

nu

al

Pro

du

cti

on

De

pre

cia

tio

n

Life in Years

$0

$2,000

$4,000

$6,000

$8,000

$10,000

$12,000

$14,000

$16,000

1 2 3 4 5

Life in Years

An

nu

al

SL

De

pre

cia

tio

n

$0

$2,000

$4,000

$6,000

$8,000

$10,000

1 2 3 4 5

An

nu

al

DD

BD

ep

rec

iati

on

Life in Years

$0

$5,000

$10,000

$15,000

$20,000

1 2 3 4 5

P2

A1


Most corporations use the Modified Accelerated Cost Recovery System (MACRS) for tax purposes.

MACRS depreciation provides for rapid write-off of an asset’s cost in order to stimulate new investment.

Most corporations use the Modified Accelerated Cost Recovery System (MACRS) for tax purposes.

MACRS depreciation provides for rapid write-off of an asset’s cost in order to stimulate new investment.

Depreciation for Tax ReportingA1


When a plant asset is acquired during the year, depreciation is calculated for the fraction of the year the asset is owned.

When a plant asset is acquired during the year, depreciation is calculated for the fraction of the year the asset is owned.

June 30

Partial-Year DepreciationC 3


Calculate the straight-line depreciation on December 31, 2007, for equipment purchased on June 30, 2007. The equipment cost $75,000, has a useful life of 10 years, and an estimated salvage value of $5,000.

Calculate the straight-line depreciation on December 31, 2007, for equipment purchased on June 30, 2007. The equipment cost $75,000, has a useful life of 10 years, and an estimated salvage value of $5,000.

Depreciation = ($75,000 - $5,000) ÷ 10

= $7,000 for all 2007

Depreciation = $7,000 × 6/12 = $3,500

Depreciation = ($75,000 - $5,000) ÷ 10

= $7,000 for all 2007

Depreciation = $7,000 × 6/12 = $3,500

Partial-Year DepreciationC 3


So depreciationis an estimate.

Predicted salvage value

Predicteduseful life

Over the life of an asset, new information may come to light that indicates theoriginal estimates were inaccurate.

Over the life of an asset, new information may come to light that indicates theoriginal estimates were inaccurate.

Change in Estimates for Depreciation

C 3


On January 1, 2004, equipment was purchased that cost $30,000, has a useful life of 10 years, and no salvage value. During 2007, the useful life was revised to eight years total (five years remaining).

Calculate depreciation expense for the yearended December 31, 2007, using thestraight-line method.

On January 1, 2004, equipment was purchased that cost $30,000, has a useful life of 10 years, and no salvage value. During 2007, the useful life was revised to eight years total (five years remaining).

Calculate depreciation expense for the yearended December 31, 2007, using thestraight-line method.


Book value at date of change

Salvage value at date of change

Remaining useful life at date of change

–

C 3



Asset cost 30,000$ Accumulated depreciation, 12/31/2006 ($3,000 per year × 3 years) 9,000 Remaining book value 21,000$ Divide by remaining life ÷ 5Revised annual depreciation 4,200$

Dr. Cr.Dec. 31 Depreciation Expense 4,200

Accumulated Depreciation - Equipment 4,200 To record depreciation for 2007

C 3


Reporting Depreciation

Property, plant, and equipment: Land and buildings 150,000$ Machinery and equipment 200,000 Office furniture and equipment 175,000 Land improvements 50,000 Total 575,000$ Less Accumulated depreciation (122,000) Net property, plant, and equipment 453,000$

C 3


Additional Expenditures

If the amounts involved are not material, most companies expense the item.

If the amounts involved are not material, most companies expense the item.

Financial Statement EffectCurrent Current

Treatment Statement Expense Income Taxes

Capital Balance sheetExpenditure account debited Deferred Higher Higher

Revenue Income statement CurrentlyExpenditure account debited recognized Lower Lower

P3


Revenue and Capital Expenditures

Type of Capital orExpenditure Revenue Identifying Characteristics

Ordinary Revenue 1. Maintains normal operating condition.Repairs 2. Does not increase productivity.

3. Does not extend life beyond original estimate.

Capital 1. Major overhauls or partial replacements.2. Extends life beyond original estimate.

Betterments and

Extraordinary Repairs

P3


Recording cashreceived (debit)or paid (credit).


Removing accumulateddepreciation (debit).


Update depreciation to the date of disposal.

Journalize disposal by: Journalize disposal by:

Removing the asset cost (credit).


Recording again (credit)

or loss (debit).


or loss (debit).

Disposals of Plant AssetsP4


Update depreciation to the date of disposal.

Journalize disposal by:

If Cash > BV, record a gain (credit).

If Cash < BV, record a loss (debit).

If Cash = BV, no gain or loss.

Discarding Plant Assets








or loss (debit).


or loss (debit).

P4


On September 30, 2007, Evans Company sells a machine that originally cost $100,000 for $60,000 cash. The machine was placed in service on January 1, 2004. It was depreciated using the straight-line method with an estimated salvage value of $20,000 and a useful life of 10 years.

Selling Plant AssetsP4


Update Depreciation to Date of Disposal

Annual Depreciation:($100,000 - $20,000) ÷ 10 Yrs. = $8,000

Depreciation to September 30, 2007:9/12 × $8,000 = $6,000

Annual Depreciation:($100,000 - $20,000) ÷ 10 Yrs. = $8,000

Depreciation to September 30, 2007:9/12 × $8,000 = $6,000

Dr. Cr.Sep. 30 Depreciation expense 6,000

Accumulated Depreciation - Machine 6,000 To update depreciation to date of disposal

P4


Determine Book Value of Asset

Cost 100,000$ Accumulated Depreciation: ( 3 yrs. × $8,000) + $6,000 = 30,000

Book Value 70,000$

P4


Determine Gain or Loss on Disposal

Cost 100,000$ Accumulated depreciation 30,000

Book Value 70,000 Cash Received 60,000

Loss on disposal (10,000)$

If Cash > BV, record a gain (credit).

If Cash < BV, record a loss (debit).

If Cash = BV, no gain or loss.

P4


Record the Disposal in the Journal

Dr. Cr.Sep. 30 Cash 60,000

Accumulated Depreciation - Machine 30,000 Loss on Disposal of Asset 10,000

Machine 100,000 To record disposal of equipment

P4


Let’s Talk About Natural Resources!

P5


Total cost,including exploration anddevelopment,is charged todepletion expenseover periodsbenefited.

Extracted fromthe naturalenvironmentand reportedat cost lessaccumulateddepletion.

Natural Resources

Examples: oil, coal, goldExamples: oil, coal, gold

P5


Cost Determination and Depletion

Step 2:DepletionExpense =

DepletionPer Unit

×Units Extracted

and Sold in Period

DepletionPer Unit

= Cost - Salvage Value Total Units of Capacity

Step 1:

P5


Apex Mining acquired a tract of land containing ore deposits. Total costs of acquisition and development were $1,000,000 and Apex estimates the land contained 40,000 tons of ore. During the first year of operations Apex extracted and sold 13,000 tons of ore.

Apex Mining acquired a tract of land containing ore deposits. Total costs of acquisition and development were $1,000,000 and Apex estimates the land contained 40,000 tons of ore. During the first year of operations Apex extracted and sold 13,000 tons of ore.

Depletion of Natural ResourcesP5


Step 2: Depletion Expense = $25 per ton × 13,000 units = $325,000

Step 1:DepletionPer Unit

= $1,000,000 - $0 40,000 tons

= $25 per ton

Depletion ExpenseP5


Plant Assets Used in Extracting Natural Resources

Specialized plant assets may be required to extract the natural resource.

These assets are recorded in a separate account and depreciated.

Specialized plant assets may be required to extract the natural resource.

These assets are recorded in a separate account and depreciated.

P5


Let’s Look at Intangible Assets!P6


Noncurrent assetswithout physicalsubstance.

Noncurrent assetswithout physicalsubstance.

Useful life isoften difficultto determine.

Useful life isoften difficultto determine.

Usually acquired for operational use.

Usually acquired for operational use.

IntangibleAssets

IntangibleAssets

Often provideexclusive rightsor privileges.

Often provideexclusive rightsor privileges.

Intangible AssetsP6


o Patentso Copyrightso Leaseholdso Leasehold Improvementso Franchises & Licenseso Goodwillo Trademarks & Trade Names

Record at current cash equivalent cost, including purchase price, legal fees, and filing fees.

Cost Determination and Amortization

P6


Types of Intangibles

Patents

The exclusive right granted to its owner to manufacture and sell a patented item or use a process for 20 years. A patent is generally amortized, using the straight-line method, over its useful life not to exceed 20 years.

P6



PatentsMatrix, Inc. purchased a patent for $10,000. The patent is expected to have a useful life of 10 years.

Dr. Cr.Amortization Expense - Patents 1,000

Accumulated Amortization - Patents 1,000 To amortize patent costs

P6



CopyrightsThe exclusive right to publish and sell a musical, literary, or artistic work during the life of the creator plus 70 years.

LeaseholdsThe rights the lessor grants to the lessee under the terms of a lease. Most leases have a determinable life.

P6



Leasehold ImprovementsA lessee may pay for alterations or improvements to the leased property such as partitions, painting, and storefronts. These costs are usually amortized over the term of the lease.

Franchises and LicensesThe right granted by a company or the government to deliver a product or service under specified conditions.

P6



Trademarks and Trade Names

A symbol, name, phrase, or jingle identified with a company, product, or service.

P6


Occurs when onecompany buys

another company.

Occurs when onecompany buys

another company.

Goodwill is not amortized. It is testedeach year to determine if there has been

any impairment in carrying value.

Goodwill is not amortized. It is testedeach year to determine if there has been

any impairment in carrying value.

GoodwillGoodwill

Only purchased goodwill is an

intangible asset.

Only purchased goodwill is an

intangible asset.

GoodwillP6


Provides information about a company’s efficiency in using its assets.

Provides information about a company’s efficiency in using its assets.

Total AssetTurnover =

Net SalesAverage Total Assets

Total Asset Turnover

2004 2003 2002 2001Coors 0.92 0.89 0.87 1.44 Anheuser-Busch 0.92 0.96 0.96 0.95

A2


Appendix 10A

Exchanging Plant Assets

Many plant assets are disposed of by exchanging them for newer assets. The next few slides will explain how exchanges are recorded.

P7



SIMILAR

Accounting for exchanges of similar assets depends on whether the book value of the asset(s) given up is less or more than the market value of the asset(s) received.


P7





A loss is recognized when the book value given up is more than the market value received.

A loss is recognized when the book value given up is more than the market value received.

A gain is not recognized when the book value given up is less than the market value received.

A gain is not recognized when the book value given up is less than the market value received.

SIMILAR

P7


On May 30, 2007, Matrix, Inc. exchanged a used bus and $35,000 cash for a new European-style bus. The old bus originally cost $40,000, had up-to-date accumulated depreciation of $30,000. The new bus had a market value of $39,000.



SIMILAR

P7


Market value of asset received 39,000$ Cost of old bus 40,000$ Accumulated depreciation 30,000

Book value of old bus 10,000 Cash 35,000 45,000

Loss on exchange 6,000$


Dr. Cr.May 30 Bus (new) 39,000

Accumulated Depreciation - Bus 30,000 Loss on Exchange 6,000

Bus (old) 40,000 Cash 35,000

Remember -- Losses are always recorded immediately.

Remember -- Losses are always recorded immediately.

P7




SIMILAR

Exchanging Plant AssetsP7


Market value of asset received 49,000$ Cost of old bus 40,000$ Accumulated depreciation 30,000

Book value of old bus 10,000 Cash 35,000 45,000

Gain on exchange 4,000$


Dr. Cr.Bus (new) 45,000 Accumulated Depreciation - Bus 30,000

Bus (old) 40,000 Cash 35,000

Market value of new bus – Gain not recognized$49,000 - $4,000 = $45,000

Market value of new bus – Gain not recognized$49,000 - $4,000 = $45,000

P7


End of Chapter 8

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