1 Chapter 10 Long-term Assets: Property, Plant, and Equipment, Natural Resources, and Intangibles Adapted from Financial Accounting 4e by Porter and Norton

2 Buildings and improvement$ 1,242.9 Machinery and equipment 3,191.1 Construction in progress $ 4,744.7 Land $ 4,968.5 Less accumulated depreciation (2,588.7) Property, plant, and equipment (net)$ 2,379.8 Johnson Controls, Inc. Property, Plant, and Equipment Book Value At Cost

3 Acquisition Cost of P,P&E l All costs necessary to acquire asset and prepare for intended use Purchase Price + Taxes Installation Costs Transportation Charges

4 Group Asset Purchases 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

5 Capitalization of Interest l Interest can be included as part of the cost of an asset if: » company constructs asset over time, and » borrows money to finance construction

6 Depreciation of P,P & E Match cost of assets with periods benefited Straight-Line Units of Production Accelerated Methods via

7 $9,000 3-year life Straight-Line Method l Allocates cost of asset evenly over its useful life $3,000 Year 1 $3,000 Year 2 $3,000 Year 3

8 Units-of-Production Method l Allocate asset cost based on number of units produced over its useful life depreciation = per unit

9 Double-Declining-Balance Method l Double the straight-line rate on a declining balance (book value) l Accelerated method - higher amount of depreciation in early years Straight-line Rate

10 Depreciation Example On January 1, Kemp Company purchases a machine for $20,000. The life of the machine is estimated at five years, after which it is expected to be sold for $2,000.

11 Depreciation Example Calculate Kemp's depreciation of the machine for years 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

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

13 Units-of-Production Depreciation l Kemp’s estimated machine production: Yr. 1 3,600 units Yr. 2 3,600 units Yr. 3 3,600 units Yr. 4 3,600 units Yr. 5 3,600 units Total 18,000 units

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

15 l Kemp’s depreciation in 2004: 4,000 units x $1/unit = $ 4,000 Units-of-Production Depreciation

16 Double-Declining-Balance Depreciation DDB rate = (100% / useful life) x 2 = (100% / 5 years) x 2 = 40%.40 Initially ignore residual value

17 Double-Declining-Balance Depreciation Year 1 Depreciation = Beginning book value x rate = $20,000 x 40% = $8,000 BeginningEnding YearRateBook Value Depreciation Book Value 140% $20,000 $8,000 $12,000

18 Double-Declining-Balance Depreciation Year 2 Depreciation = Beginning book value x rate = $12,000 x 40% = $4,800 BeginningEnding YearRateBook Value Depreciation Book Value 140% $20,000 $8,000 $12, % $12,000 4,800 7,200

19 Double declining-balance Depreciation BeginningEnding YearRateBook Value Depreciation Book Value 140% $20,000 $8,000 $12, % 12,000 4,800 7, % 7,200 2,880 4, % 4,320 1,728 2, % 2, ,000 $18,000 Final year’s depreciation = amount needed to equate book value with salvage value = Residual Value

20 Straight-line vs. DDB Depreciation

21 Reasons for Choosing Straight-Line Depreciation l Simplicity l Reporting to stockholders l Comparability l Bonus plans

22 Reasons for Choosing Accelerated Methods l Technological rate of change and competitiveness l Minimize taxable income l Comparability Income Taxes

23 Changes in Depreciation Estimates l Recompute depreciation schedule using new estimates l Record prospectively (i.e. change should affect current and future years only) Useful life is 7 years vs. 5?

24 Depreciation Change in Estimate $20,000 machine originally expected to be depreciated over 5 years. After 2 years, useful life is increased to 7 years. $3,600 planned $3,600 Yr. 1Yr. 2Yr. 3 Example: revise estimate Yr. 4Yr. 5

25 Depreciation Change in Estimate l $12,800 remaining book value allocated prospectively over remaining life Yr. 1Yr. 2Yr. 3Yr. 4 revise estimate $2,160 $3,600 Example: $2,160 Yr. 5 Yr. 6Yr. 7

26 Capital vs. Revenue Expenditures Income Statement l Revenue Expenditure » Expense immediately Balance Sheet l Capital Expenditure » Treat as asset addition to be depreciated over a period of time

27 Capital vs. Revenue Expenditures  Capitalize  Expense General Guidelines: » Increase asset life » Increase asset productivity » Normal maintenance » Material expenditures

28 Capital Expenditures $20,000 machine originally expected to be depreciated over 5 years. After 2 years, overhaul machine at cost of $3,000. Machine life is increased by 3 years. Example: replace engine $3,600 planned $3,600 Yr. 1Yr. 2Yr. 3 Yr. 4Yr. 5

29 Capital Expenditures l $12,800 remaining book value + $3,000 capital expenditure depreciated prospectively over remaining life replace engine Example: Yr. 1Yr. 2Yr. 3Yr. 4 $2,300 $3,600 $2,300 Yr. 5 Yr. 6Yr. 7

30 Disposal of Operating Assets l Record depreciation up to date of disposal l Compute gain or loss on disposal Proceeds > Book Value = Gain Proceeds < Book Value = Loss

31 Disposal of Operating Assets l Sell truck (cost $20,000; accumulated depreciation $9,000) for $12,400 Sale price$ 12,400 Less book value: Asset cost$20,000 Less: accumulated depreciation 9,000 11,000 = Gain on sale $ 1,400 Example:

32 Natural Resources (in thousands) Boise Cascade Corporation Partial Balance Sheet Property and Equipment: Land and land improvements$ 68,482 Buildings and improvements 675,905 Machinery and equipment 4,606,102 Less: accumulated depreciation (2,742,650) 2,607,839 Timber, timberlands, and timber deposits 322,132 $2,929,971

33 Natural Resources l Resource consumed as it is used l Expense called depletion vs. depreciation l Depletion method similar to units of production

34 (in millions) AOL Time Warner, Inc. Partial Balance Sheet Operating Assets: Property, plant and equipment, net$ 12,684 Music catalogues and copyrights 2,927 Film library 3,363 Cable television and sports franchises 27,109 Brands, trademarks, and other 10,684 Goodwill and other intangibles 128,338 Intangible Assets

35 Patents Intangible Assets l Long-term assets with no physical properties Goodwill Trademarks Copyrights

36 Intangible Assets l Includes cost to acquire and prepare for intended use + Purchase Price Acquisition Costs (i.e. legal fees, registration fees, etc.)

37 Research & Development l Must be expensed in period incurred l Difficult to identify future benefits

38 Amortization of Intangibles l Normally recorded using straight-line method l Reported net of accumulated amortization l Amortized over legal or useful life, whichever is shorter

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

40 Amortization of Intangibles ML Company’s annual amortization: Patent approval costs$10,000 Divide by: Lesser of legal or useful life 5 years Annual amortization$ 2,000

41 Amortization of Intangibles ML Company’s Balance Sheet Presentation: Upon End of acquisition Yr. 1Yr. 5 Long-term Assets: Intangible assets, net of accum. amortization $10,000$8,000 $ 0

42 Analyzing Long-term Assets Average Life = Property, Plant & Equipment Depreciation Expense What is the average depreciable period (or life) of the company’s assets?

43 Analyzing Long-term Assets Average Age = Accumulated Depreciation Depreciation Expense Are assets old or new?

44 Analyzing Long-term Assets Asset Turnover = Net Sales Average Total Assets How productive are the company’s assets?

45 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