© 2007 McGraw-Hill Ryerson Ltd. Electronic Presentations in Microsoft® PowerPoint® Capital Assets and Goodwill CHAPTER 12 Slides Content 1-3 Learning objectives 4-15 Terminology- link to exercises/problems 16-33 Amortization-link to exercises/problems 34-36 Partial year amortization-link to exercises/problems 37-39 Revising rates 40-41 Disposal of capital assets 42-43 Natural resources 44-45 Intangible assets 46 Goodwill 47-48 Review 49-50 Appendix 12A End slide Photo credit © 2007 McGraw-Hill Ryerson Ltd.

© 2007 McGraw-Hill Ryerson Ltd. Learning Objectives Describe capital assets and apply the cost principle to calculate their cost. Explain, record, and calculate amortization using the methods of straight-line, units of production, and double-declining balance. Explain and calculate amortization for partial years. Explain and calculate revised amortization. © 2007 McGraw-Hill Ryerson Ltd.

© 2007 McGraw-Hill Ryerson Ltd. Learning Objectives Account for asset disposal through discarding, selling, or exchanging an asset. Account for natural resources and their amortization. Account for intangible capital assets and their amortization. Account for goodwill. Explain and account for exchanging dissimilar and similar assets. Appendix 12A © 2007 McGraw-Hill Ryerson Ltd.

© 2007 McGraw-Hill Ryerson Ltd. Capital Assets Characteristics: Used in the operations of a company. Have a useful life greater than one accounting period. May be classified as Tangible or Intangible. © 2007 McGraw-Hill Ryerson Ltd.

Tangible Capital Assets Also referred to as Property, Plant and Equipment or as Fixed Assets. Examples: buildings, land, equipment, leasehold improvements, vehicles, and natural resources. © 2007 McGraw-Hill Ryerson Ltd.

Intangible Capital Assets Lack physical substance. Examples: patents, trademarks, and copyrights. Goodwill is also an intangible capital asset but it is shown separately on the balance sheet. © 2007 McGraw-Hill Ryerson Ltd.

© 2007 McGraw-Hill Ryerson Ltd. Cost of Capital Assets Capital assets are recorded at cost which, includes all normal and reasonable expenditures necessary to get the asset in place and ready for its intended use. © 2007 McGraw-Hill Ryerson Ltd.

© 2007 McGraw-Hill Ryerson Ltd. Capital Expenditures Provide material benefits extending beyond the current period. Are reported on the balance sheet as capital assets. © 2007 McGraw-Hill Ryerson Ltd.

© 2007 McGraw-Hill Ryerson Ltd. Revenue Expenditures Do not provide material benefits extending beyond the current period. Are reported on the income statement as expenses. Examples: supplies, lubricants, repair and maintenance costs. © 2007 McGraw-Hill Ryerson Ltd.

© 2007 McGraw-Hill Ryerson Ltd. Betterments An expenditure to make a capital asset more efficient or productive and/or extend the useful life of the capital asset beyond original expectations. Examples: major overhauls of machinery, roof replacements, and plant expansions. © 2007 McGraw-Hill Ryerson Ltd.

© 2007 McGraw-Hill Ryerson Ltd. Land Is not subject to amortization. Cost of land includes: Purchase price Legal fees Real estate commissions Accrued property taxes Payments for surveying, grading, draining, and clearing the land Assessments by local governments © 2007 McGraw-Hill Ryerson Ltd.

© 2007 McGraw-Hill Ryerson Ltd. Land Improvements Assets that increase the usefulness of the land but have a limited life. Costs are charged to a separate asset account. Costs are amortized over the period they benefit. © 2007 McGraw-Hill Ryerson Ltd.

© 2007 McGraw-Hill Ryerson Ltd. Buildings Costs include all expenditures to make the building ready for its intended use. Costs are amortized over the period they benefit. © 2007 McGraw-Hill Ryerson Ltd.

Leasehold Improvements Costs of alterations or improvements to leased property. Costs are amortized over the life of the improvements or the life of the lease, whichever is shorter. Examples include flooring, painting, storefronts, and partitions. © 2007 McGraw-Hill Ryerson Ltd.

Machinery and Equipment Costs include all expenditures normal and necessary to purchase it and prepare it for its intended use. Costs are amortized over the periods they benefit. © 2007 McGraw-Hill Ryerson Ltd.

© 2007 McGraw-Hill Ryerson Ltd. Amortization A process of systematically allocating the cost of a capital asset to expense over its estimated useful life. Amortization does not measure the decline in value or deterioration of an asset. Amortization begins to be recorded when the asset is put into use. © 2007 McGraw-Hill Ryerson Ltd.

© 2007 McGraw-Hill Ryerson Ltd. Amortization Capital assets help the organization earn revenues over several accounting periods. The cost of these assets is amortized (spread out) over these same periods. Cost Useful life © 2007 McGraw-Hill Ryerson Ltd.

© 2007 McGraw-Hill Ryerson Ltd. Amortization Factors relevant in determining amortization: Cost Residual value Useful life © 2007 McGraw-Hill Ryerson Ltd.

© 2007 McGraw-Hill Ryerson Ltd. Amortization Methods The most commonly used methods are: Straight-line Units-of-production Double-declining balance © 2007 McGraw-Hill Ryerson Ltd.

Straight-Line Method The same amount is expensed each period of the asset’s useful life. Straight-line amortization expense Cost – Estimated residual value = Estimated useful life © 2007 McGraw-Hill Ryerson Ltd.

© 2007 McGraw-Hill Ryerson Ltd. Illustration A piece of shoe-inspection machinery is purchased on January 1, 2011. The relevant data is as follows: Cost $10,000 Estimated residual value -1,000 Cost to be amortized $9,000 Estimated useful life: Accounting periods 5 years Units inspected 36,000 shoes © 2007 McGraw-Hill Ryerson Ltd.

Illustration: Straight-Line Method Straight-line amortization expense Cost – Estimated salvage value = Estimated useful life $10,000 – $1,000 = 5 years = $1,800/ year © 2007 McGraw-Hill Ryerson Ltd.

© 2007 McGraw-Hill Ryerson Ltd. Illustration: Straight-Line Method The annual adjusting entry to record amortization on this equipment would be: Amortization Expense, equipment 1,800 Accumulated Amortization, –equipment 1,800 2011 2012 2013 2014 2015 Equipment $10,000 Less: Acc. Amort. 1,800 3,600 5,400 7,200 9,000 Book Value $8,200 $6,400 $4,600 $2,800 $1,000 © 2007 McGraw-Hill Ryerson Ltd.

Units-of-Production Method This method is employed when the use of an asset varies greatly from one period to the next. The amount charged to expense is based on the usage of the asset. Amortization per unit Cost – Estimated residual value = Total estimated units of production Annual amortization expense Actual production Amortization per unit = x © 2007 McGraw-Hill Ryerson Ltd.

© 2007 McGraw-Hill Ryerson Ltd. Illustration: Units-of-Production Method $10,000 – $1,000 Amortization per unit (shoe) = 36,000 units (shoes) = $.25/shoe Assume actual production is as follows: 2011 2012 2013 2014 2015 Units (shoes) 7,000 8,000 9,000 7,000 6,000 x.25 x.25 x.25 x.25 x.25 Amortization $1,750 $2,000 $2,250 $1,750 $1,250* *Maximum amortization allowed since 36,000 units have been produced. © 2007 McGraw-Hill Ryerson Ltd.

© 2007 McGraw-Hill Ryerson Ltd. Illustration: Units-of-Production Method 2011 2012 2013 2014 2015 Equipment $10,000 Less: Acc. Amort. 1,750 3,750 6,000 7,750 9,000 Book Value $8,250 $6,250 $4,000 $2,250 $1,000 © 2007 McGraw-Hill Ryerson Ltd.

Declining-Balance Method This method yields larger amortization expenses in the early years of an asset’s life and smaller charges in later years. A constant rate, up to twice the straight-line rate, is applied to the asset’s beginning of the period book value. © 2007 McGraw-Hill Ryerson Ltd.

Double-Declining Balance Method Steps: Compute the double-declining balance rate.* rate = 2 / (estimated life in years) Multiply the rate by the asset’s opening book value. amortization expense = rate x book value *Note: Salvage value is not used in this calculation. © 2007 McGraw-Hill Ryerson Ltd.

© 2007 McGraw-Hill Ryerson Ltd. Illustration: Double-Declining-Balance Method Rate = 2 / 5 years x 100% = 40% per year Year Book Value at start of period Amortization Expense Accumulated Amortization end of period 2011 $10,000 40% x 10,000 = $4,000 $4,000 $6,000 2012 6,000 40% x 6,000 = 2,400 6,400 3,600 2013 40% x 3,600 = 1,440 7,840 2,160 2014 40% x 2,160 = 864 8,704 1,296 2015 296 (maximum) 9,000 1,000 (salvage value) © 2007 McGraw-Hill Ryerson Ltd.

© 2007 McGraw-Hill Ryerson Ltd. Illustration: Double Declining Balance Method 2011 2012 2013 2014 2015 Equipment $10,000 Less: Acc. Amort. 4,000 6,400 7,840 8,704 9,000 Book Value $6,000 $3,600 $2,160 $1,296 $1,000 © 2007 McGraw-Hill Ryerson Ltd.

© 2007 McGraw-Hill Ryerson Ltd. Comparison of Methods Period Straight-line Units-of-production Double-Declining Balance 2011 $1,800 $1,750 $4,000 2012 1,800 2,000 2,400 2013 2,250 1,440 2014 1,750 864 2015 1,250 296 $9,000 © 2007 McGraw-Hill Ryerson Ltd.

Partial-Year Amortization Assets may be purchased or disposed of at any time during the year. Amortization for a partial year is recorded when the purchase or disposal is made at a time other than the beginning or end of the accounting period. © 2007 McGraw-Hill Ryerson Ltd.

Partial-Year Amortization Methods: Nearest whole month If the asset is in use for more than half of the month, amortization is calculated for the whole month. If the asset is in use for less than half of the month, amortization is not calculated for the month. Half-year rule Six months’ amortization is recorded regardless when an asset is acquired or disposed of. © 2007 McGraw-Hill Ryerson Ltd.

© 2007 McGraw-Hill Ryerson Ltd. Mini-Quiz Gamma Company purchased a computer costing $4,000 on April 16. It is expected to last for three years and then sell for $400. Calculate amortization for the first year using the: Straight-line method. Double declining balance method. © 2007 McGraw-Hill Ryerson Ltd.

Mini-Quiz Gamma Company purchased a computer costing $4,000 on April 16. It is expected to last for three years and then sell for $400. Straight-line amortization expense Cost – Estimated residual value Portion of year = X Estimated useful life $4,000 – $400 = X 8/12 year 3 years = $800 © 2007 McGraw-Hill Ryerson Ltd.

Mini-Quiz = = = $1778 (rounded) Gamma Company purchased a computer costing $4,000 on April 16. It is expected to last for three years and then sell for $400. DDB amortization expense DDB rate x Cost x Portion of year = = (2 x 1/3) x $4,000 x 8/12 = $1778 (rounded) © 2007 McGraw-Hill Ryerson Ltd.

Revising Amortization Rates Amortization rates for current and future periods may be revised if there is a change in an asset’s: Estimated residual value and/or useful life. or Cost due to betterments. © 2007 McGraw-Hill Ryerson Ltd.

Changes in Estimated Useful Life and/or Estimated Salvage Value The unamortized cost of the asset is amortized (spread) over the remaining life of the asset. This is considered to be a change in an accounting estimate and not an error. © 2007 McGraw-Hill Ryerson Ltd.

Changes in Estimated Useful Life and/or Estimated residual Value Example: Straight-line Method Revised amortization for remaining years Remaining book value Revised residual value = Revised remaining useful life © 2007 McGraw-Hill Ryerson Ltd.

Disposal of Capital Assets Capital assets may be disposed of for a variety of reasons such as: Obsolescence Wear and tear Damage Changing business plans © 2007 McGraw-Hill Ryerson Ltd.

Disposal of Capital Assets Accounting for disposal involves: Recording of amortization up to date of disposal. Removal of asset and associated accumulated amortization from the accounts. Recording any cash received or paid in the disposal. Recording any gain or loss on disposal. © 2007 McGraw-Hill Ryerson Ltd.

© 2007 McGraw-Hill Ryerson Ltd. Natural Resources Tangible capital assets such as standing timber, mineral deposits, and oil fields. Are recorded at cost, which includes all expenditures necessary to acquire and prepare the resource for use. © 2007 McGraw-Hill Ryerson Ltd.

Natural Resources Natural resources are amortized based on units extracted or depleted. Amortization per unit Cost – Estimated residual value = Total units of capacity Amortization expense Units extracted Amortization per unit = x © 2007 McGraw-Hill Ryerson Ltd.

© 2007 McGraw-Hill Ryerson Ltd. Intangible Assets Have no physical substance. Are used in operations. Are recorded at cost when purchased. Are amortized over their estimated useful life. Examples include patents, trademarks, and copyrights. © 2007 McGraw-Hill Ryerson Ltd.

© 2007 McGraw-Hill Ryerson Ltd. Intangible Assets Amortization Estimated useful life may be affected by legal, regulatory, competitive, or other factors. Only the straight-line method is used. © 2007 McGraw-Hill Ryerson Ltd.

© 2007 McGraw-Hill Ryerson Ltd. Goodwill The amount by which the value of a company exceeds the fair market value of the company’s net assets if purchased separately. Goodwill Is an intangible asset but not a capital asset. Is reported separately on the balance sheet. Is not amortized but is subject to impairment. © 2007 McGraw-Hill Ryerson Ltd.

© 2007 McGraw-Hill Ryerson Ltd. Review Discuss the four issues in accounting for capital assets. The four main accounting issues include: Computing their costs Allocating their costs to the periods they benefit Accounting for expenditures such as repairs and improvements Recording their disposal. © 2007 McGraw-Hill Ryerson Ltd.

© 2007 McGraw-Hill Ryerson Ltd. Review Explain the difference between revenue and capital expenditures and how they are recorded in the accounting system. Revenue expenditures such as ordinary repairs expire in the current accounting period. They are debited to expense and are thus matched with current revenues. Capital expenditures such as extraordinary repairs and betterments, benefit future periods. They are debited to asset accounts and are matched with future periods through amortization expense. Immaterial long-term expenditures are treated as current period expenses. © 2007 McGraw-Hill Ryerson Ltd.

Exchanging Dissimilar and Similar Assets-Appendix 12A Exchanging Dissimilar Assets Any gain or loss on the disposal on the exchange is recorded. The gain or loss is computed by comparing the book value of the asset given up with the fair market value of the asset received (or trade-in allowance). © 2007 McGraw-Hill Ryerson Ltd.

Exchanging Dissimilar and Similar Assets-Appendix 12A Exchanging Similar Assets: Non-monetary If the amount of cash exchanged on a trade-in of capital assets is less than 10% of the total consideration, the transaction is a non-monetary transaction and a gain or loss is not recorded. Exchanging Similar Assets: Monetary If the amount of cash exchanged on a trade-in of capital assets is greater than 10% of the total consideration, the transaction is a monetary transaction and a gain or loss is recorded. © 2007 McGraw-Hill Ryerson Ltd.

© 2007 McGraw-Hill Ryerson Ltd. End of Chapter © 2007 McGraw-Hill Ryerson Ltd.

© 2007 McGraw-Hill Ryerson Ltd. Photograph Credits Slide Credit 5 Punchstock/Digital Vision Punchstock/Stockbyte © 2007 McGraw-Hill Ryerson Ltd.