Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Long-Lived Nonmonetary Assets and Their Amortization © The McGraw-Hill Companies, Inc., Part One: Financial Accounting

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Tangible assets: Landnot amortized Plant and equipmentdepreciation Natural resourcesdepletion Intangible assets: Goodwillamortization Patents, copyrights, etc.amortization Leasehold improvementsamortization Deferred chargesamortization Research and development costsnot capitalized Types of Long-Lived Assets Slide 7-1 Type of Asset Method of Converting to Expense

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Purchase price Sales tax Transportation costs Installation cost Items Included in Cost Slide 7-2

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Straight-Line Method Slide 7-3 Depreciation Expense = Original cost - Residual value Service life (years) The number of accounting periods over which the asset will be useful to the entity. The number of accounting periods over which the asset will be useful to the entity. The expected amount to be recovered at the end of the service life. The expected amount to be recovered at the end of the service life.

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Straight-Line Method Slide 7-4 Depreciation Expense = Original cost - Residual value Service life (years) Depreciation Expense = $10,000 - $1,000 5 years Depreciation Expense = $1,800

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 $10,000 Year 1: $10,000 x.40= $4,000 6,000 Year 2: $6,000 x.40= 2,4003,600 Year 3: $3,600 x. 40= 1,4402,160 Year 4: $2,160 x.40= 8641,296 Year 5: $1,296 - $1,000= 2961,000 Declining-Balance Method Slide 7-5 Note that this amount reduces the book value to the salvage value. Note that this amount reduces the book value to the salvage value. Depreciation Expense Book Value

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 $10,000 Year 1: 5/15 x ($10,000 - $1,000)$3,0007,000 Year 2: 4/15 x ($10,000 - $1,000)2,4004,600 Year 3: 3/15 x ($10,000 - $1,000)1,8002,800 Year 4: 2/15 x ($10,000 - $1,000)1,2001,600 Year 5: 1/15 x ($10,000 - $1,000)6001,000 n Years’-Digits Method Slide 7-6 First, determine the sum by using the following equation: n = = 15 Next, build a table: Annual Depreciation Book Value

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Units-of-Production Method Slide 7-7 Depreciation Expense = Original cost - Residual value Service life (units) Depreciation Expense = $10,000 - $1,000 90,000 miles Depreciation Expense = $.10 per mile

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Accounting for Depreciation Slide 7-8 Building, at net$1,000,000 Less: Accumulated depreciation 25,000 Building, net$975,000 December 31, 1996 Building, at net$1,000,000 Less: Accumulated depreciation 50,000 Building, net$950,000 December 31, 1997

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Accounting for Depreciation Slide 7-9 The annual journal entry to record depreciation is: Depreciation Expense25,000 Accumulated Depreciation25,000 A fully depreciated building still in use (assume no salvage value) would appear on the balance sheet as follows: Building, at net$1,000,000 Less: Accumulated depreciation1,000,000 Building, net$0

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Disposal of Plant and Equipment Slide 7-10 A building is sold for its book value of $750,000: Cash750,000 Accumulated Depreciation250,000 Building1,000,000 Assume instead that the building was sold for $650,000: Cash650,000 Accumulated Depreciation250,000 Loss on Sale of Building100,000 Building1,000,000

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Exchanges and Trade-Ins Slide 7-11 Assume a company trades in two automobiles, each of which originally cost $20,000 and each has a book value of $5,000. Each car has a market value of $7,000. Assume a company trades in two automobiles, each of which originally cost $20,000 and each has a book value of $5,000. Each car has a market value of $7,000. The first car is traded for another car with a list price of $30,000, and $18,000 cash is given to the dealer in addition to the trade-in. The first car is traded for another car with a list price of $30,000, and $18,000 cash is given to the dealer in addition to the trade-in. Automobile (New)23,000 Accumulated Depreciation (Automobile)15,000 Cash18,000 Automobile (Old)20,000 $18,000 + $7,000 - “gain” of $2,000 $18,000 + $7,000 - “gain” of $2,000

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Exchanges and Trade-Ins Slide 7-12 Assume a company trades in two automobiles, each of which originally cost $20,000 and each has a book value of $5,000. Each car has a market value of $7,000. Assume a company trades in two automobiles, each of which originally cost $20,000 and each has a book value of $5,000. Each car has a market value of $7,000. The second automobile is traded for a piece of equipment that also has a list price of $30,000 and $18,000 cash is given in addition to the trade-in. The second automobile is traded for a piece of equipment that also has a list price of $30,000 and $18,000 cash is given in addition to the trade-in. Equipment (New)25,000 Accumulated Depreciation (Automobile)15,000 Cash18,000 Automobile (Old)20,000 Gain on Disposal of Automobile2,000 $18,000 + $7,000

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Group Depreciation Slide 7-13 Group depreciation treats all similar assets (such as automobile or office chairs) as a “pool” or group rather than making the calculation for each one separately. Group depreciation treats all similar assets (such as automobile or office chairs) as a “pool” or group rather than making the calculation for each one separately. A used microcomputer which originally cost $3,000 is disposed of for $400 cash. A used microcomputer which originally cost $3,000 is disposed of for $400 cash. Cash400 Accumulated Depreciation, Microcomputers2,600 Microcomputers3,000

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999  A method provided by the tax code  Designed as an incentive to invest in capital assets  Shortened assets’ lives for tax purposes  Most classes of property acquired or disposed of at any point during the year are assumed to have been acquired or disposed of at the midpoint of the year  A method provided by the tax code  Designed as an incentive to invest in capital assets  Shortened assets’ lives for tax purposes  Most classes of property acquired or disposed of at any point during the year are assumed to have been acquired or disposed of at the midpoint of the year MACRS Slide 7-14

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., x1$ 20,0001/2 * 40% * $100,000 19x232,00040% * ($100,000 - $20,000) 19x319,20040% * ($80,000 - $32,000) 19x411,52040% * ($48,000 - $19,200) 19x511,520change to straight-line 19x6 5,7601/2 * 19x5 amount Total$100,000 MACRS Slide 7-15 Assume that a machine in the five-year class is acquired at some point in 19x1 for $100,000. Assume that a machine in the five-year class is acquired at some point in 19x1 for $100,000. Cost Recovery Year Deduction Computation

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Investment Tax Credit Slide 7-16 In late December 19x1 a company purchased a $200,000 machine that qualified for a $20,000 investment tax credit. In late December 19x1 a company purchased a $200,000 machine that qualified for a $20,000 investment tax credit. Income Tax Liability20,000 Income Tax Expense20,000 This is the flow-through method. This is the flow-through method.

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Investment Tax Credit Slide 7-17 An alternative approach is to record the investment tax credit as a deferred credit--which is analogous to unearned revenue. An alternative approach is to record the investment tax credit as a deferred credit--which is analogous to unearned revenue. Income Tax Liability20,000 Deferred Investment Tax Credits20,000 This approach is called the deferred method. This approach is called the deferred method.

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Investment Tax Credit Slide 7-18 In 19x2 and the subsequent nine years, Income Tax Expense would be decrease by $2,000. In 19x2 and the subsequent nine years, Income Tax Expense would be decrease by $2,000. Deferred Investment Tax Credits2,000 Income Tax Expense2,000 This method has the effect of increasing net income each year the entry is made. This method has the effect of increasing net income each year the entry is made.

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Depletion Expense Slide 7-19 An oil property cost $250 million and is estimated to contain 50 million barrels of oil. An oil property cost $250 million and is estimated to contain 50 million barrels of oil. Depletion Expense = Original cost - Residual value Total barrels of oil Depletion Expense = $250 million - $0 50 million Depletion Expense = $5 per barrel

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Goodwill Patent Copyrights Franchise rights Leasehold improvements Deferred charges Research and development costs Intangible Assets Slide 7-20

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Chapter 7 The End