©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Accounting for Plant Assets, Intangible Assets, and Related Expenses Chapter 10

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Asset Account onRelated Expense Account the Balance Sheeton the Income Statement Plant Assets Land………………………………………none Buildings, Machinery and Equipment, Furniture and Fixtures, and Land Improvements………………Depreciation Natural Resources………………………..Depletion Intangibles…………………………………..Amortization Plant Assets

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Measure the cost of a plant asset. Objective 1

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber An asset must be carried on the balance sheet at the amount paid for it. An asset must be carried on the balance sheet at the amount paid for it. The cost of an asset equals the sum of all of the costs incurred to bring the asset to its intended purpose, net of discounts The cost of an asset equals the sum of all of the costs incurred to bring the asset to its intended purpose, net of discounts Cost Principle

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Land and Land Improvements Purchase price of land$500,000 Add related costs: Back property taxes$40,000 Transfer taxes 8,000 Removal of buildings 5,000 Survey fees 1,000 54,000 Total cost of land$554,000 Purchase price of land$500,000 Add related costs: Back property taxes$40,000 Transfer taxes 8,000 Removal of buildings 5,000 Survey fees 1,000 54,000 Total cost of land$554,000

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Paving Fences Sprinkler systems Lights in parking lot Paving Fences Sprinkler systems Lights in parking lot Land Improvements l All improvements located on the land but subject to decay:

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Buildings – Construction Architectural fees Building permits Contractor’s charges Architectural fees Building permits Contractor’s charges Materials Labor Overhead Materials Labor Overhead

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Buildings – Purchasing 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

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Machinery and Equipment Purchase price less discounts Transportation charges Insurance in transit Sales and other taxes Purchase commissions Installation cost Expenditures to test asset before it is placed in service Purchase price less discounts Transportation charges Insurance in transit Sales and other taxes Purchase commissions Installation cost Expenditures to test asset before it is placed in service

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Capital Leases l What are capital leases? l They are lease arrangements similar to installment purchases. l Capital leases are reported as assets, even though the company does not own the asset. l Leasehold improvements are similar to land improvements.

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Capitalizing the Cost of Interest l Suppose on January 2, 2002, The Home Depot borrows $1,000,000 on a one-year, 10% note payable, to build a warehouse. l Total interest for the year is $100,000. l Assume average accumulated expenditures on the project during 2002 are $700,000. l How much interest is capitalized? l $70,000

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Dec. 31, 2002 Building (700,000 × 10%)70,000 Interest Expense30,000 Interest Payable100,000 Accrued interest of construction loan Dec. 31, 2002 Building (700,000 × 10%)70,000 Interest Expense30,000 Interest Payable100,000 Accrued interest of construction loan Capitalizing the Cost of Interest

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Lump-Sum Purchases Example l Andrea Ortiz paid $110,000 for a combined purchase of land and a building. l The land is appraised at $90,000 and the building at $60,000. l How much of the purchase price is allocated to land and how much to the building?

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Lump-Sum Purchases Example Building: $60,000 ÷ $150,000 = 40% $110,000 × 40% = $44,000 Land: $90,000 ÷ $150,000 = 60% $110,000 × 60% = $66,000

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Does the expenditure increase capacity or efficiency or extend useful life? Does the expenditure increase capacity or efficiency or extend useful life? YESNO Capital Expenditure Debit Plant Assets accounts Capital Expenditure Debit Plant Assets accounts Revenue Expenditure Debit Repairs and Maintenance account Revenue Expenditure Debit Repairs and Maintenance account Distinction Between Capital and Revenue Expenditures

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Cost or basis Estimated residual value Estimated useful life Measuring the Depreciation of Plant Assets

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Objective 2 Account for depreciation.

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Straight-Line (SL) Units-of-Production (UOP) Double-Declining-Balance (DDB) Depreciation Methods

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Depreciation Methods Example l Donishia and Richard Catering, Inc., purchased a delivery van on January 1, 200x, for $22,000. l The company expects the van to have a trade- in value of $2,000 at the end of its useful life. l The van has an estimated service life of 100,000 miles or 4 years.

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber (Cost – Residual value) ÷ years of useful life ($22,000 – 2,000) ÷ 4 = $20,000 ÷ 4 = $5,000 Year 1 Depreciation:$ 5,000 Year 2 Depreciation: 5,000 Year 3 Depreciation: 5,000 Year 4 Depreciation: 5,000 Total Depreciation:$20,000 Year 1 Depreciation:$ 5,000 Year 2 Depreciation: 5,000 Year 3 Depreciation: 5,000 Year 4 Depreciation: 5,000 Total Depreciation:$20,000 Straight-Line Method Example

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber ($22,000 – 2,000) ÷ 100,000 = $.20/mile Year 1: 30,000 miles =$ 6,000 Year 2: 27,000 miles = 5,400 Year 3: 23,000 miles = 4,600 Year 4: 20,000 miles = 4,000 Total:100,000 miles =$20,000 (Actual mileage in year 4 was 22,000) Year 1: 30,000 miles =$ 6,000 Year 2: 27,000 miles = 5,400 Year 3: 23,000 miles = 4,600 Year 4: 20,000 miles = 4,000 Total:100,000 miles =$20,000 (Actual mileage in year 4 was 22,000) Units-of-Production Method Example

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Double-Declining-Balance Method Example l Straight-line rate is 100% ÷ 4 = 25% l Double-declining-balance = 2 times the straight-line rate = 50% l What is the book value of the van at the end of the first year? l $22,000 × 50% = $11,000 l $22,000 – $11,000 = $11,000

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Double-Declining-Balance Method Example Dec. 31, 200x Depreciation Expense $11,000 Accumulated Depreciation $11,000 To record depreciation expense for a one-year period Dec. 31, 200x Depreciation Expense $11,000 Accumulated Depreciation $11,000 To record depreciation expense for a one-year period

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Depreciation Methods Comparison

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Use of Depreciation Methods

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Objective 3 Select the best depreciation method for income tax purposes.

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Relationship Between Depreciation and Taxes l MACRS was created by the Tax Reform Act of l It is an accelerated method used for depreciating equipment.

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Straight-line method: $5,000 × 3/12 = $1,250 Straight-line method: $5,000 × 3/12 = $1,250 Double-declining-balance method: $11,000 × 3/12 = $2,750 Double-declining-balance method: $11,000 × 3/12 = $2,750 Depreciation for Partial Years l Assume that Donishia and Richard Catering, Inc., owned the van for 3 months. l How much is the van’s depreciation?

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Remaining useful life Revised SL depreciation = Cost – Accumulated depreciation – New residual value ÷ Revising Depreciation Rates

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Objective 4 Account for the disposal of a plant asset.

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Disposing of Plant Assets – selling – exchanging – discarding (scrapping it) l Gain/loss is reported on the income statement... – and closed to Income Summary.

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Disposing by Discarding Example l On September 1, Joe, manager of Joe’s Landscaping, is contemplating the disposal of an old piece of equipment: l Equipment cost:$36,000 l Residual value:$ 6,000 l Accumulated depreciation:$20,000 l Estimated useful life at acquisition: 10 years

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber ($36,000 – $6,000) ÷ 10 = $3,000 $3,000 ÷ 12 = $250 $250 × 3 = $750 $20,000 + $750 = $20,750 ($36,000 – $6,000) ÷ 10 = $3,000 $3,000 ÷ 12 = $250 $250 × 3 = $750 $20,000 + $750 = $20,750 Disposing by Discarding Example l Assume the equipment is discarded on November 30. l What is the accumulated depreciation on November 30?

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Disposing by Discarding Example November 30, 20xx Accumulated Depreciation20,750 Loss on disposal15,250 Equipment 36,000 To record discarding of equipment November 30, 20xx Accumulated Depreciation20,750 Loss on disposal15,250 Equipment 36,000 To record discarding of equipment

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Selling a Plant Asset Example l Assume the equipment is sold for $10,000. l What is the gain or loss? l Nov. 30, 20xx Cash10,000 Accumulated Depreciation20,750 Loss on Sale of Equipment 5,250 Equipment 36,000 To record sale of equipment for $10,000

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Selling a Plant Asset Example l Equipment is sold for $20,000. l What is the gain or loss? l Nov. 30, 20xx Cash20,000 Accumulated Depreciation20,750 Gain on Sale of Equipment 4,750 Equipment 36,000 To record sale of equipment for $20,000

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Exchanging Plant Assets l Assume equipment with a cost of $36,000 and a book value of $15,250 is exchanged for new, similar equipment having a cost of $42,000 with a trade-in of $18,000 allowed. l Cash payment is $24,000. l What is the cost of the new asset? l $24,000 + $15,250 = $39,250

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Exchanging Plant Assets Equipment (new)$39,250 Accumulated Depreciation (old)$20,750 Equipment (old)$36,000 Cash$24,000 Equipment (new)$39,250 Accumulated Depreciation (old)$20,750 Equipment (old)$36,000 Cash$24,000

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Objective 5 Account for natural resource assets and depletion.

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber 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 resources = Depletion per unit Cost – Residual value) ÷ Estimated units of natural resources = Depletion per unit Accounting for Natural Resources

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Objective 6 Account for intangible assets and amortization.

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Patents Copyrights Trademarks Franchises Leaseholds Goodwill Not physical in nature Intangible Assets

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Intangible Assets: Patents l Patents are federal government grants. l They give the holder the right to produce and sell an invention. l Suppose a company pays $170,000 to acquire a patent on January 1. l The company believes that its expected useful life is 5 years. l What are the entries?

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Jan. 1 Patents170,000 Cash170,000 To acquire a patent Dec. 31 Amortization Expense 34,000 Patents 34,000 To amortize the cost of a patent Intangible Assets: Patents

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Literary compositions (novels) Musical compositions Films (movies) Software Other works of art Intangible Assets: Copyrights

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Trademarks, Trade Names, or Brand Names are assets that represent distinctive identifications of a product or service. Trademarks, Trade Names, or Brand Names are assets that represent distinctive identifications of a product or service. Intangible Assets: Trademarks

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Intangible Assets: Franchises l Franchises are privileges granted by private business or government to sell a product or service.

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Purchase price paid for Mexana Company$10 million Assets at market value9 million Less Mexana’s liabilities1 million Market value of Mexana’s net assets 8 million Goodwill$ 2 million Purchase price paid for Mexana Company$10 million Assets at market value9 million Less Mexana’s liabilities1 million Market value of Mexana’s net assets 8 million Goodwill$ 2 million Goodwill Example Intangible Assets: Goodwill

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber International accounting for goodwill Research and development Capitalize or expense a cost Special Issues

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber End of Chapter 10