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Long-term Assets

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Types of Long-Term Assets n Property, plant, and equipment –Long-term assets acquired for use in operations n Natural resources –Long-term assets with a value that decreases through use or sale

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Types of Long-Term Assets n Intangible assets –Long-term assets that do not have physical substance

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Plant Asset Cost Purchase price (less cash discount)

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Plant Asset Cost Purchase price (less cash discount) plus all other reasonable and necessary expenditures

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Plant Asset Cost Purchase price (less cash discount) plus all other reasonable and necessary expenditures to prepare the asset for use

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Examples of Items Included n Purchase price less any cash discount n Shipping costs n Installation costs n Cost of modifications n Interest cost during construction

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Depreciation n Allocation of the cost of an asset to the periods the asset benefits n Not a valuation process

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Factors in Estimating Depreciation n Initial cost n Estimated residual value n Estimated Useful Life

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Depreciation Methods n Straight-line –allocate an equal amount to each period n Production unit –depreciation based on volume of output

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Accelerated Depreciation Methods n Double Declining-balance –apply a uniform rate to a declining amount (book value) n Sum-of-the-Years’-Digits –annual amount the decreases by a constant amount

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Example Data n Depreciable Asset - Truck n Invoice price$20,000 n Cash discount2% n Modifications $3,400 n Estimated residual value$2,000 n Useful life - 4 years or 200,000 miles n Acquisition date - January 8, 19X1

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Cost of Truck n Invoice price$20,000 n Less: Cash discount400 n subtotal$19,600 n Modification3,400 n Cost$23,000

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Straight-Line Method Cost - Est. Residual Value Est. Useful Life = Depreciation Expense

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Straight-Line Method ExpenseAccum 19X1: ($23,000 - $2,000) / 4$5,250$5,250 19X2: ($23,000 - $2,000) / 4$5,250$10,500 19X3: ($23,000 - $2,000) / 4$5,250$15,750 19X4: ($23,000 - $2,000) / 4$5,250$21,000

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Production Units Method Cost - Est. Residual Value Est. Useful Life in Units = Depreciation Expense per Unit Depreciation Expense per Unit X Units Produced = Depreciation Expense

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Production Units Method Exp Accum ($23,000 - $2,000) / 200,000 = $0.105 per mile 19X1: 50,000 miles X $0.105$5,250$5,250 19X2: 40,000 miles x $0.105$4,200$9,450 19X3: 60,000 miles x $0.105$6,300$15,750 19X4: 10,000 miles x $0.105$1,050$16,800 19X5: 20,000 miles x $0.105$2,100$18,900 19X6: 20,000 miles x $0.105$2,100$21,000

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Double-Declining Balance n Calculate a straight-line rate ›1 divided by estimated useful life n Multiply straight-line rate by 2 n Multiply previous asset book value by doubled rate

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Double-Declining Balance Exp Accum 19X1: ($23,000 - $0) x (2)(1/4)$11,500$11,500 19X2: ($23,000 - $11,500) x.5$5,750$17,250 19X3: ($23,000 - $17,250) x.5$2,875$20,125 19X4: ($23,000 - $20,125) x.5$1,438$21,623 overdepreciated

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Double-Declining Balance Exp Accum 19X1: ($23,000 - $0) x (2)(1/4)$11,500$11,500 19X2: ($23,000 - $11,500) x.5$5,750$17,250 19X3: ($23,000 - $17,250) x.5$2,875$20,125 19X4: ($23,000 - $20,125) x.5$1,438$21,623 overdepreciated 19X4: ($23,000 - $2,000) - $20,125 $875$21,000

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Double-Declining Balance Exp Accum 19X1: ($23,000 - $0) x (2)(1/4)$11,500$11,500 19X2: ($23,000 - $11,500) x.5$5,750$17,250 19X3: ($23,000 - $17,250) x.5$2,875$20,125 19X4: ($23,000 - $2,000) - $20,125 $875$21,000

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Sum-of-the-Years’-Digits (Cost - Est. Residual Value)x Individual Year (reverse order) Sum of Years’ Digits

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Sum-of-the-Years’-Digits n Calculating sum of years’ digits n Add the numeric digits in useful life n Example ›1 + 2 + 3 + 4 = 10

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Sum-of-the-Years’-Digits Exp Accum 19X1: ($23,000 - $2,000) x 4/10$8,400$ 8,400 19X2: ($23,000 - $2,000) x 3/10$6,300$14,700 19X3: ($23,000 - $2,000) x 2/10$4,200$18,900 19X4: ($23,000 - $2,000) x 1/10$2,100$21,000

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Pattern of depreciation expense n Straight-line –Amount is constant and equal n Production –Amount varies depending on usage

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Pattern of depreciation expense n Double declining –Amount is decreasing by decreasing amounts n Sum-of-the-Year’s-Digits –Amount is decreasing by constant amount

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Comparison of Depreciation Straight-lineProduction

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Double-declining balance Sum-of-the-Years’ Digits

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Modified Accelerated Cost Recovery System - MACRS n Income tax reporting method n Applies to tangible property placed in service after 1986 n Eight cost recovery classes with rates for each year n Tax deduction equals cost times appropriate rate for each year

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Revenue and Capital Expenditures n Revenue expenditure –Benefits only the current accounting period n Capital expenditure –Significant costs that benefit two more accounting periods

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Capital Expenditures n Additions –Enhance usefulness by enlarging asset –Debited to asset n Betterments –Increase or improve services –Debited to asset

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Capital Expenditures n Extraordinary repairs –Significant expenditures that extend useful life or change residual value –Debited to accumulated depreciation n In all capital expenditures –Depreciate increased book value over remaining useful life

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Disposal of Plant Assets n Sale n Retirement n Exchange

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Accounting for Disposal n Remove asset cost and related accumulated depreciation from the records n Book value is cost - accum deprec n Determine gain or loss on disposal n Gain –Received more than book value n Loss –Received less than book value

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Sales or Retirements n Always recognize any gain or loss

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Exchanges n Always recognize loss n Recognize gain only if exchange of dissimilar assets n If gain on exchange of similar assets –Reduce cost of new asset by gain

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Natural Resources n Mineral deposits, oil reserves, timber tracts n Consumption has a cost –Recognize depletion by production method

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Intangible Assets n Long-term rights that have future value n Patents, R&D, Goodwill n Consumption has a cost –Recognize amortization by straight- line method

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Analyzing Information n Are methods, asset lives, and residual values used reasonable? n If methods, lives, or residual values are changed during year, what is impact on net income? n If some interest cost was capitalized, what is total interest cost for period? –How would this change ratio “Times Interest Earned”?

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Times Interest Earned n Net income + Income Tax Expense + Total Interest Cost n divided by n Total Interest Cost

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