Libby4ce PPT Ch09

9-1
FINANCIAL ACCOUNTING
Fourth Canadian Edition
LIBBY, LIBBY, SHORT, KANAAN, GOWING
Reporting and Interpreting Property, Plant, and Equipment; Natural Resources; and Intangibles Chapter 9
PowerPoint Author:
Robert G. Ducharme, MAcc, CA University of Waterloo, School of Accounting and Finance

Copyright 2011 McGraw-Hill Ryerson Limited
9-2
Understanding The Business
Insufficient capacity results in lost sales.

How much is enough?
Costly excess capacity reduces profits.
LO 1
9-3
Classifying Long-Lived Assets

Actively Used in Operations
Expected to Benefit Future Periods
Tangible Physical Substance

Intangible No Physical Substance

LO 1
9-4
Classifying Long-Lived Assets

Land Assets subject to depreciation Buildings and equipment Furniture and fixtures Natural resource assets subject to depletion
Definite life
Patents Copyrights Franchises Indefinite life Trademarks Goodwill
Mineral deposits and timber
Tangible Physical Substance

Intangible No Physical Substance

LO 1
9-5
Fixed Asset Turnover

Fixed = Asset Turnover Net Sales Revenue Average Net Fixed Assets
This ratio measures a companys ability to generate sales given an investment in fixed assets. During 2009, WestJet Airlines had $2,281,120 of revenue. Endof-year fixed assets were $2,307,566 and beginning-of-year fixed assets were $2,269,790. (All numbers in thousands.) Fixed $2,281,120 = Asset ($2,269,790 + $2,307,566) 2 Turnover = 1.00
2009 Fixed Asset Turnover Comparisons WestJet Southwest Ryanair 1.00 0.93 1.23
LO 1
9-6
Measuring and Recording Acquisition Cost

Acquisition cost includes the purchase price and all expenditures needed to prepare the asset for its intended use. Acquisition cost does not include financing charges and cash discounts. Buildings Purchase price Renovation and repair costs Legal and realty fees Title fees
LO 2

Equipment Purchase price Installation costs Modification to building necessary to install equipment Transportation costs Land Purchase price Real estate commissions Title insurance premiums Delinquent taxes Surveying fees Title search and transfer fees
9-7
Land is not depreciated
LO 2
9-8

Acquisition On January 1, WestJet Airlines for Cash purchased aircraft for $75,000,000 cash.
GENERAL JOURNAL
Date Jan. Description 1 Flight equipment (+A) Cash (-A) Debit 75,000,000 75,000,000
Page 8
Credit
Acquisition for Debt
On January 14, WestJet Airlines purchased aircraft for $1,000,000 cash and a $74,000,000 note payable.
GENERAL JOURNAL Page 9
Credit 1,000,000 74,000,000
LO 2
Date Jan.
Description 14 Flight equipment (+A) Cash (-A) Note payable (+L)
Debit 75,000,000
9-9
Acquisition for Non-cash Consideration

Record at the current market value of the consideration given, or the current market value of the asset acquired, whichever is more clearly evident. On July 7, WestJet gave Boeing 1,000,000 shares of $1.00 par value common shares with a market value of $50 per share plus $25,000,000 in cash for aircraft.
GENERAL JOURNAL
Date July Description 7 Flight Equipment (+A) Common Shares (+SE) Cash (-A)
Page 10
Debit Credit 50,000,000 25,000,000
LO 2
75,000,000
9-10
Acquisition by Construction
Asset cost includes:
All materials and labour traceable to the construction.
A reasonable amount of overhead.
Interest on debt incurred during the construction.
LO 2
9-11
Acquisitions as a Basket Purchase of Assets The total cost of a combined purchase of land and building is separated on the basis of their relative market values.
LO 2
9-12
Acquisitions as a Basket Purchase of Assets On January 1, WestJet purchased land and building for $300,000 cash. The appraised values are building, $189,000, and land, $126,000. How much of the $300,000 purchase price will be charged to the building and land accounts?
Continue
LO 2
9-13
Acquisitions as a Basket Purchase of Assets
Asset Land Building Total
Appraised Value a $ 126,000 189,000 $ 315,000
% of Value b* 40% 60% 100%
Purchase Price c
Assigned Cost b c
* $126,000 $315,000 = 40%
LO 2
9-14
Asset Land Building Total
Appraised Value a $ 126,000 189,000 $ 315,000
% of Value b*
Purchase Price
Assigned Cost
c b c 40% $ 300,000 = $ 120,000 60% 300,000 = 180,000 100% $ 300,000
* $126,000 $315,000 = 40%
Prepare the journal entry to record the purchase of land and building.
Copyright 2011 McGraw-Hill Ryerson Limited LO 2
9-15
GENERAL JOURNAL
Date Jan. 1 Land (+A) Building (+A) Cash (-A) Description Debit 120,000 180,000
Page 11
Credit
300,000
LO 2
9-16
Repairs, Maintenance, and Additions

Type of Capital or Expenditure Revenue
Identifying Characteristics
Ordinary Revenue 1. Maintains normal operating condition repairs and 2. Does not increase productivity maintenance 3. Does not extend life beyond original estimate 4. Recurring in nature and involve small amounts of money at each occurence Additions and Capital 1. Major overhauls or partial Improvements replacements (Extraordinary 2. Usually occur infrequently repairs and 3. Increases efficiency Betterments) 4. May extend useful life 5. Involve large amounts of money
9-17
Repairs, Maintenance, and Additions

Financial Statement Effect Treatment Statement Expense Current Current Profit Taxes
Capital Statement of Expenditure financial position account debited
Deferred
Higher
Higher Lower
Revenue Income statement Currently Expenditure account debited recognized Lower
To solve this classification problem, many companies have policies regarding the expensing of all expenditures below a certain amount according to the materiality constraint.
9-18
Depreciation Concepts
Depreciation is a cost allocation process that systematically and rationally matches acquisition costs of operational assets with periods benefited by their use. Statement of Income Statement Financial Position Acquisition Cost Expense Cost Allocation (Unused) (Used) Depreciation Expense Accumulated Depreciation
Depreciation for the current year Total of depreciation to date on an asset
Income Statement Statement of Financial Position

LO 3
Selected Items from WestJets 2009 Notes to the Consolidated Financial Statements
Property and Equipment: Aircraft Less: Accumulated depreciation Buildings and leasehold improvements Less: Accumulated depreciation Other assets under capital leases Less: Accumulated depreciation
9-19
$ 2,677,586 590,685 146,138 12,720 5,882 2,210
$ 2,086,901
133,418
3,672
Carrying Amount (= Book Values) Carrying amount = / Market value

9-20
Depreciation Concepts The calculation of depreciation requires three amounts for each asset: Acquisition cost. Estimated useful life. Estimated residual value. Alternative depreciation methods: Straight-line Units-of-production Accelerated Method: Declining balance
9-21
Depreciation Concepts
Useful Life is the expected service life of an asset to the present owner.
Residual (or Salvage) Value is the estimated amount to be recovered, less disposal costs at the end of estimated useful life of an asset.
LO 3
9-22
Straight-Line Method
Depreciation Expense per Year = Cost Residual Value Useful Life in Years
At the beginning of the year, WestJet purchased ground equipment for $62,500 cash. The equipment has an estimated useful life of 3 years and an estimated residual value of $2,500. Depreciation Expense per Year Depreciation Expense per Year
$62,500 $2,500 3 years $20,000 SL

LO 3
9-23
Straight-Line Method
Depreciation Accumulated Expense Depreciation Year (debit) (credit) 1 2 3 $ 20,000 20,000 20,000 $ 60,000 $ 20,000 20,000 20,000 60,000 Accumulated Depreciation Balance $ 20,000 40,000 60,000 Undepreciated Balance (book value) $ 62,500 42,500 22,500 2,500
Residual Value More companies use the straight-line method of depreciation in their financial reports than all other methods combined.
LO 3
SL
9-24
Units-of-Production Method
Step 1:
Depreciation = Rate
Step 2:
Cost Residual Value Life in Units of Production
Number of Depreciation Depreciation Units Produced = Expense Rate for the Year
At the beginning of the year, WestJet purchased ground equipment for $62,500 cash. The equipment has a 100,000 kilometre useful life and an estimated residual value of $2,500. If the equipment is used 30,000 kilometres in the first year, what is the amount of depreciation expense?
9-25
Units-of-Production Method
Step 1:
Depreciation = $62,500 $2,500 = $0.60 per km 100,000 km Rate

Step 2:
Depreciation = $0.60 per km 30,000 km = $18,000 Expense

Year 1 2 3 Depreciation Kilometres Expense 30,000 50,000 20,000 100,000 $ 18,000 30,000 12,000 60,000 Accumulated Depreciation Balance $ 18,000 48,000 60,000 Undepreciated Balance (book value) $ 62,500 44,500 14,500 2,500
LO 3
Residual Value
9-26
Accelerated Depreciation
Accelerated depreciation matches higher depreciation expense with higher revenues in the early years of an assets useful life when the asset is more efficient.
Depreciation Expense Early Years High Later Years Low
Repair Expense Low High

LO 3
9-27
Declining-Balance Method
Declining balance rate of 2 is double-decliningbalance (DDB) rate.
Cost Accumulated Depreciation
Annual Depreciation = expense
Net Book Value
2 Useful Life in Years
Annual computation ignores residual value. At the beginning of the year, WestJet purchased equipment for $62,500 cash. The equipment has an estimated useful life of 3 years and an estimated residual value of $2,500. Calculate the depreciation expense for the first two years.
9-28
Annual Depreciation expense Net Book Value
2 Useful Life in Years
Year 1 Depreciation: $62,500
2 3 years
) = $41,667 (
2 3 years
Year 2 Depreciation: ($62,500 $41,667)

) = $13,889
LO 3
9-29
Depreciation Expense (debit) $ 41,667 13,889 4,629 60,185 Accumulated Depreciation Balance $ 41,667 55,556 60,185 Undepreciated Balance (book value) $ 62,500 20,833 6,944 2,315
Year 1 2 3
Below residual value
($62,500 $55,556)
2 3 years
) = $4,629
LO 3
9-30
Depreciation Expense (debit) $ 41,667 13,889 4,444 60,000 Accumulated Depreciation Balance $ 41,667 55,556 60,000 Undepreciated Balance (book value) $ 62,500 20,833 6,944 2,500
Year 1 2 3
Depreciation expense is limited to the amount that reduces book value to the estimated residual value.
9-31
Changes in Depreciation Estimates

Depreciation Expense is based on . . . ESTIMATED useful ESTIMATED life residual value So depreciation is an estimate. If the estimates change, the book value less any residual value at the date of change is depreciated over the remaining useful life. Over the life of an asset, new information may come to light indicating that the original estimates were inaccurate.
9-32
If our estimates change, depreciation for the straight-line method is:

Book value at date of change Residual value at date of change
Remaining useful life at date of change
LO 3
9-33
WestJet purchased an aircraft for $60,000,000. The aircraft is depreciated using the straight-line method with a useful life of 20 years and an estimated residual value of $3,000,000. In year 5, WestJet changed the estimated useful life to 25 years and lowered the residual value to $2,400,000. Calculate depreciation expense for the fifth year using the straight-line method.
LO 3
9-34
Acquisition cost Accumulated depreciation (years 1-4) ($2,850,000 per year 4 years) Remaining book value Less: New residual value New depreciable amount Divide by remaining life Revised annual depreciation
$ 60,000,000 11,400,000 48,600,000 2,400,000 46,200,000 21 $ 2,200,000
LO 3
9-35
Depreciation and Federal Income Tax
For tax purposes, most corporations use the Capital Cost Allowance (CCA). CCA provides for rapid write-off of an assets cost in order to stimulate new investments.
LO 3
9-36
Depreciation Methods in Other Countries Many countries, including Australia, Brazil, England, and Mexico, use other methods such as depreciation based on the current fair value of assets.
LO 3
9-37
International PerspectiveIFRS
Measurement Basis for Property, Plant and Equipment
US GAAP and IFRS differ with respect to the measurement basis for property, plant and equipment on the statement of financial position. IFRS permit companies to value property, plant, and equipment at historical cost or to revalue them to their fair value as of the statement of financial position date.
LO 3
Under US GAAP and Canadian ASPE, revaluation of property, plant, and equipment to fair value is prohibited.
9-38
Measuring Asset Impairment

Impairment is the loss of a significant portion of the utility of an asset through . . . Casualty. Obsolescence. Lack of demand for the assets services.
Recognize a loss when an asset suffers a permanent impairment.
Impairment occurs when events or changed circumstances cause the carrying amount of these assets to exceed their recoverable amount, which is the higher of its value in use or its fair value less costs to sell. If Carrying amount > Recoverable amount, then the asset is impaired impairment loss = carrying amount recoverable amount
LO 4
9-39
Disposal of Property, Plant, and Equipment
Voluntary disposals: Sale Trade-in Retirement Involuntary disposals: Fire Accident
LO 5
9-40
Disposal of Property, Plant, and Equipment

Update depreciation to the date of disposal.
Journalize disposal by: Recording cash received (debit) or paid (credit). Writing off accumulated depreciation (debit).
Recording a gain (credit) or loss (debit). Writing off the asset cost (credit).
LO 5
9-41
Disposal of Property, Plant, and Equipment If Cash > BV, record a gain (credit). If Cash < BV, record a loss (debit). If Cash = BV, no gain or loss.
WestJet Airlines sold flight equipment for $11,000,000 cash at the end of its 17th year of use. The flight equipment originally cost $30,000,000, and was depreciated using the straight-line method with zero residual value and a useful life of 25 years. Lets answer the following questions.
Disposal of Property, Plant and Equipment
9-42
The amount of depreciation expense recorded at the end of the 17th year to bring depreciation up to date is: a. b. c. d. $0. $1,200,000. $1,500,000. $2,000,000.
Annual Depreciation: ($30,000,000 $0) 25 Years. = $1,200,000
LO 5

Accumulated Depreciation = (17yrs. the $1,200,000) = $20,400,000 After updating depreciation, the equipments book value at the end of BV = Cost Accumulated Depreciation the 17th year is: BV = $30,000,000 $20,400,000 = $9,600,000
9-43
a. b. c. d.
$9,600,000. $20,400,000. $12,800,000. $6,600,000.

LO 5
9-44
The equipments sale resulted in: a. b. c. d. a gain of $1,400,000. a gain of $6,200,000. a gain of $3,800,000. a loss of $1,700,000.
Gain = Cash Received Book Value Gain = $11,000,000 $9,600,000 = $1,400,000
9-45
Prepare the journal entry to record (1) the update the depreciation expense and accumulated depreciation, and (2) WestJets sale of the equipment at the end of the 17th year.
GENERAL JOURNAL
Date 1 2 Description Depreciation expense (+E) Acc. Depr. - Flight Equip. (+XA) Cash (+A) Accumulated Depreciation (-XA) Gain on Sale (+Gain, +SE) Flight Equipment (-A)
Page 8
Credit 1,200,000
Debit 1,200,000 11,000,000 20,400,000
1,400,000 30,000,000
LO 5
9-46
Acquisition and Depletion of Natural Resources

A non-current asset presented at cost less accumulated depletion. Total cost is allocated over periods benefited by means of depletion.
Extracted from the natural environment.
Total cost of asset is the cost of acquisition, exploration, and development. Examples: oil, coal, gold
Depletion is like units-of-production depreciation.

LO 6
9-47

The unit depletion rate is calculated as follows: Acquisition and Development Cost
Residual Value
Estimated Recoverable Units Depletion cost for a period is:

UNIT DEPLETION RATE
NUMBER OF UNITS EXTRACTED IN PERIOD
Cost of sales Depletion cost

Inventory for sale
Unsold Inventory
LO 6
9-48
Specialized plant assets may be required to extract the natural resource. These assets are recorded in a separate account and depreciated.
LO 6
Acquisition and Amortization of Intangible Assets

Non-current assets without physical substance. Useful life is often difficult to determine. Often provide exclusive rights or privileges. Usually acquired for operational use.
9-49
Intangible Assets
Record at current cash equivalent cost, including purchase price, legal fees, and filing fees.

Definite Life
9-50
Indefinite Life Not amortized. Tested at least annually for possible impairment, and book value is reduced to fair value if impaired.
Amortize over shorter of economic life or legal life, subject to rules specified by IFRS (GAAP). Use straight-line method.
Amortization is a cost allocation process similar to depreciation and depletion.
LO 6
Acquisition and Amortization of Intangible Assets Goodwill

Occurs when one company buys another company. Only purchased goodwill is an intangible asset.
9-51
The amount by which the purchase price exceeds the fair market value of net assets acquired.
Goodwill is not amortized. Its value must be reviewed at least annually for possible impairment, and the book value is reduced to fair value if impaired.

Arpec Company paid $2,000,000 to purchase all of Utek Companys assets and assumed liabilities of $400,000. The acquired assets were appraised at a fair value of $1,800,000.
9-52
What amount of goodwill should be recorded on Arpec Company books? a. b. c. d. $200,000 $400,000 $600,000 $800,000
LO 6

Arpec Company paid $2,000,000 to purchase all of Utek Companys assets and assumed liabilities of $400,000. The acquired assets were appraised at a fair value of $1,800,000.
9-53
What amount of goodwill should be recorded on Arpec Company books? a. b. c. d. $200,000 $400,000 $600,000 $800,000
FMV of Assets Debt Assumed FMV of Net Assets Purchase Price Goodwill $ 1,800,000 400,000 1,400,000 2,000,000 $ 600,000
LO 6

Trademarks
9-54
Copyrights The exclusive right to publish, use, and sell a literary, musical, or artistic work. Legal life is life of creator plus 50 years. Amortize cost over the period benefited.
A symbol, design, or logo associated with a business. An exclusive legal right to use a name, image or slogan. Purchased trademarks are recorded at cost.
LO 6

Patents Exclusive right granted by the federal government to sell or manufacture an invention. Cost is purchase price plus legal cost to defend. Amortize cost over the shorter of useful life or 20 years. Research and development costs that might result in a patent are normally expensed as incurred. Technology A category of intangible assets that includes a companys website and any computer programs written by its employees.
9-55
LO 6

Franchises Legally protected right purchased by a franchisee to sell products or provide services for a specified period and purpose. Purchase price is an intangible asset that is amortized. Licenses and Operating Rights Limited permissions to use a product or service according to specific terms and conditions. You may be using computer software that is made available to you through a campus licensing agreement.
9-56
LO 6
9-57
Leaseholds A lease is a contract to use property granted by a lessor (owner) to a lessee (another party). Rights granted under the lease are called a leasehold. A leasehold is recorded only if advance payment is involved. Otherwise periodic payments are treated as rent expense. Leasehold improvements are long-term alterations made by lessee to leased property and are recorded at cost and amortized over their useful life.
Research and Development Expense Not an Intangible Asset
9-58
If an intangible asset is developed internally, the cost of development normally is recorded as research and development expense. Under specific circumstances, development costs can be deferred to future accounting periods, recorded as assets, and then amortized over time, if the company can meet specific criteria for deferral.
LO 6
9-59
International PerspectiveIFRS
Research and Development Costs
US GAAP and IFRS differ with respect to the treatment of development costs.
IFRS require that research expenditures be reported as an expense, but development costs be capitalized as an asset after technical and commercial feasibility of the resulting product or service have been established.
LO 6
Under US GAAP, all research and development costs must be reported as an expense.
9-60
Focus on Cash Flows
Depreciation expense does not require a cash outflow. Because depreciation (CCA) is tax deductible, it reduces the cash outflow related to taxes (often called a tax shield).
LO 6
9-61
Focus on Cash Flows
LO 6
9-62
End of Chapter 9

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9-1

Robert G. Ducharme, MAcc, CA University of Waterloo, School of Accounting and Finance

Understanding The Business

Insufficient capacity results in lost sales.

Costly excess capacity reduces profits.

Copyright 2011 McGraw-Hill Ryerson Limited

Classifying Long-Lived Assets

Expected to Benefit Future Periods

Tangible Physical Substance

Intangible No Physical Substance

Classifying Long-Lived Assets

Mineral deposits and timber

Tangible Physical Substance

Intangible No Physical Substance

Fixed Asset Turnover

Measuring and Recording Acquisition Cost

Copyright 2011 McGraw-Hill Ryerson Limited

Measuring and Recording Acquisition Cost

Copyright 2011 McGraw-Hill Ryerson Limited

Land is not depreciated

Measuring and Recording Acquisition Cost

Acquisition for Debt

Description 14 Flight equipment (+A) Cash (-A) Note payable (+L)

Copyright 2011 McGraw-Hill Ryerson Limited

Acquisition for Non-cash Consideration

Asset cost includes:

All materials and labour traceable to the construction.

A reasonable amount of overhead.

Interest on debt incurred during the construction.

Copyright 2011 McGraw-Hill Ryerson Limited

Copyright 2011 McGraw-Hill Ryerson Limited

Copyright 2011 McGraw-Hill Ryerson Limited

Acquisitions as a Basket Purchase of Assets

Asset Land Building Total

Appraised Value a $ 126,000 189,000 $ 315,000

% of Value b* 40% 60% 100%

* $126,000 $315,000 = 40%

Copyright 2011 McGraw-Hill Ryerson Limited

Acquisitions as a Basket Purchase of Assets

Asset Land Building Total

Appraised Value a $ 126,000 189,000 $ 315,000

c b c 40% $ 300,000 = $ 120,000 60% 300,000 = 180,000 100% $ 300,000

* $126,000 $315,000 = 40%

Acquisitions as a Basket Purchase of Assets

Copyright 2011 McGraw-Hill Ryerson Limited

Repairs, Maintenance, and Additions

Repairs, Maintenance, and Additions

Capital Statement of Expenditure financial position account debited

Revenue Income statement Currently Expenditure account debited recognized Lower

Depreciation for the current year Total of depreciation to date on an asset

Income Statement Statement of Financial Position

$ 2,677,586 590,685 146,138 12,720 5,882 2,210

Carrying Amount (= Book Values) Carrying amount = / Market value

Copyright 2011 McGraw-Hill Ryerson Limited

$62,500 $2,500 3 years $20,000 SL

Cost Residual Value Life in Units of Production

Depreciation = $62,500 $2,500 = $0.60 per km 100,000 km Rate

Depreciation = $0.60 per km 30,000 km = $18,000 Expense

Copyright 2011 McGraw-Hill Ryerson Limited

Depreciation Expense Early Years High Later Years Low

Repair Expense Low High

Copyright 2011 McGraw-Hill Ryerson Limited

Cost Accumulated Depreciation