Chapter 8

Long-Term Assets

Conceptual Learning Objectives

Chapter 8: SELF-STUDY 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.

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Analytical Learning Objectives

SELF-STUDY A1: Compare and analyze alternative depreciation methods. A2: Compute total asset turnover and apply it to analyze a companys use of assets.

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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 decliningbalance methods. P3: Distinguish between revenue and capital expenditures, and account for them. P4: Account for asset disposal through discarding or selling an asset.

Self-Study (Quiz) P5: Account for natural resource assets and their depletion. P6: Account for intangible assets.
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C1

Plant Assets
Tangible in Nature

Actively Used in Operations

Expected to Benefit Future Periods

Called Property, Plant, & Equipment

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C1

Plant Assets

Acquisition 1. Compute cost.

Use 2. Allocate cost to periods benefited. 3. Account for subsequent expenditures.

Disposal 4. Record disposal.

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Land
Land is not a depreciable Asset
Cost includes:
1. The total amount paid for the land.
2. Real estate commissions, title insurance fees, legal fees, and any accrued property taxes paid by the purchaser. 3. Payments for surveying, clearing, grading, and draining, and government assessments (incurred at the time or purchase or later) for public roadways, sewers, and sidewalks.

4. Cost of removal of any existing structures (less proceeds from sale of salvaged material).
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Land Improvements
Land is not a depreciable Asset, but Land Improvements are.
Land Improvements: Costs that increase the usefulness of the land.
Examples: -Parking lot surfaces,
-Driveways, -Fences, and -Lighting systems.

Land Improvements have limited useful lives: Costs are charged to a separate Land Improvement account so that their costs can be allocated to the periods they benefit.
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Buildings
The cost of buildings include many costs; the purchase price plus the following:
Cost of purchase or construction Title fees

Brokerage fees
Taxes

Attorney fees

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Machinery and Equipment

Purchase price

Taxes

Transportation charges Installing, assembling, and testing

Insurance while in transit

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Exercise 2 Exercise 1 Quick Study 1

P1

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.

On January 1, Matrix, Inc. purchased land and building for $200,000 cash. The appraised values (FMV) 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?
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P1

Lump-Sum Asset Purchase

Appraised Value a $ 87,500 162,500 $ 250,000 % of Value b* Purchase Price Apportioned Cost

Asset Land Building Total

c b c 35% $ 200,000 = $ 70,000 35% 65% 130,000 65% 200,000 = 100% $ 200,000 100%

* $87,500 $87,500$250,000 $250,000==35% 35%

$162,500 $250,000 = 65%

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Exercise 3

C2

Depreciation

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

Income Statement
Cost Allocation

Acquisition Cost
(Unused)

Expense
(Used)

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Factors in Computing Depreciation

The calculation of depreciation requires three amounts for each asset:
1.
2. 3.

Cost Salvage Value

Useful Life

$50,000 $5,000
5 Years
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C2

Depreciation Methods
1.
2. 3.

Straight-line
Units-of-production Declining-balance
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P2

Straight-Line Method
Cost - Salvage Value Useful life
$50,000 - $5,000 = $9,000 5 years
Dr. 9,000 Cr. 9,000

Depreciation = Expense for Period

Depreciation = Expense per Year

Depreciation Expense Accumulated Depreciation - Equipment

To record annual depreciation

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P2

Straight-Line Method
Depreciation Expense (debit) $ 9,000 9,000 9,000 9,000 9,000 45,000 Accumulated Depreciation (credit) $ 9,000 9,000 9,000 9,000 9,000 45,000

Year 2009 2010 2011 2012 2013

Accumulated Depreciation $ 9,000 18,000 27,000 36,000 45,000

Book Value $ 50,000 41,000 32,000 23,000 14,000 5,000

Salvage Value
Depreciation = (100% 5 years) = 20% per year Rate
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Exercise 6

P2

Declining Balance Method

Depreciation Expense Early Years High Repair Expense Low

Later Years

Low

High

Early years total expense approximates later years total expense.

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Double-Declining-Balance Method
Step 1:
Straight-line rate

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

Step 2: Double-declining balance rate

= 2 Straight-line rate = 2 20% = 40%

Step 3: Depreciation = Double-declining expense balance rate $20,000 for 2009 = 40%

Beginning period

book value

$50,000
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P2

Double-Declining-Balance Method
2009 Depreciation: 40% $50,000 = $20,000

2010 Depreciation: 40% ($50,000 - $20,000) = $12,000

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P2

Double-Declining-Balance Method

Year 2009 2010 2011 2012 2013

Depreciation Expense $ 20,000 12,000 7,200 4,320 2,592 46,112

Accumulated Depreciation $

Book Value $ 50,000 20,000 30,000 32,000 18,000 39,200 10,800 43,520 6,480 46,112 3,888 Below salvage value

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P2

Double-Declining-Balance Method

Year 2009 2010 2011 2012 2013

Depreciation Expense $ 20,000 12,000 7,200 4,320 1,480 45,000

Accumulated Depreciation $ 20,000 32,000 39,200 43,520 45,000

Book Value $ 50,000 30,000 18,000 10,800 6,480 5,000

We usually must force depreciation expense in the last year so that book value equals salvage value.
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Exercise 5 Exercise 8

P2

Units-of-Production Method
Step 1:
Depreciation Per Unit = Cost - Salvage Value Total Units of Production

Step 2:
Depreciation Expense =

Number of Depreciation Units Produced Per Unit in the Period

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P2

Units-of-Production Method

On December 31, 2008, 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 2009, what is the amount of depreciation expense?

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P2

Units-of-Production Method

Step 1:
Depreciation = Per Unit $50,000 - $5,000 100,000 units
= $.45 per unit

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

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P2

Units-of-Production Method
Depreciation Expense $ 9,900 12,600 14,400 8,100 45,000 Accumulated Depreciation $ 9,900 22,500 22,500 36,900 45,000 Book Value $ 50,000 40,100 27,500 27,500 13,100 5,000

Year 2009 2010 2011 2012 2013

Units 22,000 28,000 32,000 18,000 100,000

No depreciation expense if the equipment is idle.

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Exercise 7

A1

Comparing Depreciation Methods

Annual Production Depreciation
$10,000

$16,000 $14,000 $12,000 $10,000 $8,000 $6,000 $4,000 $2,000 $0 1 2 3 4 5

Annual SL Depreciation

$8,000 $6,000 $4,000 $2,000 $0 1 2 3 4 5

P2

Life in Years

Life in Years

$20,000

Annual DDB Depreciation

$15,000 $10,000 $5,000 $0 1 2 3 4 5

Life in Years
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A1

Depreciation for Tax Reporting

Most corporations use the Modified Accelerated Cost Recovery System (MACRS) for tax purposes. MACRS depreciation provides for rapid write-off of an assets cost in order to stimulate new investment.

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Partial-Year Depreciation: SLD

Calculate the straight-line depreciation on December 31, 2009, for equipment purchased on June 30, 2009. 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 2009

Depreciation

$7,000 6/12 = $3,500

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Partial-Year Depreciation: DDB

Calculate the double-declining balance depreciation on December 31, 2009, for equipment purchased on June 30, 2009. The equipment cost $75,000, has a useful life of 10 years, and an estimated salvage value of $5,000. Depreciation = = $75,000 x 20%; => (1/10) * 2 $15,000 for all 2009

Depreciation

$15,000 6/12 = $7,500

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Partial-Year Depreciation: DDB

Calculate the double-declining balance depreciation on December 31, 2009, for equipment purchased on June 30, 2009. The equipment cost $75,000, has a useful life of 10 years, and an estimated salvage value of $5,000. Compute 2nd year (2010) depreciation?? 1st Year Depreciation = $15,000 6/12 = $7,500; 2nd Year Depreciation = $(75,000 7,500) x 20%; = $13,500 for all 2010

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Exercise 9
Exercise 10

Change in Estimates for Depreciation

On January 1, 2009, equipment was purchased that cost $30,000, has a useful life of 10 years, and no salvage value. During 2012, the useful life was revised to eight years (five years remaining). Calculate depreciation expense for the year ended December 31, 2012, using the straight-line method.

Book value at date of change

Salvage value at date of change

Remaining useful life at date of change

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C3

Change in Estimates for Depreciation

$ 30,000 9,000 $ 21,000 5 $ 4,200

Asset cost Accumulated depreciation, 12/31/2011 ($3,000 per year 3 years) Remaining book value Divide by remaining life Revised annual depreciation

Dec. 31 Depreciation Expense Accumulated Depreciation - Equipment

To record depreciation for 2012

Dr. 4,200

Cr. 4,200

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Exercise 11:
-Calculate BV at the end of 2nd year;

-Subtract NEW Salvage Value;

-Depreciate using NEW Useful Life.

C3

Reporting Depreciation

Property, plant, and equipment: Land and buildings Machinery and equipment Office furniture and equipment Land improvements Total Less Accumulated depreciation Net property, plant, and equipment

$ 150,000 200,000 175,000 50,000 $ 575,000 (122,000) $ 453,000

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P3

Revenue and Capital Expenditures

Type of Capital or Expenditure Revenue Identifying Characteristics Ordinary Revenue 1. Maintains normal operating condition. Repairs Expenditures 2. Does not increase productivity. 3. Does not extend life beyond original estimate. Betterments Capital 1. Major overhauls or partial and Expenditures replacements. Extraordinary 2. Extends life beyond original estimate. Repairs

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P3

Additional Expenditures
Financial Statement Effect Current Current Statement Expense Income Taxes

Treatment

Capital Balance sheet Expenditure account debited Deferred Higher Revenue Income statement Currently Expenditure account debited recognized Lower

Higher Lower

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

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Exercise 14
#1: Age = AD / Annual Depreciation; Depr. =(Cost / UL); #2: JE = Capitalize Major Expenditure (Structural Repairs); #3: New Book Value = Old BV + Major Expenditure; #4: Current Years Depreciation =New Book value / New useful Life

Disposals of Plant Assets

1. Update depreciation to the date of disposal.

2. Calculate BV @ date of Disposal

4. Record (Journalize) disposal by:
Recording cash received (debit) or paid (credit). Removing accumulated depreciation (debit). 3. Recording a gain (credit) or loss (debit). Removing the asset cost (credit).
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Discarding Plant Assets

Journalize disposal by: Update depreciation If Cash > BV, record a gain (credit). to the date of disposal. If Cash < BV, record a loss (debit). If Cash = BV, no gain or loss.
Recording cash received (debit) or paid (credit). Removing accumulated depreciation (debit). Recording a gain (credit) or loss (debit). Removing the asset cost (credit).
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Disposal of Assets
On September 30, 2009, Evans Company sells a machine that originally cost $100,000 for $60,000 cash. The machine was placed in service on January 1, 2006. It was depreciated using the straight-line method with an estimated salvage value of $20,000 and a useful life of 10 years.
1. UPDATE DEPRECIATION (Partial Year) 2. CALCULATE BV = (Cost AD) 3. CALCULATE GAIN (LOSS) = (Cash BV) 4. JOURNALIZE DISPOSAL

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Disposal of Assets
1. Update depreciation to the date of disposal
Annual Depreciation ($100,000 - $20,000) 10 Yrs. = $8,000
Depreciation to September 30, 2009:9/12 $8,000 = $6,000
Dr. Sep. 30 Depreciation expense 6,000 Accumulated Depreciation - Machine
To update depreciation to date of disposal

Cr. 6,000

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2. Determine Book Value of Asset

Cost $ 100,000 Accumulated Depreciation: ( 3 yrs. $8,000) + $6,000 = 30,000 Book Value $ 70,000

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3. Determine Gain or Loss on Disposal

If Cash > BV, record a gain (credit). If Cash < BV, record a loss (debit). If Cash = BV, no gain or loss.
Cost Accumulated depreciation Book Value Cash Received Loss on disposal $ 100,000 30,000 70,000 60,000 $ (10,000)
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Record the Disposal (Journalize)

Dr. Sep. 30 Cash 60,000 Accumulated Depreciation - Machine 30,000 Loss on Disposal of Asset 10,000 Machine
To record disposal of equipment

Cr.

100,000

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Exercise 16 Exercise 17

Natural Resources: Cost Determination and Depletion

Natural Resources assets that are physically consumed when used. Example: Timber, mineral deposits, and oil and gas fields. Since they are consumed when used, they are also called wasting assets.

Natural Resources: Cost Determination and Depletion

Cost Determination and Depletion

1. Natural resources are recorded at cost, which includes all expenditures necessary to acquire the resource and prepare it for its intended use.
2. Depletion is the process of allocating the cost of a natural resource to the period when it is consumed. 3. Natural resources are reported on the balance sheet at cost less accumulated depletion. 4. The depletion expense per period is based on the units extracted.

P5

Natural Resources: Cost Determination and Depletion

Step 1:
Depletion Per Unit = Cost - Salvage Value Total Units of Capacity

Step 2:
Depletion Expense = Depletion Per Unit

Units Extracted and Sold in Period

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P5

Depletion of Natural Resources

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.

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P5

Depletion Expense

Step 1:
Depletion Per Unit = $1,000,000 - $0 40,000 tons
= $25 per ton

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

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Depletion of Natural Resources

Plant Assets Used in Extracting:
When the usefulness of plant assets used in extracting resources is directly related to the depletion of the natural resource, its cost is depreciated using the units-of-production method in proportion to the depletion of the natural resource.

P6

Intangible Assets
Often provide exclusive rights or privileges.

Noncurrent assets without physical substance.

Intangible Assets
Useful life is often difficult to determine. Usually acquired for operational use.
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P6

Cost Determination and Amortization

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

o
o o o o o

Patents Copyrights Leaseholds Leasehold Improvements Franchises & Licenses Goodwill Trademarks & Trade Names

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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.

Matrix, Inc. purchased a patent for $10,000. The patent is expected to have a useful life of 10 years.
Amortization Expense - Patents Accumulated Amortization - Patents
To amortize patent costs
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Dr. 1,000

Cr. 1,000

P6

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

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

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P6

Types of Intangibles
Leasehold Improvements

A 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 Licenses The right granted by a company or the government to deliver a product or service under specified conditions.

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P6

Types of Intangibles
Trademarks and Trade Names A symbol, name, phrase, or jingle identified with a company, product, or service. Indefinite life. Cost of developing, maintaining, or enhancing the value of the trademark or trade name (eg. Advertising) is charged to expense. Purchased trademark is an asset.

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P6

Goodwill

Goodwill
Occurs when one company buys another company. Only purchased goodwill is an intangible asset.

Goodwill is not amortized. It is tested each year to determine if there has been any impairment in carrying value.
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Other Intangibles: -Software, -Covenant not-to-compete, -Customer lists, etc.

A2

Total Asset Turnover

Total Asset Turnover = Net Sales Average Total Assets

Provides information about a companys efficiency in using its assets.

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