Investments in Property,Plant, and Equipmentand in Intangible Assets

Investments in Property,Plant, and Equipmentand in Intangible Assets

C H A P T E R 10

Learning Objective 1

Identify the two major categories of long-term operating assets: property, plant, and equipment and intangible assets.

Define and Provide Examples of Operating Assets

Name and Define the Two Types of Operating Assets

Diagram the Time Line ofBusiness Issues

Learning Objective 2

Understand the factors important in deciding whether to acquire a long-term operating asset.

Define Capital Budgeting

What is the Time Value of Money?

Learning Objective 3

Record the acquisition of property, plant, and equipment through a simple purchase as well as through a lease, self-construction, and as part of the purchase of several assets at once.

Assets Acquired by Purchase

Frank’s Fruit Farm purchased a fork lift for use in its wholesale business. Frank’s paid $12,000 cash for the fork lift. Make the necessary journal entry for this purchase.

Assets Acquired by Purchase

Frank’s Fruit Farm purchased a fork lift for use in its wholesale business. Frank’s paid $12,000 for the fork lift. What entry is necessary if Frank paid $3,000 cash and borrowed the remaining $9,000? Make the appropriate entry.

What is a Lease?

Match Lease Terms

The party that is granted the right to use the property under the terms of a lease.

Lessee

Lessor

Operating Lease

Capital Lease

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

A simple rental agreement.

A leasing transaction that is recorded as a purchase by the lessee.

Operating Lease

Frank’s Fruit Farm leases a building with monthly rental payments of $1,000. Make the appropriate entry if rent is paid in cash the first month.

Capital Lease

Frank’s Fruit Farm enters into a non-cancelable lease agreement that requires lease payments of $100,000 a year for 20 years. At the end of 20 years, Frank’s will own the property. Make the appropriate entries.

Classifying Leases

Transfer of Ownership?

Bargain PurchaseOption?

Term 75% ofUseful Life?

PV Payment 90%of FMV?

CapitalLease

OperatingLease

Respond YES or NO. If the item below occurs, is the lease a capital lease?

Assets Acquired bySelf Construction

Self-constructed assets

recorded at cost

include all expenditures incurred to build the asset and make it ready for its intended use

Costs include

materials used to build the asset

the construction labor

capitalized interest

some reasonable share of the general company overhead

Acquisition of SeveralAssets at Once—

Define the Terms Below

Basket Purchase

Relative Fair Market Value Method

Example: Basket Purchase

Asset FMV% of Total

Value Cost

When two or more assets are acquired at a single price, the prices are allocated on the “relative fair market value” method. In this example, Frank’s Fruit Farm purchased land and a new sorting facility at a total cost of $3,600,000. Prepare the entry to record the purchase.

Learning Objective 4

Compute straight-line and units-of-production depreciation expense for plant and equipment.

Define these Depreciation Terms

Depreciation

Book Value

Salvage Value

Methods of Depreciation

Straight-Line

The cost of the asset is allocated equally over the periods of an asset’s estimated useful life.

Units-of-Production

The cost of an asset is allocated to each period on the basis of the productive output or use of the asset during the period.

Frank’s Fruit Farm purchased a fork lift on January 1 for transporting fresh produce to and from the warehouse. The following facts apply:

Acquisition cost. . . . . . . . . . . . $24,000Estimated salvage value. . . . . $ 2,000Estimated life:In years. . . . . . . . . . . . . . . . 4 yearsIn miles driven. . . . . . . . . . . 60,000 miles

Compute Frank’s annual depreciation expense using both the straight-line and units-of-production methods and determine the appropriate journal entries.

Example: Depreciation Methods

What is the Formula for theStraight-Line Method?

Annual Depreciation

Expense=

=

=

Do the calculation.

Make the

Journal Entry

What is the Formula for theUnits-of-Production Method?

Per UnitDepreciation

=

DepreciationExpense =

DepreciationExpense =

=

Do the calculation.

Make the

Journal Entry

Comparison of Methods

Year Straight-Line Units-of-Production

2000

2001

2002

2003

Total

$ 5,500

5,500

5,500

5,500

$22,000

$ 4,400

6,600

7,700

3,300

$22,000$0

$2,000

$4,000

$6,000

$8,000

2000 2001 2002 2003

Units-of-ProductionStraight-Line

Partial-Year Depreciation

*M

M- =

+M

-M

1 2 3

4 5 6

7 89

000

¥

%

Ö

+

=x

ON

CE

C

.991.75

3.16

28.03

7.15

2.90

What are the two steps to compute depreciation expense for less than a full

year?

More Depreciation TermsDefined.

Natural Resources

Depletion

Example: Depletion

Hard Hat’s mine contains an estimated 200,000 tons of coal. The depletion expense for each ton of coal is $6. Determine the journal entry if 12,000 tons are mined.

Learning Objective 5

Account for repairs and improvements of property, plant, and equipment.

Expenditures on Existing Assets

Ordinary expenditures

Capitalized expenditures

Learning Objective 6

Identify whether a long-term operating asset has suffered a decline in value and record the decline.

What is the Impairment Test?

Sum of future cash flows(from asset)

Book value(of asset)

IMPAIRMENTRecord asset at its

fair value

NO IMPAIRMENTAsset continues to bereported at book value

Sum of future cash flows less than book value

Learning Objective 7

Record the discarding and selling of property, plant, and equipment.

Discarding Property, Plant, and EquipmentFrank’s Fruit Farm purchased a conveyor system for $15,000. It has a 5-year life, no salvage value, and is depreciated on a straight-line basis. If Frank’s scraps the conveyor after 5 full years, what is the appropriate entry?

Discarding Property, Plant, and Equipment

Frank’s Fruit Farm purchased a conveyor system for $15,000. It has a 5-year life, no salvage value, and is depreciated on a straight-line basis. If Frank pays $300 to have the conveyor dismantled and removed, what is the appropriate entry?

Selling Property, Plant, and Equipment

Frank’s Fruit Farm purchased a conveyor system for $15,000. It has a 5-year life, no salvage value, and is depreciated on a straight-line basis. If Frank scraps the conveyor after only 4 years of service, there will be a loss of $3,300. What is the appropriate journal entry?

Selling Property, Plant, and Equipment

Frank’s Fruit Farm purchased a conveyor system for $15,000. It has a 5-year life, no salvage value, and is depreciated on a straight-line basis. If the conveyor is sold for $600 after 5 full years of service, what is the appropriate journal entry?

Selling Property, Plant, and Equipment

Frank’s Fruit Farm purchased a conveyor system for $15,000. It has a 5-year life, no salvage value, and is depreciated on a straight-line basis. If the conveyor is sold for $600 after only four years of service, Frank’s will experience a loss of $2,400. Make the appropriate entry.

Learning Objective 8

Account for the acquisition and amortization of intangible assets and understand the special difficulties associated with accounting for intangibles.

What are Intangible Assets?

Rights and privileges that are

Amortization

Define Each of These Intangible Assets.

Patent

Franchise

License

Amortizing a Patent

PATENT

Benefit

$200,000 Patent with useful life of 8 years:

Calculate the

amortization for each of the eight

years.

Goodwill

An intangible asset that exists when a business is valued at more than the fair market value of its net assets, usually due to:

strategic location

reputation

good customer relations

similar factors

Equal to the excess of the purchase priceover the fair market value of the net assets

purchased.

Inventory $750,000

Long-term operating assets 220,000

Other assets 25,000

Liabilities (18,000)

Total Net Assets $977,000

Example: Goodwill

Frank’s Fruit Farm purchased Farmers’ Market for $1,200,000. At the time of the purchase, Farmers’ recorded the following market values of its assets and liabilities:

Example: Goodwill

Frank’s Fruit Farm purchased Farmers’ Market for $1,200,000. Make the journal entry in Frank’s books to appropriately recognize goodwill.

Inventory. . . . . . . . . . . . . . . . . . . . . . 750,000

Long-Term Operating Assets . . . . 220,000

Other Assets. . . . . . . . . . . . . . . . . . 25,000Goodwill . . . . . . . . . . . . . . . . . . . . . 223,000

Liabilities. . . . . . . . . . . . . . . . . . 18,000Cash . . . . . . . . . . . . . . . . . . . . . . 1,200,000

Purchased Farmers’ Market for $1,200,000.

Learning Objective 9

Use the fixed asset turnover ratio as a measure of how efficiently a company is using its property, plant, and equipment.

Define Fixed Asset Turnover

Expanded MaterialLearning Objective 10

Compute declining-balance and sum-of-the-years’-digits depreciation expense for plant and equipment.

Accelerated DepreciationDefine each term.

Declining-Balance Method

Sum-of-the-Years’-Digits Method (SYD)

Accelerated Depreciation MethodsFrank’s Fruit Farm purchased a fork lift for $12,000. The fork lift has a salvage value of $2,000 and a useful life of 4 years. Compute depreciation using both the DDB and SYD depreciation methods.

X 2 =Double-Declining Balance

Depreciation Expense

Book ValueAsset’s Life in Years

Book Value = Cost – Accumulated Depreciation

Sum of theyears of theasset’s life

Sum-of-the-Year’s-Digits

(Cost – Salvage Value)

Current Year / (4+3+2+1)

Expanded MaterialLearning Objective 11

Account for changes in depreciation estimates.

Change in EstimatesFrank’s purchased a fork lift for $12,000 with a $2,000 salvage value Fruit Farm a 4-year useful life. After 3 years, better information reveals the fork lift has a 6-year useful life and a $3,000 salvage value. Calculate a new depreciation expense for the next three years.

Formula CalculationTotal

Depreciation

Annual depreciationfor first 3 years

Book value after 3 years

Annual depreciation for last3 years (based on newtotal life of 6 years and newsalvage value of $3,000)

This completes Chapter 10