1 CHAPTER 8 Long-Term Producing Assets and Investments in Equity Securities

Accounting for Long Lived Assets Figure 8-1

3 Acquisition: What Costs to Capitalize? Fair market value of the acquired asset, or Fair market value of what was given up to acquire the asset.

4 Post Acquisition Expenditures Betterments are capitalized because they: - Increase the asset’s useful life, - Improve the quality of the asset’s output, - Increase the quantity of the asset’s output, or - Reduce the costs associated with operating the asset. Maintenance costs are treated as expenses.

Cost Allocation Depreciation and amortization are methods of cost allocation. – They are used to allocate the capitalized cost of productive assets over the years benefited (matching). – Note: depreciation and amortization decrease the carrying values of assets, but are not a valuation techniques (i.e., book value is not market value).

Land – Has indefinite life and therefore is not depreciated – Historical Cost includes: Purchase price, Closing costs, Cost to get ready for intended use (Note: Sale of salvaged materials reduces cost) Land Improvements – Have definite life and therefore are depreciated – Fences, walls, parking lots, driveways Buildings – Have definite life and therefore are depreciated – Proportionate share of purchase price, or construction cost, Closing Cost, Architect & Attorney fees Machinery, Equipment, Furniture & Fixtures – Purchase price (net of cash discounts), Freight & handling, Insurance while in transit, Installation

Cost Allocation Estimated useful life Estimated salvage value Depreciation methods – Straight-line – Double-declining balance – Units-of-production (Activity)

Straight-Line = $15,000 - $3,000 = $2,400 per year 5 years Cost - Salvage Estimated Life Annual depreciation = Figure 8-2

Double-Declining Balance DDB is an accelerated depreciation technique. It generates more expense in the early years and less in the later years. Annual depreciation = % (Cost - A/D) where A/D is the accumulated depreciation for all prior years, and the percentage is double the straight line rate, or 2 x 1/Estimate life. In the example, the % = 2 x 1/5 = 2/5 = 40%. Depreciation expense for: 20x1 = 40% x (15, ) = $6,000 20x2 = 40% x (15, ,000) = $3,600 Figure 8-2 (continued)

Activity (Units-of-Production) Method Assume that a mine which cost $10 million, yielded 100,000 tons of ore in 2007 and 250,000 in 2008 when the total estimated yield from the property was accurately estimated to be 500,000 tons of ore. Annual depreciation (depletion) = Cost - Salvage Value x Current Activity Total expected activity For 2007= 100,000 tons x $10,000,000 = $2,000, ,000 tons For 2008 = 250,000 tons x $10,000,000 = $5,000, ,000 tons

Disposal: Retirement, Sales, and Trade-In Retiring producing assets – gain or loss. Permanent impairments. Selling producing assets. Trade-ins – Similar assets. – Dissimilar assets.

Investments in Equity Securities

Investment in Marketable Equity Securities -Overview Equity investments represent ownership of another company’s outstanding common stock. Marketable equity investments are actively traded on a public stock exchange. There are different accounting rules for: – (1) less than 20 percent ownership. – (2) between 20 and 50 percent ownership. – (3) greater than 50 percent ownership.

Cost Method If the securities have no readily determinable market value and less than 20% of the outstanding voting stock is held, use the cost method. Carry securities on balance sheet at their original cost. Dividends are recorded as receivables when they are declared and are reflected on the income statement.

Mark-to-Market Method If the marketable securities are intended to be sold in less than a year or if less than 20% of the outstanding voting stock is held, use the mark-to market method. Carry securities on balance sheet at market value. Revalue the securities at the end of each period based on new market price. Unrealized gains (or losses) are recognized as the investment is valued up (or down). Treatment of the unrealized gains (losses) depends on classification of security: – (a) Trading securities. – (b) Available-for-sale securities.

Equity Method Investor company acquires 20% or more but no more than 50% of the voting stock of another company. Investor company has “significant influence”. The investment in the voting shares is accounted for under the equity method.

Equity Method The initial investment in the affiliate is recorded as an asset on the books of the investor company. The investment in affiliate account is increased to reflect the investor’s pro-rata share of the earnings of the affiliate (or reduced when there is a loss). Dividends paid by the affiliate to the investor are treated as a return of capital and the investment in affiliate account is reduced.

Consolidated Financial Statements Investor company (parent) acquires a controlling interest (> 50% of the voting stock) in another company (subsidiary). Parent company prepares consolidated financial statements treating the two companies as a single economic unit.

Figure 8-3

Cash Flows from Investing Activities CF from investing activities explain the changes in cash from the purchase or sale of the company’s (primarily) long-term assets. Examples of investing activity includes: – cash paid for purchase of equipment, land, buildings, marketable securities (available-for-sale and equity), intangible assets, and most other long term assets. – cash received from sale of equipment, land, buildings, marketable securities (available-for-sale and equity), intangible assets, and most other long term assets. – cash paid for issue of non-trade notes receivable (both short-term and long-term). – cash received for repayment on non-trade notes receivable (both short-term and long-term).

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