chapter 8 long-term assets. conceptual learning objectives chapter 8: self-study c1: describe plant...

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 company’s 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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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

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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

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Land Land is not a depreciable Asset

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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).

Land ImprovementsLand is not a depreciable Asset, but Land Improvements are.

8-8

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.

Cost of purchase or construction

Cost of purchase or construction

Brokeragefees

Brokeragefees

TaxesTaxes

Title feesTitle fees

Attorney feesAttorney fees

Buildings

The cost of buildings include many costs; the purchase price plus the following:

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Purchaseprice

Purchaseprice

Installing,assembling, and

testing

Installing,assembling, and

testing

Insurance whilein transit

Insurance whilein transit

TaxesTaxes

Transportationcharges

Transportationcharges

Machinery and Equipment

8-10

Exercise 2

Exercise 1

Quick Study 1

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?

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?

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

8-12

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

8-13

Exercise 3

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

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The calculation of depreciation requires three amounts for each asset:

1. Cost $50,000

2. Salvage Value $5,000

3. Useful Life 5 Years

Factors in Computing Depreciation

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1. Straight-line

2. Units-of-production

3. Declining-balance

Depreciation MethodsC 2

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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

8-18

Depreciation AccumulatedExpense Depreciation Accumulated Book

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

2009 9,000$ 9,000$ 9,000$ 41,000 2010 9,000 9,000 18,000 32,000 2011 9,000 9,000 27,000 23,000 2012 9,000 9,000 36,000 14,000 2013 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

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Exercise 6

Depreciation RepairExpense Expense

Early Years High Low

Later Years Low High

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

Declining Balance MethodP2

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Double-Declining-Balance Method

Step 2:

Double-decliningbalance rate

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

Step 1:

Straight-line rate = 100 % ÷ Useful life = 100% ÷ 5 = 20%

Step 3:Depreciation

expense= Double-declining

balance rate×

Beginning periodbook value

$20,000 for 2009 = 40% × $50,000

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2009 Depreciation:

40% × $50,000 = $20,000

Double-Declining-Balance Method

2010 Depreciation:

40% × ($50,000 - $20,000) = $12,000

P2

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Depreciation Accumulated BookYear Expense Depreciation Value

50,000$ 2009 20,000$ 20,000$ 30,000 2010 12,000 32,000 18,000 2011 7,200 39,200 10,800 2012 4,320 43,520 6,480 2013 2,592 46,112 3,888

46,112$ Below salvage value

Double-Declining-Balance MethodP2

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Depreciation Accumulated BookYear Expense Depreciation Value

50,000$ 2009 20,000$ 20,000$ 30,000 2010 12,000 32,000 18,000 2011 7,200 39,200 10,800 2012 4,320 43,520 6,480 2013 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

8-25

Exercise 5

Exercise 8

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

8-27

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, whatis the amount of depreciation expense?

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, whatis the amount of depreciation expense?

Units-of-Production MethodP2

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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


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Depreciation Accumulated BookYear Units Expense Depreciation Value

50,000$ 2009 22,000 9,900$ 9,900$ 40,100 2010 28,000 12,600 22,500 27,500 2011 - - 22,500 27,500 2012 32,000 14,400 36,900 13,100 2013 18,000 8,100 45,000 5,000

100,000 45,000$

No depreciation expense if the equipment is idle.


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Exercise 7

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

8-32

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

8-33

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.

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

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

= $7,000 for all 2009

Depreciation = $7,000 × 6/12 = $3,500

Partial-Year Depreciation: SLD

8-34

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.

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

Depreciation = $75,000 x 20%; => (1/10) * 2

= $15,000 for all 2009

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

Partial-Year Depreciation: DDB

8-35

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??

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

1st Year Depreciation = $15,000 × 6/12 = $7,500;

2nd Year Depreciation = $(75,000 – 7,500) x 20%;

= $13,500 for all 2010

Partial-Year Depreciation: DDB

8-36

Exercise 9

Exercise 10

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.

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.

Change in Estimates for Depreciation

Book value at date of change

Salvage value at date of change

Remaining useful life at date of change

–

8-38

Change in Estimates for Depreciation

Asset cost 30,000$ Accumulated depreciation, 12/31/2011 ($3,000 per year × 3 years) 9,000 Remaining book value 21,000$ 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 2012

C 3

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Exercise 11:

-Calculate BV at the end of 2nd year;

-Subtract NEW Salvage Value;

-Depreciate using NEW Useful Life.

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

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Revenue and Capital Expenditures

Type of Capital orExpenditure 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.

Capital 1. Major overhauls or partialExpenditures replacements.

2. Extends life beyond original estimate.

Betterments and

Extraordinary Repairs

P3

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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

8-43

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 Year’s Depreciation =New Book value / New useful Life

Recording cashreceived (debit)or paid (credit).


Removing accumulateddepreciation (debit).


1. Update depreciation to the date of disposal.

4. Record (Journalize) disposal by: 4. Record (Journalize) disposal by:

Removing the asset cost (credit).


3. Recording again (credit)

or loss (debit).

3. Recording again (credit)

or loss (debit).

Disposals of Plant Assets

8-45

2. Calculate BV @ date of Disposal 2. Calculate BV @ date of Disposal

Update depreciation to the date of disposal.

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

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

If Cash = BV, no gain or loss.

Discarding Plant Assets







Recording again (credit)

or loss (debit).

Recording again (credit)

or loss (debit).

8-46

Journalize disposal by:

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.

8-47

1. UPDATE DEPRECIATION (Partial Year)

2. CALCULATE BV = (Cost – AD)

3. CALCULATE GAIN (LOSS) = (Cash – BV)

4. JOURNALIZE DISPOSAL

Disposal of Assets

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

Depreciation to September 30, 2009:9/12 × $8,000 = $6,000

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

Depreciation to September 30, 2009:9/12 × $8,000 = $6,000

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

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

8-48

1. Update depreciation to the date of disposal

2. Determine Book Value of Asset

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

Book Value 70,000$

8-49

3. 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.

8-50

Record the Disposal (Journalize)

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

8-51

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.


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.


Step 2:DepletionExpense =

DepletionPer Unit

×Units Extracted

and Sold in Period

DepletionPer Unit

= Cost - Salvage Value Total Units of Capacity

Step 1:

P5

8-55

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

8-56

Step 2: Depletion Expense

= $25 per ton × 13,000 Tons = $325,000

Step 1:DepletionPer Unit

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

= $25 per ton

Depletion ExpenseP5

8-57

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.

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

8-59

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

8-60

Types of Intangibles

Patents

Matrix, 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

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.

8-61


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

8-62


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.

P6

8-63

Types of IntangiblesP6

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.

8-64

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

8-65

Other Intangibles:

-Software, -Covenant not-to-compete, -Customer lists, etc.

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 TurnoverA2

8-67

chapter 8 long-term assets. conceptual learning objectives chapter 8: self-study c1: describe plant...

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