©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Plant Assets, Intangible Assets, and Related Expenses Chapter 7

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Learning Objective 1 Determine the cost of a plant asset.

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Types of Assets Long-lived assets used in the operation of a business are divided into categories: Plant Assets Intangible Assets

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Plant Assets Terminology Plant Assets LandNone Buildings, Machinery and Equipment, Furniture and Fixtures, and Land ImprovementsDepreciation Natural Resources Depletion Intangibles Amortization Asset Account (Balance Sheet) Related Expense Account (Income Statement)

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren How to Value Plant Assets: At Cost or at Market Value? The accounting profession is moving toward market-value accounting. The business community is not yet ready to apply market-value accounting to tangible plant assets.

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Determining the Cost of Land What is the cost of the land? It pays $10,000 in back property tax, $8,000 in transfer taxes, $5,000 for removal of an old building, a $1,000 survey fee, and $260,000 to pave the parking lot. A business signs a $300,000 note payable to purchase land for a new store site.

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Determining the Cost of Land Purchase price of land$300,000 Add related costs: Back property taxes$10,000 Transfer taxes 8,000 Removal of buildings 5,000 Survey fees 1,000 24,000 Total cost of land$324,000

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Determining the Cost of Buildings: Construction Architectural fees Building permits Contractor’s charges Architectural fees Building permits Contractor’s charges Materials Labor Overhead Materials Labor Overhead Cost of interest

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Determining the Cost of Buildings: Purchase Purchase price Brokerage commissions Sales and other taxes Repairing or renovating building for its intended purpose Purchase price Brokerage commissions Sales and other taxes Repairing or renovating building for its intended purpose

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Determining the Cost of Machinery and Equipment Purchase price less discounts Transportation charges Insurance in transit Sales and other taxes Purchase commission Installation costs Expenditures to test the asset Special platforms Purchase price less discounts Transportation charges Insurance in transit Sales and other taxes Purchase commission Installation costs Expenditures to test the asset Special platforms

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Land improvement costs are not included in the cost of land. Determining the Cost of Land and Leasehold Improvements Paving Fences Sprinkler systems Lights in parking lot Land improvements are all improvements located on the land but subject to decay.

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren The cost of improvements to leased assets appears on the company’s balance sheet as Leasehold Improvements. It is depreciated (amortized) over the term of the lease. Determining the Cost of Land and Leasehold Improvements

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Lump-Sum (or Basket) Purchases of Assets Xerox Corporation paid $2,800,000 for a combined purchase of land and a building. The land is appraised at $300,000 and the building at $2,700,000. How much of the purchase price is allocated to land and how much to the building?

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Lump-Sum (or Basket) Purchases of Assets Building: $2,700,000 ÷ $3,000,000 = 90% $2,800,000 × 90% = $2,520,000 Land: $300,000 ÷ $3,000,000 = 10% $2,800,000 × 10% = $280,000

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Does the expenditure increase capacity or efficiency or extend useful life? Capital Expenditures: Record an asset Expenses: Record an expense Capital Expenditure versus an Immediate Expense

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Capital Expenditure versus an Immediate Expense Record an Asset for Capital Expenditures Extraordinary repairs: – Major engine overhaul – Modification of body for new use of truck – Addition to storage capacity of truck Record Repair and Maintenance Expense Ordinary repairs: –Repair of transmission or other mechanism – Oil change, lubrication, etc. – Replacement tires, windshield – Paint job

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Cost or basis: $32 million Annual depreciation expense: $32 million ÷ 20 = $1.6 million Estimated useful life: 20 years Measuring Plant Asset Depreciation Estimated salvage value: none Boeing 737

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Learning Objective 2 Account for depreciation.

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Straight-line (SL) Units-of-production (UOP) Double-declining-balance (DDB) Depreciation Methods

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Depreciation Methods Data ItemsAmount Cost of truck$41,000 Less: Estimated residual value– 1,000 Depreciable cost$40,000 Estimated useful life 5 years Units of production100,000 miles Cost of truck$41,000 Less: Estimated residual value– 1,000 Depreciable cost$40,000 Estimated useful life 5 years Units of production100,000 miles

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren (Cost – Residual value) ÷ Years of useful life ($41,000 – $1,000) ÷ 5 = $8,000 Year 1 depreciation:$ 8,000 Year 2 depreciation: 8,000 Year 3 depreciation: 8,000 Year 4 depreciation: 8,000 Year 5 depreciation: 8,000 Total depreciation:$40,000 Straight-Line Method

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren ($41,000 – $1,000) ÷ 100,000 = $.40/mile Year 1: 20,000 miles × $.40 =$ 8,000 Year 2: 30,000 miles × $.40 = 12,000 Year 3: 25,000 miles × $.40 = 10,000 Year 4: 15,000 miles × $.40 = 6,000 Year 5: 10,000 miles × $.40 = 4,000 Units-of-Production Method

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Double-Declining-Balance Method Straight-line rate per year: 100% ÷ 5 = 20% Book value of truck at the end of the first year: $41,000 × 40% = $16,400 $41,000 – $16,400 = $24,600 Double-declining balance: 2 times the straight-line rate = 40%

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Comparing Depreciation Methods Year Total SL $ 8,000 8,000 $40,000 UOP $ 8,000 12,000 10,000 6,000 4,000 $40,000 DDB $16,400 9,840 5,904 3,542 4,314 $40,000 Amount of Depreciation per Year

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Depreciation Methods Used by 600 Companies 82% Straight-line 5% Units-of-production 12% Accelerated 1% Other

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Learning Objective 3 Select the best depreciation method.

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Relationship Between Depreciation and Taxes Cash revenues$400,000$400,000 Cash operating expenses 300, ,000 Cash provided by operations before tax$100,000$100,000 Depreciation expense 8,000 16,400 Income before income tax$ 92,000$ 83,600 Income tax expense (30%) 27,600 25,080 Net income$ 64,400$ 58,520 Cash revenues$400,000$400,000 Cash operating expenses 300, ,000 Cash provided by operations before tax$100,000$100,000 Depreciation expense 8,000 16,400 Income before income tax$ 92,000$ 83,600 Income tax expense (30%) 27,600 25,080 Net income$ 64,400$ 58,520 Straight-lineAccelerated

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Relationship Between Depreciation and Taxes Cash-flow analysis$100,000$100,000 Income tax expense 27,600 25,080 Cash provided by operations before taxes$ 72,400$ 74,920 Extra cash available for investment if DDB is used ($74,920 – $72,400)$ 2,520 Cash-flow analysis$100,000$100,000 Income tax expense 27,600 25,080 Cash provided by operations before taxes$ 72,400$ 74,920 Extra cash available for investment if DDB is used ($74,920 – $72,400)$ 2,520 Straight-lineAccelerated

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Modified Accelerated Cost Recovery System (MACRS) Under the Modified Accelerated Cost Recovery System (MACRS), assets are grouped into one of eight classes identified by asset life:

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Modified Accelerated Cost Recovery System (MACRS) Class Identified by Asset Life (years) Representative Assets Depreciation Method ½ 39 Race horses Automobiles, light trucks Equipment Sewage-treatment plants Certain real estate Residential rental property Nonresidential rental property DDB 150% DB SL

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Depreciation for Partial Years Suppose a calendar-year business purchases a building on April 1 for $500,000 with an estimated life of 20 years and an estimated residual value of $80,000. What is the current year’s depreciation using the straight-line method?

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Partial-year depreciation: $21,000 × 9/12 = $15,750 Depreciation for Partial Years Full-year depreciation: ($500,000 – $80,000) ÷ 20 = $21,000

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Assume an asset cost of $40,000, an eight-year useful life with no residual value, and the straight-line method. $40,000 ÷ 8 = $5,000 depreciation per year Changing the Useful Life of a Depreciable Asset What is the book value after two years? $40,000 – $10,000 = $30,000

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Management believes the asset will remain useful for an additional ten years. Changing the Useful Life of a Depreciable Asset $30,000 ÷ 10 = $3,000 (new depreciation per year)

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren The asset and its depreciation account remain in the ledger with no additional depreciation entries. Fully Depreciated Assets An asset can be used after it is fully depreciated.

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Learning Objective 4 Analyze the effect of a plant asset disposal.

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Accounting for Disposal of Plant Assets: Example Fixtures cost:$4,000 Accumulated depreciation:$3,000 Book value$1,000 Accumulated Depreciation3,000 Loss on Disposal1,000 Store Fixtures4,000 To dispose of store fixtures

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Selling a Plant Asset: Example Equipment which cost $10,000 on 1/1/2001 is sold on 9/30/2004 for $5,000. It has been depreciated on a straight-line basis over its 10 years’ estimated useful life. There is no residual value.

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren $10,000 ÷ 10 = $1,000/year $1,000 × 3 years = $3,000 $1,000 × 9/12 = $750 $3,000 + $750 = $3,750 Selling a Plant Asset: Example What is the accumulated depreciation on September 30, 2004?

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Selling a Plant Asset: Example What is the gain or loss? September 30, 2004 Cash5,000 Accumulated Depreciation3,750 Loss on Sale of Equipment1,250 Equipment10,000 To record sale of equipment for $5,000

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Exchanging Plant Assets Businesses often trade in their old plant assets for similar assets that are newer and more efficient. In many cases, the business simply transfers the book value of the old asset plus any cash payment into the new asset account.

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Exchanging Plant Assets Assume than an old delivery car with a cost of $9,000 and a book value of $1,000 is exchanged for a new car. Cash payment is $10,000. What is the cost of the new car? $10,000 + $1,000 = $11,000

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Exchanging Plant Assets Delivery Auto (new)11,000 Accumulated Depreciation (old) 8,000 Delivery Auto (old) 9,000 Cash10,000 Traded in old delivery car for new auto

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Learning Objective 5 Account for natural resources and depletion.

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Natural gas and oil Precious metals and gems Timber, coal, and iron ore Natural gas and oil Precious metals and gems Timber, coal, and iron ore (Cost – Residual value) ÷ Estimated units of natural resource = Depletion per unit (Cost – Residual value) ÷ Estimated units of natural resource = Depletion per unit Accounting for Natural Resources and Depletion

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Accounting for Natural Resources and Depletion Assume an oil lease cost $100,000 and contains an estimated 10,000 barrels of oil. Depletion rate: $100,000 ÷ 10,000 = $10 per barrel. If 3,000 barrels are extracted during the year, depletion expense is $30,000. Accumulated Depletion is a contra account similar to Accumulated Depreciation

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Learning Objective 6 Account for intangible assets and amortization.

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Intangible Assets Patents Copyrights Trademarks Franchises Leaseholds Goodwill

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Intangible Assets Amortization expense for an intangible asset can be written off directly against the asset account rather than held in an accumulated amortization account. Assets with an indefinite useful life are not amortized. All intangible assets are subject to impairment.

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Intangible Assets: Patents Patents are federal government grants. They give the holder the right to produce and sell an invention. Suppose a company pays $170,000 to acquire a patent on January 1. The company believes that its expected useful life is 5 years.

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren January 1 Patents170,000 Cash170,000 To acquire a patent December 31 Amortization Expense 34,000 Patents 34,000 To amortize the cost of a patent Intangible Assets: Patents

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Literary compositions (novels) Musical compositions Films (movies) Software Other works of art Intangible Assets: Copyrights Copyrights extend 50 years beyond the author’s life.

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Trademarks, Trade Names, or Brand Names are assets that represent distinctive identifications of a product or service. Intangible Assets: Trademarks

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Intangible Assets: Franchises Franchises are privileges granted by private business or government to sell a product or service.

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Purchase price paid for Mexana Company$10 million Assets at market value$9 million Less: Mexana’s liabilities$1 million Market value of Mexana’s net assets 8 million Goodwill$ 2 million Purchase price paid for Mexana Company$10 million Assets at market value$9 million Less: Mexana’s liabilities$1 million Market value of Mexana’s net assets 8 million Goodwill$ 2 million Goodwill Example Intangible Assets: Goodwill

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Research and Development The cost of research and development is expensed as it is incurred.

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Learning Objective 7 Report plant asset transactions on the statement of cash flows.

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Reporting Plant Asset Transactions: The Statement of Cash Flows The plant asset transactions that appear on the statement of cash flows are: Acquisitions (an investing activity) Sales Depreciation (including amortization and depletion)

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren End of Chapter 7