The McGraw-Hill Companies, Inc. 2006McGraw-Hill/Irwin Chapter Nine Accounting for Long-Term Operational Assets

Tangible versus Intangible Assets Tangible assets have a physical presence; they can be seen and touched. Intangible assets are rights or privileges. They cannot be seen or touched.

Tangible Long-Term Assets 1.Property, Plant, and Equipment 1.Property, Plant, and Equipment – Sometimes called plant assets or fixed assets. We depreciate these assets over their useful life. 2.Natural Resources 2.Natural Resources – Mineral deposits, oil and gas reserves, timber stands, coal mines, and stone quarries are some examples of natural resources. We deplete these assets over their useful life. 3.Land 3.Land – Has an infinite life and is not subject to depreciation.

Intangible Assets 1.Intangible Assets with Identifiable Useful Lives 1.Intangible Assets with Identifiable Useful Lives – These intangibles include patents and copyrights. We amortize the cost of each over its useful life. 2.Intangible Assets with Indefinite Useful Lives 2.Intangible Assets with Indefinite Useful Lives - These intangibles include renewable franchises, trademarks, and goodwill. The cost of these assets is not expensed unless it can be shown that there has been an impairment in value.

Cost of Long-Term Assets Buildings – Purchase price,Purchase price, Sales taxes,Sales taxes, Title search and transfer document costs,Title search and transfer document costs, Realtor’s and attorney’s fees, andRealtor’s and attorney’s fees, and Remodeling costs.Remodeling costs. Buildings – Purchase price,Purchase price, Sales taxes,Sales taxes, Title search and transfer document costs,Title search and transfer document costs, Realtor’s and attorney’s fees, andRealtor’s and attorney’s fees, and Remodeling costs.Remodeling costs. Equipment – Purchase price (less discounts),Purchase price (less discounts), Sales taxes,Sales taxes, Delivery costs,Delivery costs, Installation costs, andInstallation costs, and Costs to adapt to intended use.Costs to adapt to intended use. Equipment – Purchase price (less discounts),Purchase price (less discounts), Sales taxes,Sales taxes, Delivery costs,Delivery costs, Installation costs, andInstallation costs, and Costs to adapt to intended use.Costs to adapt to intended use.

Cost of Long-Term Assets Land – Purchase price,Purchase price, Sales taxes,Sales taxes, Title search and transfer document costs,Title search and transfer document costs, Realtor’s and attorney’s fees,Realtor’s and attorney’s fees, Costs of removal of old buildings, andCosts of removal of old buildings, and Grading costs.Grading costs. Land – Purchase price,Purchase price, Sales taxes,Sales taxes, Title search and transfer document costs,Title search and transfer document costs, Realtor’s and attorney’s fees,Realtor’s and attorney’s fees, Costs of removal of old buildings, andCosts of removal of old buildings, and Grading costs.Grading costs.

Basket Purchase Allocation Matrix, Inc. purchased land and a building for $5,000,000 cash. An independent appraiser estimated that the land has a fair market value of $2,000,000, and the building has a fair market value of $6,000,000. How will we assign the $5,000,000 cost between the land and building?

Life Cycle of Operational Assets Acquire Funding Buy Asset Use Asset Retire Asset

Depreciation Method 1.Straight-line method - the same amount of depreciation is taken each accounting period. 2.Double-declining-balance – produces more depreciation expense in the early years of an asset’s life, with a declining amount of expense in later years. 3.Units-of-Production – produces varying amounts of depreciation in different accounting periods depending upon the number of units produced. 1.Straight-line method - the same amount of depreciation is taken each accounting period. 2.Double-declining-balance – produces more depreciation expense in the early years of an asset’s life, with a declining amount of expense in later years. 3.Units-of-Production – produces varying amounts of depreciation in different accounting periods depending upon the number of units produced.

Asset to be Depreciated The truck has a salvage value of $4,000, and an estimated useful life of four years.

Straight-Line Depreciation Life Cycle Phase 1 Acquire $25,000 cash from the sale of common stock to purchase the truck.

Straight-Line Depreciation Life Cycle Phase 2 Purchase the truck on January 1, 2006, for a net cost of $24,000.

Straight-Line Depreciation Life Cycle Phase 3 Use the truck to generate $10,000 revenue for the period. Depreciation expense calculated under straight-line is determined as followed: (Asset Cost – Salvage Value) ÷ Useful Life ($24,000 – $4,000) ÷ 4 = $5,000 depreciation

Straight-Line Depreciation Life Cycle Phase 4 On January 1, 2010, the truck is sold for $4,500 cash.

Double-Declining-Balance Method The double-declining-balance method is called an accelerated depreciation method because more depreciation expense is recorded in the early years than in later years. Determining the amount of depreciation expense in any year is the result of a three-step process. 1.Determine the straight-line rate of depreciation. 2.Multiply the straight-line rate times two. 3.Multiply the double-declining rate by the book value of the asset at the beginning of the period. 1.Determine the straight-line rate of depreciation. 2.Multiply the straight-line rate times two. 3.Multiply the double-declining rate by the book value of the asset at the beginning of the period.

Double-Declining-Balance Method Let’s see how double-declining-balance depreciation works on our truck. (1 ÷ 4) = (25% straight-line rate × 2) = 50%

Straight-Line Depreciation Journal Entries

Units-of-Production Depreciation Cost – Salvage value Total estimated units of production = Depreciation charge per unit of production × Units of production in current accounting period = Periodic Depreciation Expense

Units-of-Production Depreciation Here is the depreciation charge per mile drive in our truck: $24,000 – $4, ,000 miles =$0.20 per mile Here is the calculation of depreciation expense based on miles driven:

Graph of Depreciation Expense = Units-of-Production = Straight-Line = Double-Declining-Balance ▲ ♦ ■

Income Tax Considerations modified accelerated cost recovery system The maximum depreciation currently allowed by tax law is computed using the modified accelerated cost recovery system (MACRS). The rate of depreciation depends on the class life of the asset and the period in which we are calculating depreciation. There are currently six categories for property, excluding real estate. They are 3-year, 5-year, 7-year, 10-year, 15- year, and 20-year property.

Income Tax Considerations Here are the tax rates for 5-year and 7-year property: Let’s assume our truck is classified as 5-year property and calculate depreciation for our tax return.

Income Tax Considerations Let’s assume our truck is classified as 5-year property and calculate depreciation for our tax return.

Revision of Estimates Estimates are frequently revised when new information surfaces. Assume we purchased equipment on January 1, 2006, for $24,000 cash and estimated salvage value was $3,000. The equipment has an estimated useful life of seven years, and the company uses straight-line depreciation. ($24,000 – $3,000) ÷ 7 = $3,000 depreciation per year On January 1, 2009, after three years of depreciation, it was determined that the machine has a remaining useful life of only two more years for a total estimated useful life of five years.

Revision of Estimates We determine the remaining annual depreciation like this: $15,000 – $3,000 = $12,000 ÷ 2 years = $6,000 per year

Continuing Expenditures for Plant Assets Costs that Are Expensed Costs that Are Expensed The cost of routine maintenance and minor repairs that are incurred to keep an asset in good working order are expensed as incurred. Assume Matrix, Inc. spent $200 cash for routine maintenance on machinery.

Continuing Expenditures for Plant Assets Costs that Are Capitalized Costs that Are Capitalized Expenditures that improve the quality of an asset are capitalized as part of the cost of that asset. Assume Matrix, Inc. spent $5,000 cash for a major overall of equipment to improve efficiency.

Continuing Expenditures for Plant Assets Costs that Extend the Life of an Asset Costs that Extend the Life of an Asset The amount of the expenditure should reduce the balance in the accumulated depreciation account. Assume Matrix, Inc. spent $8,000 cash for improvements that extended the life of equipment four years.

Natural Resources Cost – Salvage value Total estimated units recoverable = Depletion charge per unit of resource × Number of units extracted and sold this period = Periodic Depletion Expense

Natural Resources Martin Mining Company paid $10,000,000 cash to purchase land that is expected to yield 5,000,000 tons of coal. After all coal is extracted the land is not expected to have any salvage value. During 2006, the company extracted and sold 500,000 tons of coal. $10,000,000 – $0 5,000,000 tons =$2.00 per ton extracted and sold

Natural Resources Martin Mining Company paid $10,000,000 cash to purchase land that is expected to yield 5,000,000 tons of coal. After all coal is extracted the land is not expected to have any salvage value. During 2006, the company extracted and sold 500,000 tons of coal.

Intangible Assets Trademarks A name or symbol that identifies a company or a product. The cost of a trademark may include design, purchase, or defense of the trademark. Patents The exclusive legal right to produce and sell a product that has one or more unique features. The legal life of a patent is 20 years.

Intangible Assets Copyrights Protection of writings, musical composition, work of art, or other intellectual property. The protection extends for the life of the creator plus 70 years. Franchise The exclusive right to sell products or perform services in certain geographic areas.

Intangible Assets Goodwill The excess of cost over fair value of net tangible assets acquired in a business acquisition. Assume that your company is willing to pay $450,000 cash to acquire Seller Company. Let’s look at the accounting.

Goodwill Assume that your company is willing to pay $450,000 cash to acquire Seller Company. Let’s look at the accounting.

Goodwill Assume that your company is willing to pay $450,000 cash to acquire Seller Company. Let’s look at the accounting.

Expensing Intangible Assets An asset with an identifiable useful life is amortized using the straight-line method over the intangible’s legal life or its useful life. Assume we purchased a patent that has a 20-year legal and useful life for $20,000 cash.

Impairment of Intangible Asset Intangible assets with indefinite useful lives must be tested for impairment annually. If the fair value of the intangible asset is less than its book value, an impairment loss is recognized. Assume that at the end of 2006, we determine that goodwill has suffered a $10,000 impairment in value.

Balance Sheet Presentation

Effect of Judgment and Estimates Assume that Alpha Company uses straight-line depreciation and Zeta Company uses double-declining- balance method. Let’s look at their partial financial statements.

Effect of Judgment and Estimates Assume that Alpha Company uses straight-line depreciation and Zeta Company uses double-declining- balance method. Let’s look at their partial financial statements.

End of Chapter Nine