Chapter 9-1

Chapter 9-2 Reporting and Analyzing Long-Lived Assets Long-Lived Assets Financial Accounting, Fifth Edition

Chapter Describe how the cost principle applies to plant assets Explain the concept of depreciation Compute periodic depreciation using the straight-line method, and contrast its expense pattern with those of other methods Describe the procedure for revising periodic depreciation Explain how to account for the disposal of plant assets Describe methods for evaluating the use of plant assets Identify the basic issues related to reporting intangible assets Indicate how long-lived assets are reported in the financial statements Compute periodic depreciation using the declining-balance method and the units-of-activity method. Study Objectives

Chapter 9-4 Plant Assets Determining the cost of plant assets Accounting for plant assets Analyzing plant assets Intangible Assets Accounting for intangibles assets Types of intangibles assets Financial statement presentation of long- lived assets Reporting and Analyzing Long-Lived Assets

Chapter 9-5 Plant assets are resources that have physical substance (a definite size and shape), are used in the operations of a business, are not intended for sale to customers, are expected to provide service to the company for a number of years, except for land. Plant Assets Referred to as property, plant, and equipment; plant and equipment; and fixed assets. Section One

Chapter 9-6 Plant assets are critical to a company’s success Plant Assets Section One Illustration 9-1

Chapter 9-7 Cost Principle - requires that companies record plant assets at cost. Cost consists of all expenditures necessary to acquire an asset and make it ready for its intended use. Determining the Cost of Plant Assets SO 1 Describe how the cost principle applies to plant assets. Revenue expenditure - If a cost is not included in a plant asset account, then it must be expensed immediately. Capital expenditures - costs that are not expensed immediately but are instead included in a plant asset account.

Chapter 9-8 Determining the Cost of Plant Assets SO 1 Describe how the cost principle applies to plant assets. Cost is measured by the cash paid in a cash transaction or by the cash equivalent price paid. The cash equivalent price is equal to the fair market value of the asset given up or the fair market value of the asset received, whichever is more clearly determinable.

Chapter 9-9 All necessary costs incurred in making land ready for its intended use increase (debit) the Land account. Land Determining the Cost of Plant Assets Costs typically include: 1)the cash purchase price, 2)closing costs such as title and attorney’s fees, 3)real estate brokers’ commissions, and 4)Accrued property taxes and other liens on the land assumed by the purchaser. SO 1 Describe how the cost principle applies to plant assets.

Chapter 9-10 Illustration: Illustration: Assume that Hayes Manufacturing Company acquires real estate at a cash cost of $100,000. The property contains an old warehouse that is razed at a net cost of $6,000 ($7,500 in costs less $1,500 proceeds from salvaged materials). Additional expenditures are the attorney’s fee, $1,000, and the real estate broker’s commission, $8,000. Required: Required: Determine amount to be reported as the cost of the land. Determining the Cost of Plant Assets SO 1 Describe how the cost principle applies to plant assets.

Chapter 9-11 Land Required: Required: Determine amount to be reported as the cost of the land. Determining the Cost of Plant Assets SO 1 Describe how the cost principle applies to plant assets. Cash price of property ($100,000) Net removal cost of warehouse ($6,000) Attorney's fees ($1,000) 1,000 6,000 $100,000 $115,000Cost of Land Real estate broker’s commission ($8,000) 8,000

Chapter 9-12 Includes all expenditures necessary to make the improvements ready for their intended use. Land Improvements Determining the Cost of Plant Assets Examples are driveways, parking lots, fences, landscaping, and underground sprinklers. Limited useful lives. Expense (depreciate) the cost of land improvements over their useful lives. SO 1 Describe how the cost principle applies to plant assets.

Chapter 9-13 Includes all costs related directly to purchase or construction. Buildings Purchase costs: Purchase price, closing costs (attorney’s fees, title insurance, etc.) and real estate broker’s commission. Remodeling and replacing or repairing the roof, floors, electrical wiring, and plumbing. Construction costs: Contract price plus payments for architects’ fees, building permits, and excavation costs. Determining the Cost of Plant Assets SO 1 Describe how the cost principle applies to plant assets.

Chapter 9-14 Include all costs incurred in acquiring the equipment and preparing it for use. Costs typically include: Equipment cash purchase price sales taxes freight charges insurance during transit paid by the purchaser expenditures required in assembling, installing, and testing the unit Determining the Cost of Plant Assets SO 1 Describe how the cost principle applies to plant assets.

Chapter 9-15 Illustration: Lenard Company purchases a delivery truck at a cash price of $22,000. Related expenditures are sales taxes $1,320, painting and lettering $500, motor vehicle license $80, and a three-year accident insurance policy $1,600. Compute the cost of the delivery truck. Determining the Cost of Plant Assets SO 1 Describe how the cost principle applies to plant assets. Truck Cash price Sales taxes Painting and lettering 500 1,320 $22,000 $23,820Cost of Delivery Truck

Chapter 9-16 Illustration: Lenard Company purchases a delivery truck at a cash price of $22,000. Related expenditures are sales taxes $1,320, painting and lettering $500, motor vehicle license $80, and a three-year accident insurance policy $1,600. Prepare the journal entry to record these costs. Determining the Cost of Plant Assets SO 1 Describe how the cost principle applies to plant assets. Delivery truck 23,820 License expense 80 Prepaid insurance 1,600 Prepaid insurance 25,500

Chapter 9-17 A lease is a contractual agreement in which the owner of an asset (the lessor) allows another party (the lessee) to use the asset for a period of time at an agreed price. To Buy or Lease? Some advantages of leasing 1.Reduced risk of obsolescence. 2.Little or no down payment. 3.Shared tax advantages. 4.Assets and liabilities not reported. Determining the Cost of Plant Assets SO 1 Describe how the cost principle applies to plant assets. Capital lease - lessees show the asset and liability on the balance sheet.

Chapter 9-18

Chapter 9-19 Process of cost allocation, not asset valuation. Applies to land improvements, buildings, and equipment, not land. Depreciable, because the revenue-producing ability of asset will decline over the asset’s useful life. The process of allocating to expense the cost of a plant asset over its useful (service) life in a rational and systematic manner. Accounting for Plant Assets SO 2 Explain the concept of depreciation. Depreciation

Chapter 9-20 Factors in Computing Depreciation Cost SO 2 Explain the concept of depreciation. Useful LifeSalvage Value Illustration 9-6 Accounting for Plant Assets

Chapter 9-21 Management selects the method it believes best measures an asset’s contribution to revenue over its useful life. Depreciation Methods Examples include: (1)Straight-line method. (2)Declining-balance method. (3)Units-of-Activity method. SO 3 Compute periodic depreciation using the straight-line method, and contrast its expense pattern with those of other methods. Illustration 9-7 Use of depreciation methods in major U.S. companies Accounting for Plant Assets

Chapter 9-22 Illustration: Bill’s Pizzas purchased a small delivery truck on January 1, Required: Compute depreciation using the following. (a) Straight-Line. (b) Units-of-Activity. (c) Declining Balance. SO 3 Compute periodic depreciation using the straight-line method, and contrast its expense pattern with those of other methods. Accounting for Plant Assets

Chapter 9-23 Straight-Line Expense is same amount for each year. Depreciable cost is cost of the asset less its salvage value. Illustration 9-8 SO 3 Compute periodic depreciation using the straight-line method, and contrast its expense pattern with those of other methods. Accounting for Plant Assets

Chapter 9-24 Illustration: (Straight-Line Method) 2010$ 12,00020%$ 2,400 $ 10, ,000202,4004,8008, ,000202,4007,2005, ,000202,4009,6003, ,000202,40012,0001, Journal Entry Depreciation expense 2,400 Accumulated depreciation2,400 Illustration 9-9 SO 3 Compute periodic depreciation using the straight-line method, and contrast its expense pattern with those of other methods. Accounting for Plant Assets

Chapter 9-25 SO 3 Compute periodic depreciation using the straight-line method, and contrast its expense pattern with those of other methods. Accounting for Plant Assets Partial Year Illustration: (Straight-Line Method) Assuming the delivery truck was purchased on April 1, 2010.

Chapter 9-26 Declining-Balance SO 3 Compute periodic depreciation using the straight-line method, and contrast its expense pattern with those of other methods. Accounting for Plant Assets Accelerated method. Decreasing annual depreciation expense over the asset’s useful life. Double declining-balance rate is double the straight- line rate. Rate applied to book value.

Chapter 9-27 Illustration: (Declining-Balance Method) ,00040%$ 5,200 $ 7, ,800403,1208,3204, ,680401,87210,1922, ,808401,12311,3151, , *12,0001,000 * Computation of $674 ($1,685 x 40%) is adjusted to $685. Depreciation expense 5,200 Accumulated depreciation5, Journal Entry Illustration 9-10 Accounting for Plant Assets

Chapter 9-28 Companies estimate total units of activity to calculate depreciation cost per unit. Expense varies based on units of activity. Depreciable cost is cost less salvage value. Units-of-Activity SO 3 Compute periodic depreciation using the straight-line method, and contrast its expense pattern with those of other methods. Accounting for Plant Assets Illustration 9A-3

Chapter 9-29 Illustration: (Units-of-Activity Method) ,000$ 0.12$ 1,800 $ 11, , ,6005,4007, , ,4007,8005, , ,00010,8002, , ,20012,0001,000 Depreciation expense 1,800 Accumulated depreciation 1, Journal Entry Illustration 9-11 SO 3 Compute periodic depreciation using the straight-line method, and contrast its expense pattern with those of other methods. Accounting for Plant Assets

Chapter 9-30 Comparison of Depreciation Methods Illustration 9-12 Illustration 9-13 SO 3 Compute periodic depreciation using the straight-line method, and contrast its expense pattern with those of other methods. Accounting for Plant Assets Each method is acceptable because each recognizes the decline in service potential of the asset in a rational and systematic manner.

Chapter 9-31 IRS does not require taxpayer to use the same depreciation method on the tax return that is used in preparing financial statements. IRS requires the straight-line method or a special accelerated-depreciation method called the Modified Accelerated Cost Recovery System (MACRS). MACRS is NOT acceptable under GAAP. Depreciation and Income Taxes Accounting for Plant Assets SO 3 Compute periodic depreciation using the straight-line method, and contrast its expense pattern with those of other methods.

Chapter 9-32 Revising Periodic Depreciation Accounted for in the period of change and future periods (Change in Estimate). Not handled retrospectively. Not considered error. SO 4 Describe the procedure for revising periodic depreciation. Accounting for Plant Assets

Chapter 9-33 Ordinary Repairs - expenditures to maintain the operating efficiency and productive life of the unit. Debit - Repair (or Maintenance) Expense. Additions and Improvements - costs incurred to increase the operating efficiency, productive capacity, or useful life of a plant asset. Debit - the plant asset affected. Referred to as capital expenditures. Expenditure During Useful Life Accounting for Plant Assets SO 4 Describe the procedure for revising periodic depreciation.

Chapter 9-34 A permanent decline in the market value of an asset. So as not to overstate the asset on the books, the company writes the asset down to its new market value during the year in which the decline in value occurs. Impairments Accounting for Plant Assets SO 4 Describe the procedure for revising periodic depreciation.

Chapter 9-35 Companies dispose of plant assets in three ways — Retirement, Sale, or Exchange (appendix). SO 5 Explain how to account for the disposal of a plant asset. Record depreciation up to the date of disposal. Eliminate asset by (1) debiting Accumulated Depreciation, and (2) crediting the asset account. Illustration 9-15 Plant Asset Disposals Accounting for Plant Assets

Chapter 9-36 Sale of Plant Assets Compare the book value of the asset with the proceeds received from the sale. If proceeds exceed the book value, a gain on disposal occurs. If proceeds are less than the book value, a loss on disposal occurs. Plant Asset Disposals SO 5 Explain how to account for the disposal of a plant asset.

Chapter 9-37 Illustration: On July 1, 2010, Wright Company sells office furniture for $16,000 cash. The office furniture originally cost $60,000. As of January 1, 2010, it had accumulated depreciation of $41,000. Depreciation for the first six months of 2010 is $8,000. Prepare the journal entry to record depreciation expense up to the date of sale. SO 5 Explain how to account for the disposal of a plant asset. Depreciation expense8,000 Accumulated depreciation 8,000 July 1 Plant Asset Disposals

Chapter 9-38 Illustration: Wright records the sale as follows. SO 5 Explain how to account for the disposal of a plant asset. Cash16,000 Accumulated depreciation 49,000 Illustration 9-16 Computation of gain on disposal Office equipment60,000 Gain on disposal 5,000 July 1 Plant Asset Disposals

Chapter 9-39 SO 5 Explain how to account for the disposal of a plant asset. Cash9,000 Accumulated depreciation 49,000 Illustration 9-17 Computation of loss on disposal Office equipment60,000 Gain on disposal 2,000 July 1 Plant Asset Disposals Illustration: Assume that instead of selling the office furniture for $16,000, Wright sells it for $9,000.

Chapter 9-40 Illustration: Assume that Hobart Enterprises retires its computer printers, which cost $32,000. The accumulated depreciation on these printers is $32,000. The journal entry to record this retirement is? SO 5 Explain how to account for the disposal of a plant asset. Accumulated depreciation32,000 Printing equipment32,000 Question: What happens if a fully depreciated plant asset is still useful to the company? Plant Asset Disposals

Chapter 9-41 Retirement of Plant Assets Plant Asset Disposals SO 5 Explain how to account for the disposal of a plant asset.  No cash is received.  Decrease (debit) Accumulated Depreciation for the full amount of depreciation taken over the life of the asset.  Decrease (credit) the asset account for the original cost of the asset.

Chapter 9-42 Return on Asset Ratio indicates the amount of net income generated by each dollar of assets. Illustration 9-18 Analyzing Plant Assets SO 6 Describe methods for evaluating the use of plant assets. (Answers on notes page)

Chapter 9-43

Chapter 9-44 Asset Turnover Ratio indicates how efficiently a company uses its assets to generate sales. Illustration 9-19 Analyzing Plant Assets SO 6 Describe methods for evaluating the use of plant assets.

Chapter 9-45 Profit Margin Ratio Revisited Illustration 9-20 Analyzing Plant Assets SO 6 Describe methods for evaluating the use of plant assets. Tells how effective a company is in turning its sales into income— that is, how much income each dollar of sales provides. Illustration 9-21 You can evaluate the return on assets ratio by evaluating its components.

Chapter 9-46 Intangible assets are rights, privileges, and competitive advantages that result from ownership of long-lived assets that do not possess physical substance. Intangible Assets Patents Copyrights Franchises or licenses Trademarks Trade names Goodwill Limited life or an indefinite life. Common types of intangibles: SO 7 Identify the basic issues related to reporting intangible assets. Section Two

Chapter 9-47 Amortization of Intangibles Limited-Life Intangibles: Amortize to expense. Credit asset account or accumulated amortization. Indefinite-Life Intangibles: No foreseeable limit on time the asset is expected to provide cash flows. No amortization. Accounting for Intangible Assets SO 7 Identify the basic issues related to reporting intangible assets.

Chapter 9-48 Patents Exclusive right to manufacture, sell, or otherwise control an invention for a period of 20 years from the date of the grant. Capitalize costs of purchasing a patent and amortize over its 20-year life or its useful life, whichever is shorter. Expense any R&D costs in developing a patent. Legal fees incurred successfully defending a patent are capitalized to Patent account. Types of Intangible Assets SO 7 Identify the basic issues related to reporting intangible assets.

Chapter 9-49 Illustration: Assume that National Labs purchases a patent at a cost of $60,000 on June 30. National estimates the useful life of the patent to be eight years. Prepare the journal entry to record the amortization for the six-month period ended December 31. Amortization expense 3,750 Patent 3,750 Cost $60,000 Useful life/ 8 Annual expense$ 7,500 6 monthsx 6/12 Amortization$ 3,750 Journal Entry SO 7 Identify the basic issues related to reporting intangible assets. Types of Intangible Assets

Chapter 9-50 Expenditures that may lead to patents, copyrights, new processes, and new products. All R & D costs are expensed when incurred. Research and Development Costs SO 7 Identify the basic issues related to reporting intangible assets. Types of Intangible Assets

Chapter 9-51 Copyrights Give the owner the exclusive right to reproduce and sell an artistic or published work. Copyright is granted for the life of the creator plus 70 years. Capitalize costs of acquiring and defending it. Amortized to expense over useful life. SO 7 Identify the basic issues related to reporting intangible assets. Types of Intangible Assets

Chapter 9-52 Trademarks and Trade Names Word, phrase, jingle, or symbol that identifies a particular enterprise or product.  Wheaties, Monopoly, Sunkist, Kleenex, Coca-Cola, Big Mac, and Jeep. Trademark or trade name has legal protection for indefinite number of 20 year renewal periods. Capitalize acquisition costs. No amortization. SO 7 Identify the basic issues related to reporting intangible assets. Types of Intangible Assets

Chapter 9-53 Franchises and Licenses Contractual arrangement between a franchisor and a franchisee.  Toyota, Shell, Subway, and Marriott are franchises. Franchise (or license) with a limited life should be amortized to expense over the life of the franchise. Franchise with an indefinite life should be carried at cost and not amortized. SO 7 Identify the basic issues related to reporting intangible assets. Types of Intangible Assets

Chapter 9-54

Chapter 9-55 Goodwill Includes exceptional management, desirable location, good customer relations, skilled employees, high-quality products, etc. Only recorded when an entire business is purchased. Goodwill is recorded as the excess of... over purchase price over the FMV of the identifiable net assets acquired. Internally created goodwill should not be capitalized. SO 7 Identify the basic issues related to reporting intangible assets. Types of Intangible Assets

Chapter The allocation to expense of the cost of an intangible asset over the asset’s useful life. 2. Rights, privileges, and competitive advantages that result from the ownership of long-lived assets that do not possess physical substance. 3. An exclusive right granted by the federal government to reproduce and sell an artistic or published work. Amortization Intangible Assets Copyrights Illustration: Identify the term most directly associated with each statement. SO 7 Identify the basic issues related to reporting intangible assets. Types of Intangible Assets

Chapter 9-57 Illustration: Identify the term most directly associated with each statement. 4. A right to sell certain products or services or to use certain trademarks or trade names within a designated geographic area. 5. Costs incurred by a company that often lead to patents or new products. These costs must be expensed as incurred. Franchise Research and Development Costs SO 7 Identify the basic issues related to reporting intangible assets. Types of Intangible Assets

Chapter 9-58

Chapter 9-59 Illustration 9-22 Statement Presentation of Long-Lived Assets SO 8 Indicate how long-lived assets are reported in the financial statements.

Chapter 9-60 Statement Presentation of Long-Lived Assets A difference between accrual-accounting net income and net cash provided by operating activities is caused by depreciation and amortization expense. SO 8 Indicate how long-lived assets are reported in the financial statements.

Chapter 9-61 Decreasing annual depreciation expense over the asset’s useful life. Double declining-balance rate is double the straight- line rate. Rate applied to book value. Declining-Balance Depreciation using Other Methods Illustration 9-A1 Appendix SO 9 Compute periodic depreciation using the declining- balance method and the units-of-activity method.

Chapter 9-62 Illustration: (Declining-Balance Method) ,00040%$ 5,200 $ 7, ,800403,1208,3204, ,680401,87210,1922, ,808401,12311,3151, , *12,0001,000 * Computation of $674 ($1,685 x 40%) is adjusted to $685. Depreciation expense 5,200 Accumulated depreciation5, Journal Entry Illustration 9-A2 Depreciation using Other Methods

Chapter 9-63 Depreciation using Other Methods Illustration: (Declining-Balance Method) Partial Year Purchased on 4/1/10 SO 9 Compute periodic depreciation using the declining- balance method and the units-of-activity method.

Chapter 9-64 Suited to equipment whose activity can be measured in units of output, miles driven, or hours in use. Calculate depreciation cost per unit. Expense varies based on units of activity. Depreciable cost is cost less salvage value. Units-of-Activity Depreciation using Other Methods Illustration 9A-3 SO 9 Compute periodic depreciation using the declining- balance method and the units-of-activity method.

Chapter 9-65 Illustration: (Units-of-Activity Method) ,000$ 0.12$ 1,800 $ 11, , ,6005,4007, , ,4007,8005, , ,00010,8002, , ,20012,0001,000 Depreciation expense 1,800 Accumulated depreciation 1, Journal Entry Illustration 9A-4 Depreciation using Other Methods SO 9 Compute periodic depreciation using the declining- balance method and the units-of-activity method.

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