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8-1 PowerPoint Authors: Susan Coomer Galbreath, Ph.D., CPA Charles W. Caldwell, D.B.A., CMA Jon A. Booker, Ph.D., CPA, CIA Cynthia J. Rooney, Ph.D., CPA.

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Presentation on theme: "8-1 PowerPoint Authors: Susan Coomer Galbreath, Ph.D., CPA Charles W. Caldwell, D.B.A., CMA Jon A. Booker, Ph.D., CPA, CIA Cynthia J. Rooney, Ph.D., CPA."— Presentation transcript:

1 8-1 PowerPoint Authors: Susan Coomer Galbreath, Ph.D., CPA Charles W. Caldwell, D.B.A., CMA Jon A. Booker, Ph.D., CPA, CIA Cynthia J. Rooney, Ph.D., CPA Reporting and Interpreting Property, Plant, and Equipment; Natural Resources; and Intangibles Chapter 08 McGraw-Hill/Irwin Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.

2 8-2 Understanding The Business How much is enough? Insufficient capacity results in lost sales. Costly excess capacity reduces profits.

3 8-3 Tangible Physical Substance Intangible No Physical Substance Expected to Benefit Future Periods Actively Used in Operations Classifying Long-Lived Assets

4 8-4 Tangible Physical Substance Intangible No Physical Substance Classifying Long-Lived Assets Land Assets subject to depreciation Buildings and equipment Furniture and fixtures Natural resource assets subject to depletion Mineral deposits and timber Definite life Patents Copyrights Franchises Indefinite life Trademarks Goodwill

5 8-5 Fixed Asset Turnover Net Sales Revenue Average Net Fixed Assets = This ratio measures a companys ability to generate sales given an investment in fixed assets. During 2009, Southwest Airlines had $10,350 of revenue. End- of-year fixed assets were $10,634 and beginning-of-year fixed assets were $11,040. (All numbers in millions.) Fixed Asset Turnover $10,350 ($10,634 + $11,040) ÷ 2 == 0.96

6 8-6 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. Buildings Purchase price Renovation and repair costs Legal and realty fees Title fees Buildings Purchase price Renovation and repair costs Legal and realty fees Title fees

7 8-7 Measuring and Recording Acquisition Cost Equipment Purchase price Installation costs Modification to building necessary to install equipment Transportation costs Equipment Purchase price Installation costs Modification to building necessary to install equipment Transportation costs Land Purchase price Real estate commissions Title insurance premiums Delinquent taxes Surveying fees Title search and transfer fees Land Purchase price Real estate commissions Title insurance premiums Delinquent taxes Surveying fees Title search and transfer fees Land is not depreciated

8 8-8 On January 1, Southwest Air Lines purchased aircraft for $75,000,000 cash. Measuring and Recording Acquisition Cost Acquisition for Cash On January 14, Southwest Air Lines purchased aircraft for $1,000,000 cash and a $74,000,000 note payable. Acquisition for Debt

9 8-9 Acquisition for Noncash Consideration Record at the current market value of the consideration given, or the current market value of the asset acquired, whichever is more clearly evident. On July 7, Southwest gave Boeing 1,000,000 shares of $1.00 par value common stock with a market value of $50 per share plus $25,000,000 in cash for aircraft.

10 8-10 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.

11 8-11 Repairs, Maintenance, and Additions

12 8-12 Repairs, Maintenance, and Additions To solve this problem, many companies have policies regarding the expensing of all expenditures below a certain amount according to the materiality constraint.

13 8-13 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 Concepts Acquisition Cost Depreciation Expense Income Statement Balance Sheet Accumulated Depreciation Depreciation for the current year Total of depreciation to date on an asset

14 8-14 Depreciation Concepts 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. Alternative depreciation methods: Straight-line Units-of-production Accelerated Method: Declining balance Alternative depreciation methods: Straight-line Units-of-production Accelerated Method: Declining balance

15 8-15 Straight-Line Method Cost - Residual Value Useful Life in Years Depreciation Expense per Year Depreciation Expense per Year == At the beginning of the year, Southwest purchased ground equipment for $62,500 cash. The equipment has an estimated useful life of 3 years and an estimated residual value of $2,500. Depreciation Expense per Year = Depreciation Expense per Year = $20,000 $62,500 - $2,500 3 years

16 8-16 Residual Value SL More companies use the straight-line method of depreciation in their financial reports than all other methods combined. Straight-Line Method

17 8-17 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 At the beginning of the year, Southwest 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?

18 8-18 Units-of-Production Method $62,500 - $2,500 100,000 miles = $.60 per mile Depreciation Rate = Step 1: Step 2: $.60 per mile × 30,000 miles = $18,000 Depreciation Expense = Residual Value

19 8-19 Accelerated Depreciation Depreciation Repair Expense Early Years High Low Later Years Low High Accelerated depreciation matches higher depreciation expense with higher revenues in the early years of an assets useful life when the asset is more efficient.

20 8-20 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. At the beginning of the year, Southwest 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.

21 8-21 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 Declining-Balance Method Year 1 Depreciation: Year 2 Depreciation:

22 8-22 () ($62,500 – $55,556) × 3 years 2 = $4,629 Below residual value Declining-Balance Method

23 8-23 Depreciation expense is limited to the amount that reduces book value to the estimated residual value. Declining-Balance Method

24 8-24 International PerspectiveIFRS Measurement Basis for Property, Plant and Equipment IFRS permit companies to value property, plant, and equipment at historical cost or to revalue them to their fair value as of the balance sheet date. Under GAAP, revaluation of property, plant, and equipment to fair value is prohibited. US GAAP and IFRS differ with respect to the measurement basis for property, plant and equipment on the balance sheet.

25 8-25 Measuring Asset Impairment Impairment is the loss of a significant portion of the utility of an asset through... Casualty. Obsolescence. Lack of demand for the assets services. Recognize a loss when an asset suffers a permanent impairment. Disposal of Property, Plant and Equipment Voluntary disposals: Sale Trade-in Retirement Involuntary disposals: Fire Accident Disposal of Property, Plant and Equipment Voluntary disposals: Sale Trade-in Retirement Involuntary disposals: Fire Accident

26 8-26 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). Update depreciation to the date of disposal. Disposal of Property, Plant and Equipment

27 8-27 If Cash > BV, record a gain (credit). If Cash < BV, record a loss (debit). If Cash = BV, no gain or loss. 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 Southwest Airlines sold flight equipment for $11,000,000 cash at the end of its 17th year of use. The flight equipment originally cost $30,000,000, and was depreciated using the straight-line method with zero residual value and a useful life of 25 years. Lets answer the following questions. Southwest Airlines sold flight equipment for $11,000,000 cash at the end of its 17th year of use. The flight equipment originally cost $30,000,000, and was depreciated using the straight-line method with zero residual value and a useful life of 25 years. Lets answer the following questions.

28 8-28 The amount of depreciation expense recorded at the end of the 17th year to bring depreciation up to date is: a.$0. b.$1,200,000. c.$1,500,000. d.$2,000,000. The amount of depreciation expense recorded at the end of the 17th year to bring depreciation up to date is: a.$0. b.$1,200,000. c.$1,500,000. d.$2,000,000. Annual Depreciation: ($30,000,000 – $0) ÷ 25 Years. = $1,200,000 Disposal of Property, Plant and Equipment

29 8-29 After updating the depreciation, the equipments book value at the end of the 17th year is: a.$9,600,000. b.$20,400,000. c.$12,800,000. d.$6,600,000. After updating the depreciation, the equipments book value at the end of the 17th year is: a.$9,600,000. b.$20,400,000. c.$12,800,000. d.$6,600,000. Accumulated Depreciation = (17yrs. × $1,200,000) = $20,400,000 BV = Cost – Accumulated Depreciation BV = $30,000,000 – $20,400,000 = $9,600,000 Disposal of Property, Plant and Equipment

30 8-30 The equipments sale resulted in: a.a gain of $1,400,000. b.a gain of $6,200,000. c.a gain of $3,800,000. d.a loss of $1,700,000. The equipments sale resulted in: a.a gain of $1,400,000. b.a gain of $6,200,000. c.a gain of $3,800,000. d.a loss of $1,700,000. Gain = Cash Received – Book Value Gain = $11,000,000 – $9,600,000 = $1,400,000 Disposal of Property, Plant and Equipment

31 8-31 Prepare the journal entry to record Southwests sale of the equipment at the end of the 17th year. Disposal of Property, Plant and Equipment

32 8-32 Acquisition and Depletion of Natural Resources Examples: oil, coal, gold Extracted from the natural environment. A noncurrent asset presented at cost less accumulated depletion. Total cost of asset is the cost of acquisition, exploration, and development. Total cost is allocated over periods benefited by means of depletion. Depletion is like units-of-production depreciation.

33 8-33 The unit depletion rate is calculated as follows: Estimated Recoverable Units Acquisition and Residual Development Cost Value – Depletion cost Inventory for sale Unsold Inventory Cost of goods sold Depletion cost for a period is: UNIT DEPLETION RATE NUMBER OF UNITS EXTRACTED IN PERIOD × Acquisition and Depletion of Natural Resources

34 8-34 Acquisition and Amortization of 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 Record at current cash equivalent cost, including purchase price, legal fees, and filing fees.

35 8-35 Acquisition and Amortization of Intangible Assets Definite Life Amortize over shorter of economic life or legal life, subject to rules specified by GAAP. Use straight-line method. Definite Life Amortize over shorter of economic life or legal life, subject to rules specified by GAAP. Use straight-line method. Indefinite Life Not amortized. Tested at least annually for possible impairment, and book value is reduced to fair value if impaired. Indefinite Life Not amortized. Tested at least annually for possible impairment, and book value is reduced to fair value if impaired. Amortization is a cost allocation process similar to depreciation and depletion.

36 8-36 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. Goodwill Acquisition and Amortization of Intangible Assets Goodwill is not amortized. Its value must be reviewed at least annually for possible impairment, and the book value is reduced to fair value if impaired.

37 8-37 Arpec Company paid $2,000,000 to purchase all of Utek Companys assets and assumed liabilities of $400,000. The acquired assets were appraised at a fair value of $1,800,000. What amount of goodwill should be recorded on Arpec Company books? a.$200,000 b.$400,000 c.$600,000 d.$800,000 What amount of goodwill should be recorded on Arpec Company books? a.$200,000 b.$400,000 c.$600,000 d.$800,000 Acquisition and Amortization of Intangible Assets

38 8-38 Acquisition and Amortization of Intangible Assets Trademarks A symbol, design, or logo associated with a business. An exclusive legal right to use a name, image or slogan. Purchased trademarks are recorded at cost. Trademarks A symbol, design, or logo associated with a business. An exclusive legal right to use a name, image or slogan. Purchased trademarks are recorded at cost. Copyrights The exclusive right to publish, use, and sell a literary, musical, or artistic work. Legal life is life of creator plus 70 years. Amortize cost over the period benefited. Copyrights The exclusive right to publish, use, and sell a literary, musical, or artistic work. Legal life is life of creator plus 70 years. Amortize cost over the period benefited.

39 8-39 Acquisition and Amortization of Intangible Assets Patents Exclusive right granted by the 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. Research and development costs that might result in a patent are normally expensed as incurred. Patents Exclusive right granted by the 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. Research and development costs that might result in a patent are normally expensed as incurred. Technology A category of intangible assets that includes a companys website and any computer programs written by its employees. Technology A category of intangible assets that includes a companys website and any computer programs written by its employees.

40 8-40 Franchises Legally protected right purchased by a franchisee to sell products or provide services for a specified period and purpose. Purchase price is an intangible asset that is amortized. Franchises Legally protected right purchased by a franchisee to sell products or provide services for a specified period and purpose. Purchase price is an intangible asset that is amortized. Acquisition and Amortization of Intangible Assets Licenses and Operating Rights Limited permissions to use a product or service according to specific terms and conditions. You may be using computer software that is made available to you through a campus licensing agreement. Licenses and Operating Rights Limited permissions to use a product or service according to specific terms and conditions. You may be using computer software that is made available to you through a campus licensing agreement.

41 8-41 International PerspectiveIFRS Measurement Basis for Property, Plant and Equipment IFRS require that research expenditures be reported as an expense, but development costs be capitalized as an asset after technical and commercial feasibility of the resulting product or service have been established. Under GAAP, all research and development costs must be reported as an expense. US GAAP and IFRS differ with respect to the treatment of development costs.

42 8-42 Focus on Cash Flows

43 8-43 Chapter Supplement A – Changes in Depreciation Estimates Depreciation Expense is based on... ESTIMATED useful life ESTIMATED residual value If the estimates change, the book value less any residual value at the date of change is depreciated over the remaining useful life. Southwest purchased an aircraft for $60,000,000. The aircraft is depreciated using the straight-line method with a useful life of 20 years and an estimated residual value of $3,000,000. In year 5, Southwest changed the estimated useful life to 25 years and lowered the residual value to $2,400,000. Calculate depreciation expense for the fifth year using the straight-line method.

44 8-44 Chapter Supplement A – Changes in Depreciation Estimates

45 8-45 End of Chapter 08


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