Long-Term and Intangible Assets Chapter 13 Long-Term and Intangible Assets

Property and Equipment Tangible Assets Acquired for use in the ordinary operation of the business Useful life more than one year ©2004 Pearson Education, Inc. Upper Saddle River, NJ 07458

Property and Equipment Categories Land Building Leaseholds and Leasehold Improvements Construction in Progress Furniture and Equipment China, Glassware, Silver, Linen, and Uniforms Accounting for the Hospitality Industry Elisa S. Moncarz and Nestor de Portocarrero ©2004 Pearson Education, Inc. Upper Saddle River, NJ 07458

Plant Assets Tangible in Nature Actively Used in Operations Expected to Benefit Future Periods Plant assets are tangible assets that are used actively in the operations of the entity. We fully expect these assets, sometimes referred to as property, plant, and equipment, to benefit future periods. Called Property, Plant, & Equipment

Cost Determination Acquisition Cost P1 Purchase price All expenditures needed to prepare the asset for its intended use Acquisition Cost The cost of a plant asset includes the purchase price as well as all costs necessary to get the asset in place and ready for its intended use. We record the purchase price net of any cash discounts available. Finance charges are not included in the cost of an asset. If we elect to finance the purchase over a period of time, the interest cost is charged as an expense when incurred. Acquisition cost excludes financing charges and cash discounts.

Land is not depreciable. Title insurance premiums Purchase price Delinquent taxes Real estate commissions Surveying fees Land is not a depreciable plant asset. In addition to the purchase price, there are many costs generally incurred in connection with the acquisition. Many of these costs are related to obtaining legal title to the land. Title search and transfer fees Land is not depreciable.

Land Improvements P1 Parking lots, driveways, fences, walks, shrubs, and lighting systems. Depreciate over useful life of improvements. Land improvements are depreciated over their useful life. Land improvements include parking lots, driveways, fences, sidewalks, landscaping, and any outdoor lighting systems.

Buildings P1 Cost of purchase or construction Title fees Brokerage fees Attorney fees Whether we purchase or construct a building, the cost should include the purchase price plus any attorney fees or title fees. If we construct the building, the cost will include all the necessary construction costs as well as the costs we have just mentioned. Taxes

Machinery and Equipment Purchase price Taxes Transportation charges Machinery and equipment is recorded at its purchase price less any available cash discount. The company may have to pay delivery charges on the truck; these costs are included in the cost of the truck. If we need to install any special parts to make the machinery or equipment ready for its intended use, we will include these costs in the price of the assets. Installing, assembling, and testing Insurance while in transit

Concept of Depreciation Over time, fixed assets such as equipment, buildings, and land improvements lose their ability to provide services. The periodic transfer of the cost of fixed assets to expense is called depreciation The three factors in determining the amount of depreciation expense to be recognized each period are: (a) the fixed asset’s initial cost, (b) its expected useful life, and (c) its estimated value at the end of the useful life. The fixed asset’s estimated value at the end of its useful life is called the residual value, scrap value, salvage value, or trade-in value. A fixed asset’s residual value and its expected useful life must be estimated at the time the asset is placed in service.

Depreciation Methods Straight-Line Accelerated Methods Units of Output Declining-Balance Sum of Years’ Digits Units of Output

Illustration of Depreciation Methods Tour Bus cost $12,000 Salvage value $2,000 Useful life: five years Miles traveled: 200,000

STRAIGHT-LINE DEPRECIATION Spreads the total depreciation equally over all periods of useful life of the property or equipment Depreciation = Cost – salvage value # of years of useful life Higher Net Income Higher Asset Value 12,000-2,000 = $2,000 5

Double-Declining-Balance Method Step 1: Straight-line rate = 100 % ÷ Useful life = 100% ÷ 5 = 20% Step 2: Double-declining- balance rate = 2 × Straight-line rate = 2 × 20% = 40% Calculating depreciation expense under the double-declining-balance method is a three-step process. The first step is the calculate the straight-line depreciation rate. Recall that we do this by dividing one hundred percent by the asset’s useful life. In our specific case we divide one hundred percent by the five-year useful life to get a straight-line rate of twenty percent. The second step is to calculate the double-declining-balance rate. We do this by multiplying the straight-line rate times two. In our case that would be twenty percent times two, or forty percent. The third, and final step is to determine depreciation expense. We multiply the double-declining rate times the book value of the asset at the beginning of the period. Under the double-declining-balance method we ignore estimated salvage value. The beginning book value (cost less accumulated depreciation), is fifty thousand dollars. Depreciation expense for 2008 is twenty thousand dollars, forty percent times fifty thousand dollars. Don’t forget that salvage value is not used in the double-declining-balance method. Step 3: Depreciation expense = Double-declining- balance rate × Beginning period book value 40% × $12,000 = $4,800

Double-Declining Balance Apply double the straight Line Rate to the Net book value of the property or equipment Straight Line Rate X 2 = 100 = 20% x 2 = 40% 5 years 40% x 12,000 = 4,800 Year 1 Depreciation Expense $4800 Accumulated Depreciation $4,800 Net Book value-end of Year 1 $7,200 40% x 7,200 = 2,880 Year 2 Depreciation Expense $2,880 Accumulated Depreciation $7,680 Net Book value-end of Year 2 $4,320 YEAR 1 YEAR 2

Units-of-Production Method Depreciation Per Unit = Cost - Salvage Value Total Units of Production Step 1: Step 2: Depreciation Expense = Per Unit × Number of Units Produced in the Period Under the units-of-production method, the first step is to calculate the depreciation expense per unit of production. Take the asset’s cost less its salvage value and divide this amount by the total estimated number of units that will be produced by the assets. Once we complete the first step, we may calculate depreciation expense for the period. Multiply the depreciation expense per unit that we determined in step one by the number of units produced in the current period. Let’s look at a specific example.

Units of Production (or Activity) Method Cost – Salvage Value X Annual units of output Estimated units of output over entire life 12,000 - 2,000 = $0.05 per mile depreciation 200,000 miles Year 1 Bus travels 40,000 miles Depreciation Expense $0.05 x 40,000 miles = $2,000 Accumulated Depreciation $2,000 Net Book Value $12,000-2,000 = $8,000 Year 2 Bus travels 20,000 miles Depreciation Expense $0.05 X 20,000 miles = $1,000 Accumulated Depreciation $3,000 Net Book value $9,000

13-3 Units-of-Activity Depreciation Formula for Units-of-Activity Method Depreciable Cost ÷ Total Units of Activity = Depreciation Cost per Unit X Units of Activity during the Year Depreciation Expense Example: COST: $20,000 SALVAGE: $2,000 LIFE: 10,000 units Depreciable Cost ÷ Total Units of Activity = Depreciation Cost per Unit $18,000 10,000 $1.80 X Units of Activity during the Year Depreciation Expense 2,500 $4,500 Depreciation Schedule Year Cost / Unit Units / Activity Depreciation Expense 1 $1.80 X 2,500 $4,500 2 2,800 $5,040 3 1,100 $1,980 4 1,900 $3,420 5 1,700 $3,060 10,000 $18,000 PLANT ASSET ACCUMULATED DEPRECIATION 20,000 Year 1 4,500 Year 2 5,040 Year 3 1,980 Year 4 3,420 Year 5 3,060 Bal. 18,000

Sum of Years’ Digits The depreciation rate each year is a fraction in which the sum of digits and the numerator is years in inverse order n (n+1) = 5 (6) = 15 Fractions year 1 5 2 2 15 2 4 15 Year 1 depreciation 5/15 X 10,000= $3,333 Year 2 depreciation 4/15 X 10,000= $2,667 ACCELERATED METHOD

13-5 Sum-of-Years’ Digit Depreciation Depreciable Cost X Years’ Digits in Reverse Order ÷ Sum of Years’ Digits = Depreciation Expense Formula for Sum-of-Years’ Digit Example: COST: $20,000 SALVAGE: $2,000 LIFE: 5 years Depreciable Cost X Years’ Digits in Reverse Order ÷ Sum of Years’ Digits = Depreciation Expense $18,000 5/15 $6,000 Depreciation Schedule Year Book Value at Beginning of Year Rate Depreciation Expense 1 $18,000 X 5/15 $6,000 2 18,000 4/15 $4,800 3 3/15 $3,600 4 2/15 $2,400 5 1/15 $1,200 PLANT ASSET ACCUMULATED DEPRECIATION 20,000 Year 1 6,000 Year 2 4,800 Year 3 3,600 Year 4 2,400 Year 5 1,200 Bal. 18,000

Amortization Write-off of the cost of an asset over its estimated useful life Always calculated on the straight line basis It is used to record cost expiration of leasehold and leasehold improvements and other intangible assets

Depreciation for Tax Reporting Most corporations use the Modified Accelerated Cost Recovery System (MACRS) for tax purposes. MACRS depreciation provides for rapid write-off of an asset’s cost in order to stimulate new investment. When filing a tax return most corporations use the modified accelerated cost recovery system developed by the Internal Revenue Service. Because the title of the method is so long most accountants refer to the tax method as MACRS. MACRS is an accelerated depreciation method. It was designed to permit companies to quickly write off the cost of plant assets and thereby stimulate investment in new plant assets.

13-8 Long-Term Asset Disposals - Retirements Fully Depreciated Asset Asset originally purchased on 1/1/07 is discarded on 1/1/10 and there is no salvage value. Equipment Accumulated Depreciation – Equipment 20,000 12/31/07 5,000 12/31/08 12/31/09 12/31/10 Bal. Book Value = $0 Entry: 20,0000 Note: When recording a plant asset disposal, the plant asset account is always credited and the related accumulated depreciation account is always debited to remove them from the books

13-8 Long-Term Asset Disposals – Retirements (continued) Asset is Not Fully Depreciated Asset originally purchased on 1/1/07 is discarded on 1/1/10 and there is no salvage value. Equipment Accumulated Depreciation – Equipment 20,000 12/31/07 5,000 12/31/08 12/31/09 Bal. 15,000 Book Value = $0 Entry: Loss on Disposal

13-9 Long-Term Asset Disposals – Sales Asset Sold at a Gain Asset originally purchased on 1/1/07 is discarded on 1/1/10 for $8,000. Equipment Accumulated Depreciation – Equipment 20,000 12/31/07 5,000 12/31/08 12/31/09 Bal. 15,000 Book Value = $5,000 Entry: Cash 8,000 Gain on Disposal 3,000 Calculation of gain or loss on disposal: Cash proceeds $8,000 Book value of asset Gain on disposal $3,000

13-9 Long-Term Asset Disposals – Sales (continued) Asset Sold at a Loss Asset originally purchased on 1/1/07 is discarded on 1/1/10 for $3,000. Equipment Accumulated Depreciation – Equipment 20,000 12/31/07 5,000 12/31/08 12/31/09 Bal. 15,000 Book Value = $5,000 Entry: Cash 3,000 Loss on Disposal 2,000 Calculation of gain or loss on disposal: Cash proceeds $3,000 Book value of asset Gain on disposal ($2,000)

13-10 Long-Term Asset Disposals – Exchange of Similar Assets Asset Exchanged at a Loss Asset originally purchased on 1/1/07 is exchanged for a similar asset on 1/1/10. Cash of $10,000 is also paid and the old asset has fair market value of $4,000 on the date of exchange. Equipment Accumulated Depreciation – Equipment 20,000 12/31/07 5,000 12/31/08 12/31/09 Bal. 15,000 Book Value = $5,000 Entry: Equipment (new) 14,000 Loss on Disposal 1,000 Equipment (old) Cash 10,000 Cost of new asset acquired: Loss on exchange of old asset: Fair value of old asset $4,000 Cash paid Book value of old asset Cost of new asset $14,000 Loss on disposal ($1,000)

Accumulated Depreciation – Equipment 13-10 Long-Term Asset Disposals – Exchange of Similar Assets (continued) Asset Exchanged at a Gain Asset originally purchased on 1/1/07 is exchanged for a similar asset on 1/1/10. Cash of $10,000 is also paid and the old asset has fair market value of $8,000 on the date of exchange. Equipment Accumulated Depreciation – Equipment 20,000 12/31/07 5,000 12/31/08 12/31/09 Bal. 15,000 Book Value = $5,000 Entry: Equipment (new) Equipment (old) Cash 10,000 Cost of new asset acquired: Gain on exchange of old asset: Fair value of old asset $8,000 Cash paid Book value of old asset $18,000 Gain on disposal $3,000 Less: Gain on disposal 3,000 $15,000

Amortization Period, the Shorter of 13-11 Intangible Assets Asset Type Legal Life Amortization Period, the Shorter of Minimum Maximum Patents 20 years Useful life Franchise & Licenses By contract of indefinite 40 years Copyrights Life of creator plus 50 years Not Amortized Goodwill Indefinite Trademarks & Tradenames