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Chapter 8 Reporting and Interpreting Property, Plant, and Equipment; Natural Resources; and Intangibles.

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Presentation on theme: "Chapter 8 Reporting and Interpreting Property, Plant, and Equipment; Natural Resources; and Intangibles."— Presentation transcript:

1 Chapter 8 Reporting and Interpreting Property, Plant, and Equipment; Natural Resources; and Intangibles

2 © 2004 The McGraw-Hill Companies McGraw-Hill/Irwin 8-2 Understanding The Business How much is enough? Insufficient capacity results in lost sales. Costly excess capacity reduces profits.

3 © 2004 The McGraw-Hill Companies McGraw-Hill/Irwin 8-3 Tangible Physical Substance Intangible No Physical Substance Expected to Benefit Future Periods Actively Used in Operations Classifying Long-Lived Assets

4 © 2004 The McGraw-Hill Companies McGraw-Hill/Irwin 8-4 Tangible Physical Substance Intangible No Physical Substance Expected to Benefit Future Periods Actively Used in Operations Land Assets subject to depreciation Buildings and equipment Furniture and fixtures Natural resource assets subject to depletion Mineral deposits and timber Examples Classifying Long-Lived Assets

5 © 2004 The McGraw-Hill Companies McGraw-Hill/Irwin 8-5 Tangible Physical Substance Intangible No Physical Substance Expected to Benefit Future Periods Actively Used in Operations Value represented by rights that produce benefits Patents Copyrights Trademarks Franchises Goodwill Subject to amortization Examples Classifying Long-Lived Assets

6 © 2004 The McGraw-Hill Companies McGraw-Hill/Irwin 8-6 Fixed Asset Turnover Net Sales Revenue Average Net Fixed Assets = This ratio measures a company’s ability to generate sales given an investment in fixed assets. For the year 2000, Delta Airlines had $16,741 of revenue. End-of-year fixed assets were $14,840 and beginning-of-year fixed assets were $12,450. (All numbers in millions.)

7 © 2004 The McGraw-Hill Companies McGraw-Hill/Irwin 8-7 Fixed Asset Turnover $16,741 ($14,840 + $12,450) ÷ 2 == 1.23 Fixed Asset Turnover Net Sales Revenue Average Net Fixed Assets =

8 © 2004 The McGraw-Hill Companies McGraw-Hill/Irwin 8-8 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. 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.

9 © 2004 The McGraw-Hill Companies McGraw-Hill/Irwin 8-9 Purchase price Architectural fees Cost of permits Excavation costs Construction costs Purchase price Architectural fees Cost of permits Excavation costs Construction costs Acquisition Cost Buildings

10 © 2004 The McGraw-Hill Companies McGraw-Hill/Irwin 8-10 Purchase price Installation costs Modification to building necessary to install equipment Transportation costs Purchase price Installation costs Modification to building necessary to install equipment Transportation costs Acquisition Cost Equipment

11 © 2004 The McGraw-Hill Companies McGraw-Hill/Irwin 8-11 Purchase price Real estate commissions Title insurance premiums Delinquent taxes Surveying fees Title search and transfer fees Purchase price Real estate commissions Title insurance premiums Delinquent taxes Surveying fees Title search and transfer fees Land is not depreciable. Acquisition Cost Land

12 © 2004 The McGraw-Hill Companies McGraw-Hill/Irwin 8-12 Acquisition for Cash On June 1, Delta Air Lines purchased aircraft for $60,000,000 cash.

13 © 2004 The McGraw-Hill Companies McGraw-Hill/Irwin 8-13 Acquisition for Cash On June 1, Delta Air Lines purchased aircraft for $60,000,000 cash.

14 © 2004 The McGraw-Hill Companies McGraw-Hill/Irwin 8-14 Acquisition for Debt On June 14, Delta Air Lines purchased aircraft for $1,000,000 cash and a $59,000,000 note payable.

15 © 2004 The McGraw-Hill Companies McGraw-Hill/Irwin 8-15 Acquisition for Debt On June 14, Delta Air Lines purchased aircraft for $1,000,000 cash and a $59,000,000 note payable.

16 © 2004 The McGraw-Hill Companies McGraw-Hill/Irwin 8-16 Record at the current market value of the consideration given, or the current market value of the asset acquired, whichever is more clearly evident. Acquisition for Noncash Consideration

17 © 2004 The McGraw-Hill Companies McGraw-Hill/Irwin 8-17 Acquisition for Noncash Consideration On July 7, Delta gave Boeing 400,000 shares of $3 par value common stock with a market value of $85 per share plus $26,000,000 in cash for aircraft.

18 © 2004 The McGraw-Hill Companies McGraw-Hill/Irwin 8-18 Acquisition for Noncash Consideration On July 7, Delta gave Boeing 400,000 shares of $3 par value common stock with a market value of $85 per share plus $26,000,000 in cash for aircraft.

19 © 2004 The McGraw-Hill Companies McGraw-Hill/Irwin 8-19 Acquisition by Construction Asset cost includes: All materials and labor traceable to the construction. A reasonable amount of overhead. Interest on debt incurred during the construction.

20 © 2004 The McGraw-Hill Companies McGraw-Hill/Irwin 8-20 Repairs, Maintenance, and Additions

21 © 2004 The McGraw-Hill Companies McGraw-Hill/Irwin 8-21 Capital and Revenue Expenditures Many companies have policies expensing all expenditures below a certain amount according to the materiality constraint.

22 © 2004 The McGraw-Hill Companies McGraw-Hill/Irwin 8-22 Depreciation is a cost allocation process that systematically and rationally matches acquisition costs of operational assets with periods benefited by their use. Cost Allocation (Unused) Balance Sheet (Used) Income Statement Expense Depreciation Acquisition Cost

23 © 2004 The McGraw-Hill Companies McGraw-Hill/Irwin 8-23 Depreciation Depreciation Expense Income Statement Balance Sheet Accumulated Depreciation Depreciation for the current year Total of depreciation to date on an asset

24 © 2004 The McGraw-Hill Companies McGraw-Hill/Irwin 8-24 Book Values Depreciation on Delta’s 2000 Balance Sheet Book value = Market value /

25 © 2004 The McGraw-Hill Companies McGraw-Hill/Irwin 8-25 The calculation of depreciation requires three amounts for each asset:  Acquisition cost.  Estimated useful life.  Estimated residual value. The calculation of depreciation requires three amounts for each asset:  Acquisition cost.  Estimated useful life.  Estimated residual value. Depreciation Concepts

26 © 2004 The McGraw-Hill Companies McGraw-Hill/Irwin 8-26 Alternative Depreciation Methods  Straight-line  Units-of-production  Accelerated Method: Declining balance  Straight-line  Units-of-production  Accelerated Method: Declining balance

27 © 2004 The McGraw-Hill Companies McGraw-Hill/Irwin 8-27 At the beginning of the year, Delta purchased equipment for $62,500 cash. The equipment has an estimated useful life of 3 years and an estimated residual value of $2,500. Cost - Residual Value Life in Years Depreciation Expense per Year = Straight-Line Method SL

28 © 2004 The McGraw-Hill Companies McGraw-Hill/Irwin 8-28 Depreciation Expense per Year = Depreciation Expense per Year = $20,000 $62,500 - $2,500 3 years Straight-Line Method Cost - Residual Value Life in Years Depreciation Expense per Year = SL

29 © 2004 The McGraw-Hill Companies McGraw-Hill/Irwin 8-29 Residual Value Straight-Line Method SL More than 95 percent of companies use the straight-line method for some or all of their assets disclosed in financial reports.

30 © 2004 The McGraw-Hill Companies McGraw-Hill/Irwin 8-30 Units-of-Production Method Depreciation Rate = Cost - Residual Value Life in Units of Production Step 1: Step 2: Depreciation Expense = Depreciation Rate × Number of Units Produced for the Year

31 © 2004 The McGraw-Hill Companies McGraw-Hill/Irwin 8-31 Units-of-Production Method At the beginning of the year, Delta purchased ground equipment for $62,500 cash. The equipment has a 100,000 mile useful life and an estimated residual value of $2,500. If the equipment is used 30,000 miles in the first year, what is the amount of depreciation expense?

32 © 2004 The McGraw-Hill Companies McGraw-Hill/Irwin 8-32 Units-of-Production Method $62,500 - $2, ,000 miles = $.60 per mile Depreciation Rate = Step 1: Step 2: $.60 per mile × 30,000 miles = $18,000 Depreciation Expense =

33 © 2004 The McGraw-Hill Companies McGraw-Hill/Irwin 8-33 Units-of-Production Method

34 © 2004 The McGraw-Hill Companies McGraw-Hill/Irwin 8-34 Residual Value Units-of-Production Method

35 © 2004 The McGraw-Hill Companies McGraw-Hill/Irwin 8-35 Accelerated Depreciation DepreciationRepair Expense Early YearsHighLow Later YearsLowHigh Accelerated depreciation matches higher depreciation expense with higher revenues in the early years of an asset’s useful life when the asset is more efficient.

36 © 2004 The McGraw-Hill Companies McGraw-Hill/Irwin 8-36 Double-Declining-Balance Method Annual Depreciation expense Net Book Value () Useful Life in Years 2 = × Cost – Accumulated Depreciation Declining balance rate of 2 is double-declining-balance (DDB) rate. Annual computation ignores residual value.

37 © 2004 The McGraw-Hill Companies McGraw-Hill/Irwin 8-37 At the beginning of the year, Delta 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. Double-Declining-Balance Method

38 © 2004 The McGraw-Hill Companies McGraw-Hill/Irwin 8-38 Annual Depreciation expense Net Book Value () Useful Life in Years 2 = × () $62,500 × 3 years 2 = $41,667 () ($62,500 – $41,667) × 3 years 2 = $13,889 Double-Declining-Balance Method Year 1 Depreciation: Year 2 Depreciation:

39 © 2004 The McGraw-Hill Companies McGraw-Hill/Irwin 8-39 () ($62,500 – $55,556) × 3 years 2 = $4,629 Below residual value Double-Declining-Balance Method

40 © 2004 The McGraw-Hill Companies McGraw-Hill/Irwin 8-40 Depreciation expense is limited to the amount that reduces book value to the estimated residual value. Double-Declining-Balance Method

41 © 2004 The McGraw-Hill Companies McGraw-Hill/Irwin 8-41 For tax purposes, most corporations use the Modified Accelerated Cost Recovery System (MACRS). MACRS depreciation provides for rapid write-off of an asset’s cost in order to stimulate new investment. For tax purposes, most corporations use the Modified Accelerated Cost Recovery System (MACRS). MACRS depreciation provides for rapid write-off of an asset’s cost in order to stimulate new investment. Depreciation and Federal Income Tax

42 © 2004 The McGraw-Hill Companies McGraw-Hill/Irwin 8-42 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.

43 © 2004 The McGraw-Hill Companies McGraw-Hill/Irwin 8-43 Asset Impairment Impairment is the loss of a significant portion of the utility of an asset through... Casualty. Obsolescence. Lack of demand for the asset’s services. A loss should be recognized when an asset suffers a permanent impairment.

44 © 2004 The McGraw-Hill Companies McGraw-Hill/Irwin 8-44 Voluntary disposals: Sale Trade-in Retirement Involuntary disposals: Fire Accident Disposal of Property, Plant, and Equipment

45 © 2004 The McGraw-Hill Companies McGraw-Hill/Irwin 8-45 Disposal of Property, Plant, and Equipment  Update depreciation to the date of disposal.  Journalize disposal by: Writing off accumulated depreciation (debit). Writing off the asset cost (credit). Recording cash received (debit) or paid (credit). Recording a gain (credit) or loss (debit).

46 © 2004 The McGraw-Hill Companies McGraw-Hill/Irwin 8-46 If Cash > BV, record a gain (credit). If Cash < BV, record a loss (debit). If Cash = BV, no gain or loss. Disposal of Property, Plant, and Equipment

47 © 2004 The McGraw-Hill Companies McGraw-Hill/Irwin 8-47 Delta Airlines sold flight equipment for $5,000,000 cash at the end of its 17th year of use. The flight equipment originally cost $20,000,000, and was depreciated using the straight-line method with zero salvage value and a useful life of 20 years. Disposal of Property, Plant, and Equipment

48 © 2004 The McGraw-Hill Companies McGraw-Hill/Irwin 8-48 The amount of depreciation recorded at the end of the 17th year to bring depreciation up to date is: a.$0. b.$1,000,000. c.$2,000,000. d.$4,000,000. The amount of depreciation recorded at the end of the 17th year to bring depreciation up to date is: a.$0. b.$1,000,000. c.$2,000,000. d.$4,000,000. Disposal of Property, Plant, and Equipment

49 © 2004 The McGraw-Hill Companies McGraw-Hill/Irwin 8-49 The amount of depreciation recorded at the end of the 17th year to bring depreciation up to date is: a.$0. b.$1,000,000. c.$2,000,000. d.$4,000,000. The amount of depreciation recorded at the end of the 17th year to bring depreciation up to date is: a.$0. b.$1,000,000. c.$2,000,000. d.$4,000,000. Annual Depreciation: ($20,000,000 - $0) ÷ 20 Years. = $1,000,000 Disposal of Property, Plant, and Equipment

50 © 2004 The McGraw-Hill Companies McGraw-Hill/Irwin 8-50 After updating the depreciation, the equipment’s book value at the end of the 17th year is: a.$3,000,000. b.$16,000,000. c.$17,000,000. d.$4,000,000. After updating the depreciation, the equipment’s book value at the end of the 17th year is: a.$3,000,000. b.$16,000,000. c.$17,000,000. d.$4,000,000. Disposal of Property, Plant, and Equipment

51 © 2004 The McGraw-Hill Companies McGraw-Hill/Irwin 8-51 After updating the depreciation, the equipment’s book value at the end of the 17th year is: a.$3,000,000. b.$16,000,000. c.$17,000,000. d.$4,000,000. After updating the depreciation, the equipment’s book value at the end of the 17th year is: a.$3,000,000. b.$16,000,000. c.$17,000,000. d.$4,000,000. Accumulated Depreciation = (17yrs. × $1,000,000) = $17,000,000 BV = Cost - Accumulated Depreciation BV = $20,000,000 - $17,000,000 = $3,000,000 Disposal of Property, Plant, and Equipment

52 © 2004 The McGraw-Hill Companies McGraw-Hill/Irwin 8-52 The equipment’s sale resulted in: a.a gain of $2,000,000. b.a gain of $3,000,000. c.a gain of $4,000,000. d.a loss of $2,000,000. The equipment’s sale resulted in: a.a gain of $2,000,000. b.a gain of $3,000,000. c.a gain of $4,000,000. d.a loss of $2,000,000. Disposal of Property, Plant, and Equipment

53 © 2004 The McGraw-Hill Companies McGraw-Hill/Irwin 8-53 The equipment’s sale resulted in: a.a gain of $2,000,000. b.a gain of $3,000,000. c.a gain of $4,000,000. d.a loss of $2,000,000. The equipment’s sale resulted in: a.a gain of $2,000,000. b.a gain of $3,000,000. c.a gain of $4,000,000. d.a loss of $2,000,000. Gain = Cash Received - Book Value Gain = $5,000,000 - $3,000,000 = $2,000,000 Disposal of Property, Plant, and Equipment

54 © 2004 The McGraw-Hill Companies McGraw-Hill/Irwin 8-54 Prepare the journal entry to record Delta’s sale of the equipment at the end of the 17th year. Disposal of Property, Plant, and Equipment

55 © 2004 The McGraw-Hill Companies McGraw-Hill/Irwin 8-55 Disposal of Property, Plant, and Equipment Prepare the journal entry to record Delta’s sale of the equipment at the end of the 17th year.

56 © 2004 The McGraw-Hill Companies McGraw-Hill/Irwin 8-56 Natural Resources Depletion is like depreciation. Total cost of asset is the cost of acquisition, exploration, and development. Total cost is allocated over periods benefited by means of depletion.

57 © 2004 The McGraw-Hill Companies McGraw-Hill/Irwin 8-57 Intangible Assets Noncurrent assets without physical substance. Useful life is often difficult to determine. Usually acquired for operational use. Often provide exclusive rights or privileges. Intangible Assets

58 © 2004 The McGraw-Hill Companies McGraw-Hill/Irwin 8-58 Goodwill Trademarks Patents Copyrights Franchises Leaseholds Record at current cash equivalent cost, including purchase price, legal fees, and filing fees. Intangible Assets

59 © 2004 The McGraw-Hill Companies McGraw-Hill/Irwin 8-59 Amortize over shorter of economic life or legal life, subject to rules specified by GAAP. Use straight-line method. Research and development costs are normally expensed as incurred. Amortize over shorter of economic life or legal life, subject to rules specified by GAAP. Use straight-line method. Research and development costs are normally expensed as incurred. Intangible Assets

60 © 2004 The McGraw-Hill Companies McGraw-Hill/Irwin 8-60 Occurs when one company buys another company. The amount by which the purchase price exceeds the fair market value of net assets acquired. Only purchased goodwill is an intangible asset. Intangible Assets Goodwill Goodwill

61 © 2004 The McGraw-Hill Companies McGraw-Hill/Irwin 8-61 Not amortized. Subject to assessment for impairment value and may be written down. Goodwill Intangible Assets Goodwill

62 © 2004 The McGraw-Hill Companies McGraw-Hill/Irwin 8-62 Intangible Assets Goodwill Eddy Company paid $1,000,000 to purchase all of James Company’s assets and assumed liabilities of $200,000. The acquired assets were appraised at a fair value of $900,000.

63 © 2004 The McGraw-Hill Companies McGraw-Hill/Irwin 8-63 What amount of goodwill should be recorded on Eddy Company books? a.$100,000 b.$200,000 c.$300,000 d.$400,000 What amount of goodwill should be recorded on Eddy Company books? a.$100,000 b.$200,000 c.$300,000 d.$400,000 Intangible Assets Goodwill

64 © 2004 The McGraw-Hill Companies McGraw-Hill/Irwin 8-64 What amount of goodwill should be recorded on Eddy Company books? a.$100,000 b.$200,000 c.$300,000 d.$400,000 What amount of goodwill should be recorded on Eddy Company books? a.$100,000 b.$200,000 c.$300,000 d.$400,000 Intangible Assets Goodwill

65 © 2004 The McGraw-Hill Companies McGraw-Hill/Irwin 8-65 A symbol, design, or logo associated with a business. Purchased trademarks are recorded at cost. Internally developed trademarks have no recorded asset cost. Intangible Assets Trademarks

66 © 2004 The McGraw-Hill Companies McGraw-Hill/Irwin 8-66 Intangible Assets Patents Exclusive right granted by 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.

67 © 2004 The McGraw-Hill Companies McGraw-Hill/Irwin 8-67 Intangible Assets Copyrights Exclusive right granted by the federal government to protect artistic or intellectual properties. Amortize cost over the period benefited. Legal life is life of creator plus 70 years.

68 © 2004 The McGraw-Hill Companies McGraw-Hill/Irwin 8-68 Legally protected right to sell products or provide services purchased by franchisee from franchisor. Purchase price is an intangible asset that is amortized. Intangible Assets Franchises

69 © 2004 The McGraw-Hill Companies McGraw-Hill/Irwin 8-69 Intangible Assets Leaseholds A lease is a contract to use property granted by lessor to lessee and rights granted under the lease are called a leasehold. A leasehold is recorded only if advance payment is involved. Otherwise periodic payments are rent expense. A lease is a contract to use property granted by lessor to lessee and rights granted under the lease are called a leasehold. A leasehold is recorded only if advance payment is involved. Otherwise periodic payments are rent expense.

70 © 2004 The McGraw-Hill Companies McGraw-Hill/Irwin 8-70 Long-lived alterations made by lessee to leased property. Intangible Assets Leasehold Improvements Leasehold improvements are recorded at cost and amortized over their useful life.

71 © 2004 The McGraw-Hill Companies McGraw-Hill/Irwin 8-71 This computer is about to become fully depreciated! End of Chapter 8


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