1. Accounting Fundamentals Dr. Yan Xiong Department of Accountancy CSU Sacramento The lecture notes are primarily based on Reimers (2003). 7/11/02

2. Chapter 5: Acquisitions Agenda  Acquisition costs of long-term assets  Depreciation  Asset Disposal  Depletion and Amortization

3. Classification of Operational Assets t Operational assets are assets used by a business to generate revenue. t Difference between Operational assets and Inventory

4. Agenda t Acquisition Costs of Long-term Assets

5. Long-term Operational Assets... t Long-term assets will be used more than one year. t Tangible operational assets have physical substance. u Land, buildings, fixtures, and equipment u Natural resources t Tangible operational assets are reported on the balance sheet in a classification called Property, Plant, and Equipment.

6. Classification of Operational Assets Classification of Operational Assets t Intangible operational assets lack physical substance and confer specific use rights on the owner. p Patents p Copyrights p Franchises p Licenses p Trademarks

7. Purchased operational assets are recorded at cost, an amount that includes all normal and reasonable expenditures necessary to get the asset in place and ready for its intended use. Invoice price p Sales taxes p Transportation costs p Installation costs p Renovation and repair cost incurred prior to use. Measuring and Recording Acquisition Cost

8. t Financing charges are excluded from the acquisition cost but should be reported as interest expense. Measuring Acquisition Cost

9. t The cost of land includes: u Acquisition price u Real estate commissions u Title search and transfer fees u Title insurance premiums u Delinquent taxes u Surveying fees t Land is not depreciated. Measuring Acquisition Cost

10. When land and building are purchased together, the land cost and the building cost are placed in separate accounts. When land and building are purchased together, the land cost and the building cost are placed in separate accounts. The total cost of the purchase is separated on the basis of relative market values. Basket Purchase of Acquisitions

11. Example: On March 1, Arco Co. purchased land and building for $200,000 cash. The appraised value of the building was $172,500, and the land was appraised at $57,500. How much of the $200,000 purchase price will be allocated to each account? Example: On March 1, Arco Co. purchased land and building for $200,000 cash. The appraised value of the building was $172,500, and the land was appraised at $57,500. How much of the $200,000 purchase price will be allocated to each account? Basket Purchase of Acquisitions

12. Fair Market Values: Building$ 172,500 Land$ 57,500 Total market value$ 230,000 Allocation of cost: Building* $200,000 = Land* $200,000 = Basket Purchase of Acquisitions

13. Fair Market Values: Building$ 172,500 Land$ 57,500 Total market value$ 230,000 Allocation of cost: Building172,500/230,000* $200,000 = Land 57,500/230,000 * $200,000 = Basket Purchase of Acquisitions

14. Fair Market Values: Building$ 172,500 Land$ 57,500 Total market value$ 230,000 Allocation of cost: Building.75* $200,000 = 150,000 Land.25 * $200,000 = 50,000 Basket Purchase of Acquisitions

15. t How would the acquisition of the land and building be recorded in the journal? DateTransaction DebitCredit Mar 1 Land 50,000 Building 150,000 Cash200,000

16. Agenda t Depreciation

17. Nature of Depreciation, Depletion, and Amortization The matching principle requires that part of the acquisition cost be expensed in periods when the future revenues are earned. Cost of asset on Balance Sheet...as the asset is used..... Expense on Income Statement [capitalize] [expense]

18. Terminology: Write-off….amortize t Amortization: u Intangible assets t Depreciation: u Property, plant, equipment franchise l Depletion: –Natural resources The most general term for writing off an asset is amortization amortization. However, specific terms are used for certain assets:

19. Depreciation Methods p Straight-line p Production method p (Double) Declining balance

20. Cost - Residual Value Life in Years Depreciation Expense per Year = Straight-Line Method

21. On January 1, 2003, equipment was purchased for $55,000 cash. The equipment has an estimated useful life of 5 years and an estimated residual value of $10,000. What is the annual straight-line depreciation expense? Straight-Line Method: Example

22. Depreciation Expense per Year = Depreciation Expense per Year = Cost - Residual Value Life in Years Depreciation Expense per Year = 55,000 - 10,000 5 9,000 Straight-Line Method: Example

23. Calculate depreciation expense for the fourth year of the asset’s life. $9000 Depreciation expense is the same amount each year of the asset’s life using the straight-line method. Straight-Line Method: Example

24. t How would each year’s depreciation be recorded in the journal? DateTransaction DebitCredit Dec 31 Depreciation expense 9,000 Accumulated depreciation9,000

25. Units-of-Production Method Depreciation Rate Rate= Cost - Residual Value Cost - Residual Value Estimated units of useful life Step 1: Step 2: Depreciation Expense = Depreciation Rate × Number of Units Produced for the Year

26. Given the same information [asset cost $55,000, a residual value of $10,000, and a useful life of five years] plus the asset is estimated to have a total productive capacity of 100,000 units during the useful life: If 22,000 units were produced this year, what is the amount of depreciation expense? Given the same information [asset cost $55,000, a residual value of $10,000, and a useful life of five years] plus the asset is estimated to have a total productive capacity of 100,000 units during the useful life: If 22,000 units were produced this year, what is the amount of depreciation expense? Units of Production Method: Example

27. Step 1: Step 2: Depreciation Expense = $.45/unit* 22,000 = 9,900 Depreciation Rate Rate = = Cost – Residual value Estimated Units produced 45,000 100,000 Dep. rate * units produced Production Method: Example

28. t How would the first year’s depreciation be recorded in the journal? DateTransaction DebitCredit Dec 31 Depreciation expense 9,900 Accumulated depreciation9,900

29. t If 15,000 units are produced during the second year of the asset’s life, what is the amount of depreciation expense?.45 * 675015000 = Production Method: Example

30. t How would the second year’s depreciation be recorded in the journal? DateTransaction DebitCredit Dec 31 Depreciation expense 6,750 Accumulated depreciation6,750

31. t Accelerated depreciation methods result in more depreciation expense in the early years of an asset’s useful life and less depreciation expense in later years of the an asset’s useful life. Accelerated Depreciation

32. Double-Declining Balance Method t Declining-balance depreciation is based on the straight-line rate multiplied by an acceleration factor. u For example, when the acceleration factor is 200 percent, the method is referred to as double-declining balance depreciation. t Declining-balance depreciation computations ignore residual value, although the asset can’t be depreciated below the residual value.

33. The annual depreciation amount is calculated with the following formula: Book Value × (2 / useful life in years) First, calculate a rate by dividing 2 by the number of years of useful life. = Double-Declining Balance Method

34. Annual depreciation expense is calculated with the following formula: () Book Value × Useful Life in Years 2 Double-Declining Balance Method

35. Using the same information from our earlier example [asset cost $55,000, residual value is $10,000, and useful life is 5 years]: Calculate the depreciation expense for the first two years of the asset’s life. Double-Declining-Balance Example

36. First year’s depreciation: 55,000 *.40 = 22,000 Rate = 2/5 = 40%

37. Double-Declining-Balance Example t How would the first year’s depreciation be recorded in the journal? DateTransaction DebitCredit Dec 31 Depreciation expense 22,000 Accumulated depreciation22,000

38. Double-Declining-Balance Example First year’s depreciation: Second year’s depreciation: 55,000 *.40 = 22,000 33,000 *.40 = 13,200 Rate = 2/5 = 40%

39. Double-Declining-Balance Example t How would the second year’s depreciation be recorded in the journal? DateTransaction DebitCredit Dec 31 Depreciation Expense 13,200 Accumulated Depreciation13,200

40. t The total amount of depreciation recorded over the useful life of an asset is the same regardless of the method used. t Depreciation expense recorded in any one period will vary according to method used. t The straight-line method is used by about 95 percent of companies because it is easy to use and to explain. Comparison of Methods

41. Revising Estimates of Salvage Value or of Useful Life t When an estimate is revised, no changes are made to amounts reported in the past. t The new estimates are incorporated into the present and future calculations only. t Depreciation amounts are revised using the book value and the estimated useful life and salvage value at beginning of the year of the revision.

42. Continuing Expenditures for Plant Assets t Expenditures made to keep an asset in good working order are expensed in the period in which they are incurred. t Substantial costs spent to improve the quality or extend the life of an asset are capitalized.

43. Agenda t Asset Disposal

44. t Voluntary disposal refers to situations where a business gives up ownership of an asset by: u Sale u Trade-in u Retirement t Involuntary disposal results because of a casualty such as a fire or an accident. Disposal of Operational Assets

45. 1.Update the depreciation on the asset to the date of disposal. 2. Compare the book value of the asset to the cash proceeds from the disposal. If the proceeds > book value, there is a gain on the disposal. If the book value > proceeds, then there is a loss on the sale. 3. Gains and losses go on the income statement. Disposal of Operational Assets

46. t On Jun 1, a Truck which was purchased for $10,000 and with accumulated depreciation of $8,000 was sold for $3,000. Asset Disposal: Example

47. t Compare the Book Value (10,000-8,000) to the cash proceeds (3,000). t The difference is a gain or loss on the sale. t This sale results in a gain: Proceeds of $3,000 > BV of $2,000 t Gain of $1,000 goes to the income statement.

48. Asset Disposal: Gain recognized t How would the sale of the truck be recorded in the journal? DateTransaction DebitCredit Jun 1 Cash 3,000 Accumulated depreciation8,000 Gain on sale of truck 1,000 Truck 10,000

49. t On Jun 1, a Truck which was purchased for $10,000 and with accumulated depreciation of $8,000 was sold for $1,000. Asset Disposal: Example

50. l Compare the Book Value (10,000-8,000) to the cash proceeds (1,000). l The difference is a gain or loss on the sale. l Here the sale results in a loss: Book value of $2,000 > Proceeds of $1,000 l Loss on disposal of $1,000 goes to the income statement.

51. Asset Disposal: Loss recognized t How would the sale of the truck be recorded in the journal? DateTransaction DebitCredit Jun 1 Cash 1,000 Accumulated depreciation8,000 Loss on sale of truck 1,000 Truck 10,000

52. Compare cash received for the asset with the asset’s book value (BV). u If cash greater than BV, record a gain. u If cash less than BV, record a loss. u If cash equals BV, no gain or loss. asset for sale Disposal of Operational Assets

53. Agenda t Depletion and Amortization

54. t Assets supplied by nature u Examples: gold, oil, and coal t Presented on balance sheet as non-current assets at cost less depletion to date. t Depletion is just like “units of production” depreciation. Natural Resources

55. t Total cost of the asset is the cost of acquisition, exploration and development. t Total cost is apportioned by means of depletion over periods in which resulting revenues are earned. Natural Resources

56. A depletion rate is calculated using the units-of-production method. Depletion Cost Per Unit Is Calculated As Follows: Total Cost of Natural Resource Estimated Number of Available Units of Natural Resource Natural Resources

57. t Noncurrent assets without physical substance that confer certain rights and privileges on the owner of the asset. u Examples: patents, copyrights, franchises and licenses, leaseholds, leasehold improvements, trademarks, and goodwill. t Purchased intangible assets are recorded at cost. Intangible Assets

58. t Purchased intangible assets are amortized over the shorter of their economic life or legal life, subject to a maximum of 40 years. t Normally the straight-line method is used and the asset is reported in the balance sheet at book value without a related accumulated amortization account. Intangible Assets

59. t A patent is an exclusive right granted by federal government to sell or manufacture an invention. t A patent is amortized over the shorter of its useful life or 17-year legal life. Intangible Assets: Patents