Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 8 Reporting and Interpreting Property, Plant, and Equipment; Natural Resources; and Intangibles

8-2 Understanding The Business How much is enough? Insufficient capacity results in lost sales. Costly excess capacity reduces profits.

8-3 Tangible Physical Substance Intangible No Physical Substance Expected to Benefit Future Periods Actively Used in Operations Classifying Long-Lived Assets

8-4 Fixed Asset Turnover Net Sales Revenue Average Net Fixed Assets = This ratio measures a company’s ability to generate sales given an investment in fixed assets. For the year 2003, Delta Airlines had $13,303 of revenue. End-of-year fixed assets were $16,752 and beginning-of-year fixed assets were $16,524. (All numbers in millions.)

8-5 Fixed Asset Turnover $13,303 ($16,524 + $16,752) ÷ 2 == 0.80 Fixed Asset Turnover Net Sales Revenue Average Net Fixed Assets = Fixed Asset Turnover

8-6 Measuring and Recording Acquisition Cost Acquisition cost includes the purchase price and all expenditures needed to prepare the asset for its intended use. Acquisition cost does not include financing charges and cash discounts. Acquisition cost includes the purchase price and all expenditures needed to prepare the asset for its intended use. Acquisition cost does not include financing charges and cash discounts.

8-7 Purchase price Renovation and repair costs Legal and realty fees Title fees Purchase price Renovation and repair costs Legal and realty fees Title fees Acquisition Cost – Buildings

8-8 Purchase price Installation costs Modification to building necessary to install equipment Transportation costs Purchase price Installation costs Modification to building necessary to install equipment Transportation costs Acquisition Cost – Equipment

8-9 Purchase price Real estate commissions Title insurance premiums Delinquent taxes Surveying fees Title search and transfer fees Purchase price Real estate commissions Title insurance premiums Delinquent taxes Surveying fees Title search and transfer fees Land is not depreciable. Acquisition Cost – Land

8-10 Acquisition for Cash On January 1, Delta Air Lines purchased aircraft for $70,000,000 cash.

8-11 Acquisition for Cash On January 1, Delta Air Lines purchased aircraft for $70,000,000 cash.

8-12 Acquisition for Debt On January 14, Delta Air Lines purchased aircraft for $1,000,000 cash and a $69,000,000 note payable.

8-13 Acquisition for Debt On January 14, Delta Air Lines purchased aircraft for $1,000,000 cash and a $69,000,000 note payable.

8-14 Record at the current market value of the consideration given, or the current market value of the asset acquired, whichever is more clearly evident. Acquisition for Noncash Consideration

8-15 Acquisition for Noncash Consideration On July 7, Delta gave Boeing 6,000,000 shares of $1.50 par value common stock with a market value of $7 per share plus $28,000,000 in cash for aircraft.

8-16 Acquisition for Noncash Consideration On July 7, Delta gave Boeing 6,000,000 shares of $1.50 par value common stock with a market value of $7 per share plus $28,000,000 in cash for aircraft.

8-17 Acquisition by Construction Asset cost includes: All materials and labor traceable to the construction. A reasonable amount of overhead. Interest on debt incurred during the construction.

8-18 Repairs, Maintenance, and Additions

8-19 Depreciation is a cost allocation process that systematically and rationally matches acquisition costs of operational assets with periods benefited by their use. Cost Allocation (Unused) Balance Sheet (Used) Income Statement Expense Depreciation Acquisition Cost

8-20 Depreciation Expense Income Statement Balance Sheet Accumulated Depreciation Depreciation for the current year Total of depreciation to date on an asset Depreciation

8-21 Book Values Depreciation on Delta’s 2003 Balance Sheet Book value = Market value / /

8-22 Depreciation Concepts The calculation of depreciation requires three amounts for each asset:  Acquisition cost.  Estimated useful life.  Estimated residual value. The calculation of depreciation requires three amounts for each asset:  Acquisition cost.  Estimated useful life.  Estimated residual value.

8-23 Alternative Depreciation Methods  Straight-line  Units-of-production  Accelerated Method: Declining balance  Straight-line  Units-of-production  Accelerated Method: Declining balance

8-24 Straight-Line Method At the beginning of the year, Delta purchased ground equipment for $62,500 cash. The equipment has an estimated useful life of 3 years and an estimated residual value of $2,500. Cost - Residual Value Life in Years Depreciation Expense per Year Depreciation Expense per Year == SL

8-25 Depreciation Expense per Year = Depreciation Expense per Year = $20,000 $62,500 - $2,500 3 years Cost - Residual Value Life in Years Depreciation Expense per Year Depreciation Expense per Year == SL Straight-Line Method

8-26 Residual Value SL More companies use the straight-line method of depreciation in their financial reports than all other methods combined. Straight-Line Method

8-27 Units-of-Production Method Depreciation Rate = Cost - Residual Value Life in Units of Production Step 1: Step 2: Depreciation Expense = Depreciation Rate × Number of Units Produced for the Year

8-28 At the beginning of the year, Delta purchased ground equipment for $62,500 cash. The equipment has a 100,000 mile useful life and an estimated residual value of $2,500. If the equipment is used 30,000 miles in the first year, what is the amount of depreciation expense? Units-of-Production Method

8-29 $62,500 - $2, ,000 miles = $.60 per mile Depreciation Rate = Step 1: Step 2: $.60 per mile × 30,000 miles = $18,000 Depreciation Expense = Units-of-Production Method

8-30 Units-of-Production Method

8-31 Residual Value Units-of-Production Method

8-32 Accelerated Depreciation Depreciation Repair Expense Early Years High Low Later Years Low High Accelerated depreciation matches higher depreciation expense with higher revenues in the early years of an asset’s useful life when the asset is more efficient.

8-33 Double-Declining-Balance Method Annual Depreciation expense Net Book Value () Useful Life in Years 2 = × Cost – Accumulated Depreciation Declining balance rate of 2 is double-declining-balance (DDB) rate. Annual computation ignores residual value.

8-34 At the beginning of the year, Delta purchased equipment for $62,500 cash. The equipment has an estimated useful life of 3 years and an estimated residual value of $2,500. Calculate the depreciation expense for the first two years. Double-Declining-Balance Method

8-35 Annual Depreciation expense Net Book Value () Useful Life in Years 2 = × () $62,500 × 3 years 2 = $41,667 () ($62,500 – $41,667) × 3 years 2 = $13,889 Double-Declining-Balance Method Year 1 Depreciation: Year 2 Depreciation:

8-36 () ($62,500 – $55,556) × 3 years 2 = $4,629 Below residual value Double-Declining-Balance Method

8-37 Depreciation expense is limited to the amount that reduces book value to the estimated residual value. Double-Declining-Balance Method

8-38 Depreciation and Federal Income Tax For tax purposes, most corporations use the Modified Accelerated Cost Recovery System (MACRS). MACRS depreciation provides for rapid write- off of an asset’s cost in order to stimulate new investment. For tax purposes, most corporations use the Modified Accelerated Cost Recovery System (MACRS). MACRS depreciation provides for rapid write- off of an asset’s cost in order to stimulate new investment.

8-39 Depreciation Methods in Other Countries Many countries, including Australia, Brazil, England, and Mexico, use other methods such as depreciation based on the current fair value of assets.

8-40 Learning Objectives Explain the effect of asset impairment on financial statements.

8-41 Asset Impairment Impairment is the loss of a significant portion of the utility of an asset through...  Casualty.  Obsolescence.  Lack of demand for the asset’s services. A loss should be recognized when an asset suffers a permanent impairment.

8-42 Learning Objectives Analyze the disposal of property, plant, and equipment.

8-43 Disposal of Property, Plant, and Equipment Voluntary disposals:  Sale  Trade-in  Retirement Involuntary disposals:  Fire  Accident Voluntary disposals:  Sale  Trade-in  Retirement Involuntary disposals:  Fire  Accident

8-44 Disposal of Property, Plant, and Equipment  Update depreciation to the date of disposal.  Journalize disposal by: Writing off accumulated depreciation (debit). Writing off the asset cost (credit). Recording cash received (debit) or paid (credit). Recording a gain (credit) or loss (debit).

8-45 If Cash > BV, record a gain (credit). If Cash < BV, record a loss (debit). If Cash = BV, no gain or loss. If Cash > BV, record a gain (credit). If Cash < BV, record a loss (debit). If Cash = BV, no gain or loss. Disposal of Property, Plant, and Equipment

8-46 Delta Airlines sold flight equipment for $5,000,000 cash at the end of its 17th year of use. The flight equipment originally cost $20,000,000, and was depreciated using the straight-line method with zero residual value and a useful life of 20 years. Let’s answer the following questions. Delta Airlines sold flight equipment for $5,000,000 cash at the end of its 17th year of use. The flight equipment originally cost $20,000,000, and was depreciated using the straight-line method with zero residual value and a useful life of 20 years. Let’s answer the following questions. Disposal of Property, Plant, and Equipment

8-47 The amount of depreciation expense recorded at the end of the 17th year to bring depreciation up to date is: a.$0. b.$1,000,000. c.$2,000,000. d.$4,000,000. The amount of depreciation expense recorded at the end of the 17th year to bring depreciation up to date is: a.$0. b.$1,000,000. c.$2,000,000. d.$4,000,000. Disposal of Property, Plant, and Equipment

8-48 The amount of depreciation expense recorded at the end of the 17th year to bring depreciation up to date is: a.$0. b.$1,000,000. c.$2,000,000. d.$4,000,000. The amount of depreciation expense recorded at the end of the 17th year to bring depreciation up to date is: a.$0. b.$1,000,000. c.$2,000,000. d.$4,000,000. Annual Depreciation: ($20,000,000 - $0) ÷ 20 Years. = $1,000,000 Disposal of Property, Plant, and Equipment

8-49 After updating the depreciation, the equipment’s book value at the end of the 17th year is: a.$3,000,000. b.$16,000,000. c.$17,000,000. d.$4,000,000. After updating the depreciation, the equipment’s book value at the end of the 17th year is: a.$3,000,000. b.$16,000,000. c.$17,000,000. d.$4,000,000. Disposal of Property, Plant, and Equipment

8-50 After updating the depreciation, the equipment’s book value at the end of the 17th year is: a.$3,000,000. b.$16,000,000. c.$17,000,000. d.$4,000,000. After updating the depreciation, the equipment’s book value at the end of the 17th year is: a.$3,000,000. b.$16,000,000. c.$17,000,000. d.$4,000,000. Accumulated Depreciation = (17yrs. × $1,000,000) = $17,000,000 BV = Cost - Accumulated Depreciation BV = $20,000,000 - $17,000,000 = $3,000,000 Disposal of Property, Plant, and Equipment

8-51 The equipment’s sale resulted in: a.a gain of $2,000,000. b.a gain of $3,000,000. c.a gain of $4,000,000. d.a loss of $2,000,000. The equipment’s sale resulted in: a.a gain of $2,000,000. b.a gain of $3,000,000. c.a gain of $4,000,000. d.a loss of $2,000,000. Disposal of Property, Plant, and Equipment

8-52 The equipment’s sale resulted in: a.a gain of $2,000,000. b.a gain of $3,000,000. c.a gain of $4,000,000. d.a loss of $2,000,000. The equipment’s sale resulted in: a.a gain of $2,000,000. b.a gain of $3,000,000. c.a gain of $4,000,000. d.a loss of $2,000,000. Gain = Cash Received - Book Value Gain = $5,000,000 - $3,000,000 = $2,000,000 Disposal of Property, Plant, and Equipment

8-53 Prepare the journal entry to record Delta’s sale of the equipment at the end of the 17th year. Disposal of Property, Plant, and Equipment

8-54 Prepare the journal entry to record Delta’s sale of the equipment at the end of the 17th year. Disposal of Property, Plant, and Equipment

8-55 Learning Objectives Apply measurement and reporting concepts for natural resources and intangible assets.

8-56 Natural Resources Examples: oil, coal, gold Extracted from the natural environment. A noncurrent asset presented at cost less accumulated depletion.

8-57 Depletion is like depreciation. Total cost of asset is the cost of acquisition, exploration, and development. Total cost is allocated over periods benefited by means of depletion. Natural Resources

8-58 Depletion of Natural Resources Depletion is calculated using the units-of-production method. Unit depletion rate is calculated as follows: Estimated Recoverable Units Acquisition and Residual Development Cost Value –

8-59 Total depletion cost for a period is: UNIT DEPLETION RATE NUMBER OF UNITS EXTRACTED IN PERIOD × Total depletion cost Inventory for sale Unsold Inventory Cost of goods sold Depletion of Natural Resources

8-60 Specialized plant assets may be required to extract the natural resource. These assets are recorded in a separate account and depreciated. Natural Resources

8-61 Intangible Assets Noncurrent assets without physical substance. Useful life is often difficult to determine. Usually acquired for operational use. Often provide exclusive rights or privileges. Intangible Assets

8-62 Goodwill Trademarks Patents Copyrights Franchises Licensing Rights Technology Record at current cash equivalent cost, including purchase price, legal fees, and filing fees. Intangible Assets

8-63 Definite Life Amortize over shorter of economic life or legal life, subject to rules specified by GAAP. Use straight-line method. Definite Life Amortize over shorter of economic life or legal life, subject to rules specified by GAAP. Use straight-line method. Intangible Assets Indefinite Life Not amortized. Tested at least annually for possible impairment, and book value is reduced to fair value if impaired. Indefinite Life Not amortized. Tested at least annually for possible impairment, and book value is reduced to fair value if impaired. Amortization is a cost allocation process similar to depreciation and depletion.

8-64 Occurs when one company buys another company. The amount by which the purchase price exceeds the fair market value of net assets acquired. Only purchased goodwill is an intangible asset. Goodwill Intangible Assets – Goodwill

8-65 Intangible Assets – Goodwill Goodwill Indefinite Life Not amortized. Value must be reviewed at least annually for possible impairment, and book value is reduced to fair value if impaired.

8-66 Arpec Company paid $2,000,000 to purchase all of Utek Company’s assets and assumed liabilities of $400,000. The acquired assets were appraised at a fair value of $1,800,000. Intangible Assets – Goodwill

8-67 What amount of goodwill should be recorded on Arpec Company books? a.$200,000 b.$400,000 c.$600,000 d.$800,000 What amount of goodwill should be recorded on Arpec Company books? a.$200,000 b.$400,000 c.$600,000 d.$800,000 Intangible Assets – Goodwill

8-68 What amount of goodwill should be recorded on Arpec Company books? a.$200,000 b.$400,000 c.$600,000 d.$800,000 What amount of goodwill should be recorded on Arpec Company books? a.$200,000 b.$400,000 c.$600,000 d.$800,000 Intangible Assets – Goodwill

8-69 Intangible Assets – Trademarks A symbol, design, or logo associated with a business. Purchased trademarks are recorded at cost. Internally developed trademarks have no recorded asset cost.

8-70 Intangible Assets – Patents Exclusive right granted by federal government to sell or manufacture an invention. Cost is purchase price plus legal cost to defend. Amortize cost over the shorter of useful life or 20 years. Research and development costs that might result in a patent are normally expensed as incurred.

8-71 Intangible Assets – Copyrights Exclusive right granted by the federal government to protect artistic or intellectual properties. Amortize cost over the period benefited. Legal life is life of creator plus 70 years.

8-72 Intangible Assets – Franchises Legally protected right to sell products or provide services purchased by franchisee from franchisor. Purchase price is an intangible asset that is amortized.

8-73 Intangible Assets – Licensing Rights Limited permissions to use a product or service according to specific terms and conditions. You may be using computer software that is made available to you through a campus licensing agreement.

8-74 Intangible Assets - Technology A category of intangible assets that includes a company’s website and any computer programs written by its employees.

8-75 Learning Objectives Explain the impact on cash flows of acquiring, using, and disposing of long-lived assets.

8-76 Focus on Cash Flows

8-77 Changes in Depreciation Estimates Chapter Supplement A

8-78 Changes in Estimates Depreciation Expense is based on... ESTIMATED useful life ESTIMATED residual value If the estimates change, the book value less any residual value at the date of change is depreciated over the remaining useful life.

8-79 Delta purchased an aircraft for $60,000,000. The aircraft is depreciated using the straight-line method with a useful life of 20 years and an estimated residual value of $3,000,000. In year 5, Delta changed the estimated useful life to 25 years and lowered the residual value to $2,400,000 Calculate depreciation expense for the fifth year using the straight-line method. Delta purchased an aircraft for $60,000,000. The aircraft is depreciated using the straight-line method with a useful life of 20 years and an estimated residual value of $3,000,000. In year 5, Delta changed the estimated useful life to 25 years and lowered the residual value to $2,400,000 Calculate depreciation expense for the fifth year using the straight-line method. Changes in Estimates

8-80 Changes in Estimates

8-81 End of Chapter 8