Chapter 8, Slide #1 Using Financial Accounting Information: The Alternative to Debits and Credits Fifth Edition Gary A. Porter and Curtis L. Norton Copyright © 2008 Thomson South-Western, a part of the Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license.

Chapter 8, Slide #2 (in millions) May 31, 2004 Property, plant, and equipment, net $ 1,586.9 Identifiable intangible assets, net Goodwill Deferred income taxes and other assets Nike, Inc. Property, Plant, and Equipment LO1

Chapter 8, Slide #3 Acquisition Cost of Property, Plant, and Equipment  All of the costs necessary to acquire the asset and prepare it for its intended use Purchase price + Taxes Installation costs Transportation charges LO2

Chapter 8, Slide #4 Group Purchase Allocate cost of lump-sum purchase based on fair market values Cost $100,000 $75,000 $25,000 Allocated Cost Land = $30,000 Building = $90,000 Fair Market Value 75% 25% % of Market Value LO3

Chapter 8, Slide #5 Capitalization of Interest  Interest can be included as part of the cost of an asset if the company: Constructs the asset over time and Borrows money to finance construction LO 4

Chapter 8, Slide #6 Depreciation of Property, Plant, and Equipment Straight Line Units of Production Double Declining Balance via LO5 Match cost of assets with periods benefited

Chapter 8, Slide #7 $9,000 3-year life Straight-Line Method  Allocates the cost of the asset evenly over its useful life $3,000 Year 1 $3,000 Year 2 $3,000 Year 3

Chapter 8, Slide #8 Units-of-Production Method  Allocates the asset cost based on the number of units produced over its useful life depreciation = per unit $

Chapter 8, Slide #9 Double-Declining-Balance Method  Accelerated method – higher amount of depreciation in early years  Double the straight-line rate on a declining amount (book value) Straight-line rate X 2

Chapter 8, Slide #10 Depreciation Example On January 1, ExerCo purchases a machine for $20,000. The life of the machine is estimated at 5 years, after which it is expected to be sold for $2,000.

Chapter 8, Slide #11 Depreciation Example Calculate ExerCo’s depreciation of the machine for years 1 through 5 using the straight-line, units-of-production and double- declining-balance depreciation methods. $20,000 cost – $2,000 residual value = $18,000 to be depreciated

Chapter 8, Slide #12 Straight-Line Depreciation Depreciation = Cost – Residual Value Life = $20,000 – $2,000 5 years = $3,600 $18,000 5-year life $3,600 Year 1 $3,600 Year 2 $3,600 Year 3 $3,600 Year 4 $3,600 Year 5

Chapter 8, Slide #13 Units-of-Production Depreciation  ExerCo’s estimated machine production: Year 1 3,600 units Year 2 3,600 units Year 3 3,600 units Year 4 3,600 units Year 5 3,600 units Total 18,000 units

Chapter 8, Slide #14 Units-of-Production Depreciation Depreciation = Cost – Residual Value per unit Life in Units = $20,000 – $2,000 18,000 = $1.00 per unit

Chapter 8, Slide #15  ExerCo’s Depreciation in 2007: 4,000 Units × $1 per Unit = $ 4,000 Units-of-Production Depreciation

Chapter 8, Slide #16 Double-Declining-Balance Depreciation DDB Rate = (100%/Useful Life) × 2 = (100%/5 Years) × 2 = 40% Initially ignore residual value

Chapter 8, Slide #17 Double-Declining-Balance Depreciation 2007 Depreciation= Beginning Book Value × Rate = $20,000 × 40% = $8,000 Book Value at Book Value at Year Rate Beginning of Year Depreciation End of Year %$20,000 $8,000 $12,000

Chapter 8, Slide #18 Double-Declining-Balance Depreciation 2008 Depreciation = Beginning Book Value × Rate = $12,000 × 40% = $4,800 Book Value at Book Value at Year Rate Beginning of Year Depreciation End of Year %$20,000 $8,000 $12, ,000 4,8007,200

Chapter 8, Slide #19 Double-Declining-Balance Depreciation Book Value at Book Value at Year Rate Beginning of Year Depreciation End of Year % $20,000 $ 8,000 $12, ,000 4,800 7, ,200 2,880 4, ,320 1,728 2, , ,000 $18,000 Final year’s depreciation = amount needed to equate book value with salvage value = Residual Value

Chapter 8, Slide #20 Straight-Line vs. Double-Declining- Balance Depreciation

Chapter 8, Slide #21 Reasons for Choosing the Straight- Line Method  Simplicity  Reporting to stockholders  Comparability  Bonus plans

Chapter 8, Slide #22 Reasons for Choosing Accelerated Methods  Technological rate of change and competitiveness  Minimize taxable income  Comparability

Chapter 8, Slide #23 Change in Depreciation Estimate  Recompute depreciation schedule using new estimates  Record prospectively (i.e., change should affect current and future years only) LO6

Chapter 8, Slide #24 Depreciation Change in Depreciation Estimate A $20,000 machine purchased on January 1, 2007 is originally expected to be depreciated over 5 years. After 2 years, useful life is increased to 7 years. planned $3,600 Example: revise estimate $3,

Chapter 8, Slide #25 Depreciation Change in Depreciation Estimate  $12,800 remaining book value allocated prospectively over remaining life revise estimate Example: $2,160 $3,600 $2,

Chapter 8, Slide #26 Capital vs. Revenue Expenditures Income Statement  Revenue Expenditure Expense immediately Balance Sheet  Capital Expenditure Treat as asset addition to be depreciated over a period of time LO7

Chapter 8, Slide #27 Capital vs. Revenue Expenditures CategoryExampleAsset or Expense Normal maintenanceRepaintingExpense Minor repairReplace spark plugsExpense Major repairReplace a vehicle’s engineAsset* AdditionAdd a wing to a buildingAsset *if life or productivity is enhanced

Chapter 8, Slide #28 Capital Expenditures A $20,000 machine purchased on January 1, 2007 is originally expected to be depreciated over 5 years. After 2 years, an overhaul of the machine is made at a cost of $3,000. Machine life is increased by 3 years. Example: replace engine $3, planned $3,600

Chapter 8, Slide #29 Capital Expenditures  $12,800 remaining book value + $3,000 capital expenditure depreciated prospectively over remaining life replace engine Example: $2,300 $3,600 $2,

Chapter 8, Slide #30 Disposal of Property, Plant, and Equipment  Record depreciation up to date of disposal  Compute gain or loss on disposal Selling Price > Book Value = Gain Selling Price < Book Value = Loss LO8

Chapter 8, Slide #31 Disposal of Property, Plant, and Equipment  Sell machine (cost $20,000; accumulated depreciation $9,000) for $12,400 Asset cost$20,000 Less: Accumulated depreciation9,000 Book value$11,000 Sale price12,400 Gain on sale of asset$ 1,400 Example:

Chapter 8, Slide #32 (in millions) Weyerhaeuser Company Partial Balance Sheet Property and equipment, net 11,843 Construction in progress 269 Investments in and advances to equity affiliates 489 Goodwill 3, Timber and timberlands at cost, less depletion charged to disposals4,212 Natural Resources

Chapter 8, Slide #33 Natural Resources  When a natural resource is used or consumed, it should be treated as an expense  Recording the expense is referred to as depletion  Depletion method is similar to the units-of- production method

Chapter 8, Slide #34 Patents Intangible Assets  Long-term assets with no physical properties Goodwill Trademarks Copyrights LO9

Chapter 8, Slide #35 Intangible Assets  Includes cost to acquire and prepare for intended use + Purchase Price Acquisition Costs (i.e. legal fees, registration fees, etc.)

Chapter 8, Slide #36 (in millions) Nike, Inc. Partial Balance Sheet 2004 Amortized intangible assets: Patents $ 16.0 Trademarks 2.6 Other 6.2 $ 24.8 Unamortized intangible assets: Trademarks $341.5 Total $366.3 Intangible Assets

Chapter 8, Slide #37 Research and Development Costs  Must be expensed in period incurred  Difficult to identify future benefits

Chapter 8, Slide #38 Amortization of Intangibles  Normally recorded using the straight-line method  Reported net of accumulated amortization  Amortized over the legal or useful life, whichever is shorter LO10

Chapter 8, Slide #39 Amortization of Intangibles Nike developed a patent for $10,000. The patent’s legal life is 20 years, but its anticipated useful life is 5 years. Example:

Chapter 8, Slide #40 Amortization of Intangibles Nike’s annual amortization: Patent approval costs $10,000 Divided by: Lesser of legal or useful life 5 years Annual amortization$ 2,000 To record amortization of patent for one year: Balance Sheet Income Statement Assets = Liabilities + Stockholders’ + Revenues - Expenses Equity Accumulated Patent Expense (2,000) Amortization (2,000)

Chapter 8, Slide #41 Long-Term Assets and the Statement of Cash Flows Operating Activities Net income xxx Depreciation and amortization + Gain on sale of asset – Loss on sale of asset + Investing Activities Purchase of asset – Sale of asset + Financing Activities LO11

Chapter 8, Slide #42 Analyzing Long-Term Assets Property, Plant, and Equipment Depreciation Expense What is the average depreciable period (or life) of the company’s assets? LO12 Average Life =

Chapter 8, Slide #43 Analyzing Long-Term Assets Are assets old or new? Accumulated Depreciation Depreciation Expense Average Age =

Chapter 8, Slide #44 Analyzing Long-Term Assets How productive are the company’s assets? Net Sales Average Total Assets Asset Turnover =

Chapter 8, Slide #45 End of Chapter 8