10 Property, Plant and Equipment and Intangibles CHAPTER PowerPoint Slides to accompany Fundamental Accounting Principles, 14ce Prepared by Joe Pidutti, Durham College © 2013 McGraw-Hill Ryerson Limited.

© 2013 McGraw-Hill Ryerson Limited. Learning Objectives Describe property, plant and equipment (PPE) and calculate their cost. (LO1) Explain, record, and calculate depreciation using the methods of straight-line, units of production, and double-declining balance. (LO2) Explain and calculate depreciation for partial years. (LO3) © 2013 McGraw-Hill Ryerson Limited.

© 2013 McGraw-Hill Ryerson Limited. Learning Objectives Explain and calculate revised depreciation. (LO4) Explain and record impairment losses. (LO5) Account for asset disposal through discarding, selling, or exchanging an asset. (LO6) Account for intangible assets and their amortization. (LO7) © 2013 McGraw-Hill Ryerson Limited.

© 2013 McGraw-Hill Ryerson Limited. Learning Objectives Explain and calculate revised depreciation when there is a subsequent capital expenditure that creates partial period depreciation. Appendix 10A (LO8) © 2013 McGraw-Hill Ryerson Limited.

Property, Plant and Equipment (PPE) Characteristics: Non-current assets used in the operations of a company. Have a useful life greater than one accounting period. May be classified as Tangible or Intangible. LO 1 © 2013 McGraw-Hill Ryerson Limited.

Property, Plant and Equipment (PPE) Also referred to as Fixed Assets. Examples: buildings, land, equipment, machinery, leasehold improvements, and vehicles. LO 1 © 2013 McGraw-Hill Ryerson Limited.

© 2013 McGraw-Hill Ryerson Limited. Intangible Assets Lack physical substance. Examples: patents, trademarks, copyrights, leaseholds and drilling rights. LO 1 © 2013 McGraw-Hill Ryerson Limited.

© 2013 McGraw-Hill Ryerson Limited. Cost of PPE PPE are recorded at cost, which includes all normal and reasonable expenditures necessary to get the asset in place and ready for its intended use. LO 1 © 2013 McGraw-Hill Ryerson Limited.

© 2013 McGraw-Hill Ryerson Limited. Capital Expenditures Are costs of PPE that provide material benefits extending beyond the current period. Are reported on the balance sheet under PPE. LO 1 © 2013 McGraw-Hill Ryerson Limited.

© 2013 McGraw-Hill Ryerson Limited. Revenue Expenditures Are costs that maintain an asset but do not materially increase the asset’s life or productive capabilities. Are reported on the income statement as expenses. Examples: supplies, lubricants, repair and maintenance costs. LO 1 © 2013 McGraw-Hill Ryerson Limited.

Subsequent Expenditures Expenditures that make PPE more efficient or productive and/or extend the useful life of the PPE beyond original expectations. Examples: roofing replacement, plant expansion and major overhauls of machinery and equipment. LO 1 © 2013 McGraw-Hill Ryerson Limited.

© 2013 McGraw-Hill Ryerson Limited. Land Is not subject to depreciation. 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 LO 1 © 2013 McGraw-Hill Ryerson Limited.

© 2013 McGraw-Hill Ryerson Limited. Land Improvements Assets that increase the usefulness of the land but have a limited life. Costs are charged to a separate PPE account. Costs are allocated over the period they benefit. Cost examples include parking lot surfaces, driveways, fences and lighting systems. LO 1 © 2013 McGraw-Hill Ryerson Limited.

© 2013 McGraw-Hill Ryerson Limited. Buildings Costs include all expenditures to make the building ready for its intended use. Costs are depreciated over the period they benefit. Cost examples include purchase price, brokerage fees, taxes, title fees and legal costs. LO 1 © 2013 McGraw-Hill Ryerson Limited.

Leasehold Improvements Costs of alterations or improvements to leased property. Costs are depreciated over the life of the improvements or the life of the lease, whichever is shorter. Examples include flooring, painting, storefronts, and partitions. LO 1 © 2013 McGraw-Hill Ryerson Limited.

Machinery and Equipment Costs include all expenditures normal and necessary to purchase it and prepare it for its intended use. Costs are depreciated over the periods they benefit. Cost examples include purchase price, less discounts, plus non-refundable sales taxes, transportation charges, insurance while in transit. LO 1 © 2013 McGraw-Hill Ryerson Limited.

Lump-Sum Asset Purchase PPE may be purchased in a group with a single transaction for a lump-sum price. The cost of the purchase is allocated to the various PPE based on their relative values. LO 1 © 2013 McGraw-Hill Ryerson Limited.

© 2013 McGraw-Hill Ryerson Limited. Depreciation A process of matching (or allocating) the depreciable cost of an asset in a rational and systematic manner over the asset’s useful life. Depreciation does not measure the decline in market value of an asset. Depreciation begins to be recorded when the asset is put into use. LO 2 © 2013 McGraw-Hill Ryerson Limited.

© 2013 McGraw-Hill Ryerson Limited. Depreciation PPE help the organization earn revenues over several accounting periods. The cost of these PPE are depreciated (spread out) over these same periods. Cost Useful life LO 2 © 2013 McGraw-Hill Ryerson Limited.

© 2013 McGraw-Hill Ryerson Limited. Depreciation Factors relevant in determining depreciation: Cost Residual value Useful (service) life LO 2 © 2013 McGraw-Hill Ryerson Limited.

© 2013 McGraw-Hill Ryerson Limited. Depreciation Methods The most commonly used methods are: Straight-line Units-of-production Double-declining balance LO 2 © 2013 McGraw-Hill Ryerson Limited.

Straight-Line Method The same amount is expensed each period of the asset’s useful life. Straight-line depreciation expense Cost – Estimated residual value = Estimated useful life LO 2 © 2013 McGraw-Hill Ryerson Limited.

© 2013 McGraw-Hill Ryerson Limited. Illustration A piece of shoe-inspection machinery is purchased on January 1, 2014. The relevant data is as follows: Cost $10,000 Estimated residual value -1,000 Cost to be depreciated $9,000 Estimated useful life: Accounting periods 5 years Units inspected 36,000 shoes LO 2 © 2013 McGraw-Hill Ryerson Limited.

Illustration: Straight-Line Method Straight-line depreciation expense Cost – Estimated residual value = Estimated useful life in years $10,000 – $1,000 = 5 years = $1,800/ year LO 2 © 2013 McGraw-Hill Ryerson Limited.

Illustration: Straight-Line Method The annual adjusting entry to record depreciation on this equipment would be: Depreciation Expense-Equipment 1,800 Accumulated Deprec. -Equipment 1,800 2014 2015 2016 2017 2018 Equipment $10,000 Less: Acc. Deprec. 1,800 3,600 5,400 7,200 9,000 Book Value $8,200 $6,400 $4,600 $2,800 $1,000 LO 2 © 2013 McGraw-Hill Ryerson Limited.

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. Depreciation per unit Cost – Estimated residual value = Total estimated units of production Annual depreciation expense Actual production depreciation per unit = x LO 2 © 2013 McGraw-Hill Ryerson Limited.

© 2013 McGraw-Hill Ryerson Limited. Illustration: Units-of-Production Method $10,000 – $1,000 Depreciation per unit (shoe) = 36,000 units (shoes) = $.25/shoe Assume actual production is as follows: 2014 2015 2016 2017 2018 Units (shoes) 7,000 8,000 9,000 7,000 6,000 x.25 x.25 x.25 x.25 x.25 depreciation $1,750 $2,000 $2,250 $1,750 $1,250* *Maximum depreciation allowed since 36,000 units have been produced. LO 2 © 2013 McGraw-Hill Ryerson Limited.

© 2013 McGraw-Hill Ryerson Limited. Illustration: Units-of-Production Method 2014 2015 2016 2017 2018 Equipment $10,000 Less: Acc. Deprec. 1,750 3,750 6,000 7,750 9,000 Book Value $8,250 $6,250 $4,000 $2,250 $1,000 LO 2 © 2013 McGraw-Hill Ryerson Limited.

Declining-Balance Method This method yields larger depreciation expenses in the early years of an asset’s life and smaller charges in later years. A depreciation rate, up to twice the straight-line rate, is applied to the asset’s beginning of the period book value. LO 2 © 2013 McGraw-Hill Ryerson Limited.

Double-Declining Balance Method Steps: Calculate the double-declining balance rate.* rate = 2 / (Estimated years of useful life) Calculate deprecation expense by multiplying the rate by the asset’s beginning-of-period book value. (depreciation expense = rate x book value) *Note: Residual value is not used in these calculations. LO 2 © 2013 McGraw-Hill Ryerson Limited.

© 2013 McGraw-Hill Ryerson Limited. Illustration: Double-Declining-Balance Method Rate = 2 / 5 years x 100% = 40% per year Year Book Value at start of period Depreciation Expense Accumulated Depreciation end of period 2014 $10,000 40% x 10,000 = $4,000 $4,000 $6,000 2015 6,000 40% x 6,000 = 2,400 6,400 3,600 2016 40% x 3,600 = 1,440 7,840 2,160 2017 40% x 2,160 = 864 8,704 1,296 2018 296 (maximum) 9,000 1,000 (residual value) LO 2 © 2013 McGraw-Hill Ryerson Limited.

© 2013 McGraw-Hill Ryerson Limited. Illustration: Double-Declining-Balance Method 2014 2015 2016 2017 2018 Equipment $10,000 Less: Acc. Deprec. 4,000 6,400 7,840 8,704 9,000 Book Value $6,000 $3,600 $2,160 $1,296 $1,000 LO 2 © 2013 McGraw-Hill Ryerson Limited.

© 2013 McGraw-Hill Ryerson Limited. Comparison of Methods Period Straight-line Units-of-production Double-Declining Balance 2014 $1,800 $1,750 $4,000 2015 1,800 2,000 2,400 2016 2,250 1,440 2017 1,750 864 2018 1,250 296 $9,000 LO 2 © 2013 McGraw-Hill Ryerson Limited.

Partial-Year Depreciation Assets may be purchased or disposed of at any time during the year. Depreciation 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. LO 3 © 2013 McGraw-Hill Ryerson Limited.

Partial-Year Depreciation Methods: Nearest whole month If the asset is in use for more than half of the month, depreciation is calculated for the whole month. If the asset is in use for less than half of the month, depreciation is not calculated for the month. Half-year convention Six months’ depreciation is recorded regardless when an asset is acquired or disposed of. LO 3 © 2013 McGraw-Hill Ryerson Limited.

© 2013 McGraw-Hill Ryerson Limited. Mini-Quiz Gamma Company purchased a computer costing $4,000 on April 18. It is expected to last for three years and then sell for $400. Calculate depreciation for the first year using the: Straight-line method. Double declining balance method. © 2013 McGraw-Hill Ryerson Limited.

Mini-Quiz Gamma Company purchased a computer costing $4,000 on April 18. It is expected to last for three years and then sell for $400. Straight-line depreciation expense Cost – Estimated residual value Portion of year = X Estimated useful life $4,000 – $400 = X 8/12 year 3 years = $800 © 2013 McGraw-Hill Ryerson Limited.

Mini-Quiz = = = $1,778 (rounded) Gamma Company purchased a computer costing $4,000 on April 18. It is expected to last for three years and then sell for $400. DDB depreciation expense DDB rate x Cost x Portion of year = = (2 /3) x $4,000 x 8/12 = $1,778 (rounded) © 2013 McGraw-Hill Ryerson Limited.

Depreciation for Income Tax Reporting rules for financial accounting usually differ from rules for income tax accounting purpose of financial accounting is to report useful information on financial performance and position purpose of income tax accounting reflects government objectives in raising revenues

Depreciation for Income Tax Reporting Income Tax Act requires declining-balance method for depreciation Capital cost allowance (CCA) is the term used to describe depreciation for tax purposes The declining balance method reduces taxable income in the early years of an asset's life because depreciation is greatest in the early years. The government hopes to encourage capital investment by allowing the higher deduction and tax savings in the early years. The Income Tax Act specifies rates for various groups of assets.

Revising Depreciation Rates Depreciation 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 subsequent capital expenditures. LO 4 © 2013 McGraw-Hill Ryerson Limited.

Changes in Estimated Residual Value and/or Estimated Useful Life The undepreciated cost of the asset is depreciated (allocated) over the remaining life of the asset. This is considered to be a change in an accounting estimate and not an error. LO 4 © 2013 McGraw-Hill Ryerson Limited.

Changes in Estimated Residual Value and/or Estimated Useful Life Example: Straight-line Method Revised depreciation for remaining years Remaining book value Revised residual value = Revised remaining useful life LO 4 © 2013 McGraw-Hill Ryerson Limited.

Revising Depreciation Rates EXAMPLE: Straight-line Method Equipment costing $10,000 was depreciated using the straight-line method. The estimated useful life was 5 years with a residual value of $1,000. The depreciation expense is $1,800 each year. After two years, the account balances are as follows: Cost $10,000 Accumulated Depreciation 3,600 Book Value $ 6,400 At the beginning of its third year, the predicted number of years remaining in its useful life changes from three to four years and its estimate of residual value changes from $1,000 to $400. Calculate the depreciation expense for the remaining years.

© 2013 McGraw-Hill Ryerson Limited. Revising Depreciation Rates When There is a Subsequent Capital Expenditure Subsequent capital expenditures cause the cost of an asset to change. These expenditures can be the addition of a component to an existing asset or the replacement or overhaul of a component. LO 4 © 2013 McGraw-Hill Ryerson Limited.

© 2013 McGraw-Hill Ryerson Limited. Revising Depreciation Rates When There is a Subsequent Capital Expenditure Revised depreciation is calculated to reflect the new cost and/or changes in estimated life/residual value. When a subsequent expenditure results in a replacement of a component, the cost and accumulated depreciation of the component must be removed and a gain or loss is recorded. LO 4 © 2013 McGraw-Hill Ryerson Limited.

Revising Depreciation Rates When There is a Subsequent Capital Expenditure EXAMPLE: On January 3, 2014, Lexi Company paid $15,000 cash for a refrigeration unit installed on its delivery van. The delivery van had a book value of $32,000 at December 31, 2013, and an estimated remaining useful life of 10 years and no residual value. Assume the refrigeration unit had an estimated life of five years and no residual value and that its addition to the delivery van did not change the van's useful life or residual value.

The entries to record the addition of the refrigeration unit on January 3 and revised depreciation at December 31 are:

Revising Depreciation Rates When There is a Subsequent Capital Expenditure EXAMPLE: On January 2, 2014, Lexi company purchased equipment with several components including an engine. The engine had a cost of $50,000, an estimated useful life of five years, and a residual value of $8,000. On January 5, 2016, the engine suffered major damage and was replaced with a new one for $55,000 on account with an estimated useful life of six years and residual value of $7,000. If the old engine was scrapped (no cash received), two entries are required on January 5, 2016.

First, the old engine must be removed from the accounting records.

The purchase of the new engine on the same date must also be recorded

These two entries could be combined as:

If the old engine was sold for $5,000 cash instead of being scrapped, the entry would be:

Impairment of PPE Assets An impairment loss occurs when the book value of PPE is greater than the amount to be recovered through the asset’s use or sale. Impairments may result from: A significant decline in the market value of the asset. Technological, economic, or legal factors. LO 5 © 2013 McGraw-Hill Ryerson Limited.

Impairment of PPE Assets PPE must be assessed for impairments annually to ensure assets and income are not overstated. If an impairment loss occurs: The loss is recorded. Depreciation is revised for future periods. LO 5 © 2013 McGraw-Hill Ryerson Limited.

Impairment of PPE Assets EXAMPLE: On December 31, 2014, the adjusted trial balance showed equipment with a cost of $50,000 and accumulated depreciation of $27,000. As part of its December 31, 2014 year-end procedures, the business performed an asset impairment assessment and found that the equipment had a recoverable value of $15,000. Prepare the entries for: a) the impairment loss on December 31, 2014 and b) the revised depreciation on December 31, 2015 if straight-line depreciation is used and that the remaining useful life is four years and the residual value of the equipment is zero.

a) 2014 Dec 31 Impairment Loss 8,000 Equipment 8,000 To record impairment loss on equipment.

b) 2015 Dec 31 Depreciation Expense-Equipment 3,750 Accumulated Depreciation – Equipment 3,750 To record revised depreciation caused by impairment loss. Revised cost = $50,000-8,000 = $42,000 Remaining book value = $42,000-$27,000 = $15,000 Revised depreciation = $15,000/4 = $3,750

Impairment of PPE Assets

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 LO 6 © 2013 McGraw-Hill Ryerson Limited.

© 2013 McGraw-Hill Ryerson Limited. Disposal of PPE Accounting for disposal involves: Record depreciation up to date of disposal. Compare the asset’s book value with the net amount received/paid at disposal and record any resulting gain/loss. Remove the balances of the disposed asset and related accumulated depreciation accounts. Record any cash (and other assets) received or paid in the disposal. LO 6 © 2013 McGraw-Hill Ryerson Limited.

© 2013 McGraw-Hill Ryerson Limited. Intangible Assets Have no physical substance. Are used in operations. Provide future economic benefits. Are recorded at cost when purchased. Examples include patents, copyrights, trademarks, drilling rights, trademarks and trade names, and leaseholds. LO 7 © 2013 McGraw-Hill Ryerson Limited.

© 2013 McGraw-Hill Ryerson Limited. Intangible Assets Are recorded at cost when purchased. Cost is amortized over estimated useful life. The straight-line method is usually used. Are shown on the balance sheet separately from PPE. LO 7 © 2013 McGraw-Hill Ryerson Limited.

© 2013 McGraw-Hill Ryerson Limited. Goodwill The amount by which the price paid for a company exceeds the fair market value of the company’s net assets if purchased separately. Goodwill Is not an intangible asset. Is reported separately on the balance sheet. Is not amortized but may be decreased if it is impaired. LO 7 © 2013 McGraw-Hill Ryerson Limited.

© 2013 McGraw-Hill Ryerson Limited. 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 provide material benefits extending beyond the current period. They are debited to PPE accounts and are matched with future periods through depreciation expense. Immaterial long-term expenditures are treated as current period expenses. © 2013 McGraw-Hill Ryerson Limited.

© 2013 McGraw-Hill Ryerson Limited. Revised Depreciation When There is a Subsequent Capital Expenditure That Creates Partial Period Depreciation-Appendix 10A Steps in Revising Depreciation: Depreciation is updated to the date of the subsequent capital expenditure. The subsequent capital expenditure and any gain/loss is recorded(if a replacement). Revised depreciation is calculated. LO 8 © 2013 McGraw-Hill Ryerson Limited.

© 2013 McGraw-Hill Ryerson Limited. End of Chapter © 2013 McGraw-Hill Ryerson Limited.