Overview of Long-Lived Assets Long-lived assets - resources that are held for an extended time, such as land, buildings, equipment, natural resources, and patents –These assets help produce revenues over many periodsby facilitating the production and sale of goods or services to customers.

Overview of Long-Lived Assets Tangible assets - physical items that can be seen and touched, such as land, natural resources, buildings, and equipment –Also known as fixed assets or plant assets Intangible assets - rights or economic benefits, such as franchises, patents, trademarks, copyrights, and goodwill that are not physical in nature

Overview of Long-Lived Assets Terms for allocation of costs over time: –Depreciation - allocation of the cost of tangible assets to the periods in which the assets are used –Depletion - allocation of the cost of natural resources to the periods in which the resources are used –Amortization - allocation of the cost of intangible assets to the periods that benefit from these assets Land is not depreciated because it does not wear out or become obsolete.

Acquisition Cost of Tangible Assets The acquisition cost of long-lived assets is the purchase price, including incidental costs required to complete the purchase, to transport the asset, and to prepare it for use.

Acquisition Cost of Tangible Assets Land –The acquisition cost of land includes costs of land surveys, legal fees, title fees, realtor commissions, transfer taxes, and the demolition costs of old structures. –Under historical cost accounting, land is carried on the balance sheet at its original cost even if the market value of the land is many times that of the original cost.

Acquisition Cost of Tangible Assets Buildings and Equipment –Costs should include all costs of acquisition and preparation for use, such as sales taxes, transportation costs, installation costs, and repairs to the asset prior to use. –Costs included in the cost of an asset are capitalized (added to the asset account), as distinguished from being expensed immediately.

Depreciation of Buildings and Equipment Depreciation in the accounting sense is not a process of valuation. –Depreciation is a form of allocating the cost of an asset to periods when the asset is used. Depreciation is one key factor that distinguishes accrual accounting from cash-basis accounting. –Under the accrual basis, the cost of the asset is allocated to the periods benefited. –Under the cash basis, the cost of the asset would be expensed immediately.

Depreciation of Buildings and Equipment Depreciable value - the amount of acquisition cost to be allocated as depreciation over the total useful life of an asset –The depreciable value is the difference between the acquisition cost and the predicted residual value. Residual value - the amount received from disposal of a long-lived asset at the end of its useful life

Depreciation of Buildings and Equipment Useful life (economic life) - the time period over which an asset is depreciated –The useful life is the shorter of the physical life of the asset before it wears out or the economic life of the asset before it becomes obsolete. –The useful life can be measured in terms other than time. For example, the life of a truck can be measured in miles driven.

Straight-Line Depreciation Straight-line depreciation - a method that spreads the depreciable value evenly over the useful life of an asset Depreciation expense

Straight-Line Depreciation A truck with a cost of $41,000 and a residual value of $1,000 has a useful life of 4 years. Depreciation expense is calculated as follows: ($41,000 - $1,000) / 4 = $10,000* *Depreciation is the same each year for the life of the asset.

Depreciation Based on Units Unit depreciation - a depreciation method based on units of service when physical wear and tear is the dominating influence on the useful life of the asset –A depreciation rate per unit is determined by dividing the depreciable value (cost less residual value) by the useful life in units. –To determine depreciation expense, the actual usage of the asset is multiplied by the depreciation rate.

Depreciation Based on Units A truck with a cost of $41,000 and a residual value of $1,000 has a useful life of 200,000 miles. During the year, the truck is driven for 45,000 miles. Depreciation expense is calculated as follows: ($41,000 - $1,000) / 200,000 = $.20 per mile 45,000 x $.20 = $9,000* *Depreciation over the life of the asset will fluctuate as the usage of the asset fluctuates.

Declining-Balance Depreciation Accelerated depreciation - any depreciation method that writes off depreciable costs more quickly than the ordinary straight-line method based on expected useful life Double-declining-balance (DDB) depreciation - the most popular form of accelerated depreciation –It is computed by doubling the straight-line rate and multiplying the resulting DDB rate by the beginning book value.

Declining-Balance Depreciation Computing DDB depreciation: –Compute a rate by dividing 100% by the number of years of useful life. –Double the rate. –Ignore the residual value, and multiply the asset’s book value at the beginning of the year by the DDB rate. Stop depreciation when the book value reaches the residual value.

Declining-Balance Depreciation A truck with a cost of $41,000 and a residual value of $1,000 has a useful life of 4 years. Double-declining-balance depreciation expense is calculated as follows: 100% / 4 = 25% x 2 = 50% per year Year 1: $41,000 x 50% = $20,500* Year 2: ($41,000 - $20,500) x 50% = $10,250* *Depreciation over the life of the asset declines each year.

Comparing and Choosing Depreciation Methods Straight-line gives the same depreciation expense each year of the useful life of the asset. DDB gives accelerated depreciation expense (more than regular straight-line) in the first years of the useful life of the asset. –Companies will often switch from DDB to straight-line part way through the life of the asset to compensate for the fact the DDB may not fully depreciate the asset.

Comparing and Choosing Depreciation Methods Companies do not always use the same depreciation methods for all types of depreciable assets. The choice of depreciation alternatives comes from several places: –Tradition or use by other companies in the industry –Better matching of expenses with revenues –The nature of the industry and the equipment and the goals of management

Contrasting Income Tax and Shareholder Reporting Reports to stockholders must follow GAAP, but reports to income tax authorities must follow the income tax rules and regulations. –These rules are usually alike, but sometimes they differ. –These difference cause business to keep two sets of books – one for financial statements and one for taxes. Financial Statements Taxes

Depreciation on Tax Reports Tax laws require the use of the Modified Accelerated Cost Recovery System (MACRS) for computing accelerated depreciation. –MACRS uses tax lives that are much shorter than the real economic life of most assets. –These short lives produce very accelerated depreciation in the early years of the life of the asset, which lowers taxable income in those years.

Shareholder Reporting Shareholder reporting is driven by efforts to match the cost of assets to the periods in which the assets generate revenues. –Most companies use straight-line depreciation to accomplish this. Companies also want higher earnings in their financial statements. –Straight-line produces lower depreciation in the early years than accelerated depreciation.

Depreciation and Cash Flow Depreciation does not generate cash. –Depreciation allocates the original cost of an asset to the periods when the asset is used. –Accumulated depreciation is merely the total amount that an asset has been depreciated throughout its life. 2002

Effects of Depreciation on Cash Depreciation has no effect on ending cash balances because it is a noncash expense. Before taxes, changes in the depreciation method affect only the Accumulated Depreciation and Retained Earnings accounts.

Effects of Depreciation on Income Taxes Depreciation is a deductible noncash expense for income tax purposes. –If depreciation expense is higher, taxes are lower, and more cash can be kept for use in the business. Accelerated depreciation generally has higher depreciation expense. Depreciation does not generate cash, but it does have a cash benefit if it results in lower taxes.

Contrasting Long-Lived Asset Expenditures With Expenses Expenditures - purchases of goods or services, whether for cash or on credit Asset-related expenditures that will benefit more than one year are capitalized. –Capital expenditures add new fixed assets or increase the capacity, efficiency, or useful life of an existing fixed asset. Expenditures that provide a benefit lasting one year or less are expensed in the current year.

Gains and Losses on Sales of Tangible Assets Assets are often sold before the end of their useful lives. –When an asset is sold, a gain or loss usually occurs. –The gain or loss is the difference between cash received and the net book value of the asset given up.

Recording Gains and Losses Remember that when depreciation is recorded, two accounts are affected, Depreciation Expense and Accumulated Depreciation. –Accumulated depreciation reduces the book value of the fixed asset. The disposal of a fixed asset requires the removal of its book value (carrying amount), which appears in two accounts, the asset account and Accumulated Depreciation.

Recording Gains and Losses A piece of equipment with an original cost of $50,000 that has $20,000 of accumulated depreciation is sold for $35,000 cash. The journal entry to record this transaction is as follows: Cash35,000 Accumulated depreciation20,000 Equipment50,000 Gain on sale of equipment* 5,000 *[35,000 - (50, ,000) = 5,000]

Recording Gains and Losses A piece of equipment with an original cost of $50,000 that has $20,000 of accumulated depreciation is sold for $23,000 cash. The journal entry to record this transaction is as follows: Cash23,000 Accumulated depreciation20,000 Loss on sale of equipment* 7,000 Equipment50,000 *[23,000 - (50, ,000) = -7,000]

Income Statement Presentation Gains and losses on sales of assets are usually insignificant, so they are included as “other income” on the income statement.