© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 9-1 PLANT AND INTANGIBLE ASSETS Chapter 9

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 9-2 Long-lived assets acquired for use in business operations. Similar to long-term prepaid expenses The cost of plant assets is the advance purchase of services. As years pass, and the services are used, the cost is transferred to depreciation expense. Plant Assets

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 9-3 Major Categories of Plant Assets

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 9-4  Acquisition.  Allocation of the acquisition cost to expense over the asset’s useful life (depreciation).  Sale or disposal.  Acquisition.  Allocation of the acquisition cost to expense over the asset’s useful life (depreciation).  Sale or disposal. Accountable Events

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 9-5 Asset price... for getting the asset to the desired location.... for getting the asset ready for use. Cost Acquisition of Plant Assets = Reasonable and necessary costs... +

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 9-6 On May 4, Heat Co., an Ohio maker of stoves, buys a new machine from a Texas company. The new machine has a price of $52,000. Sales tax was computed at 8%. Heat Co. pays $500 shipping cost to get the machine to Ohio. After the machine arrives, set-up costs of $1,300 are incurred, along with $4,000 in testing costs. Compute the cost of Heat Co.’s new machine. On May 4, Heat Co., an Ohio maker of stoves, buys a new machine from a Texas company. The new machine has a price of $52,000. Sales tax was computed at 8%. Heat Co. pays $500 shipping cost to get the machine to Ohio. After the machine arrives, set-up costs of $1,300 are incurred, along with $4,000 in testing costs. Compute the cost of Heat Co.’s new machine. Determining Cost

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 9-7 Determining Cost

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 9-8 Improvements to land such as driveways, fences, and landscaping are recorded separately. Cost includes real estate commissions, escrow fees, legal fees, clearing and grading the property. Land Improvements Land Special Considerations

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 9-9 Repairs made prior to the building being put in use are considered part of the building’s cost. Buildings Special Considerations Equipment Related interest, insurance, and property taxes are treated as expenses of the current period.

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 9-10 I think I’ll buy the whole thing; barn, land, and animals. Special Considerations The allocation is based on the relative Fair Market Value of each asset purchased. The total cost must be allocated to separate accounts for each asset. Allocation of a Lump-Sum Purchase

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 9-11 Capital Expenditure Revenue Expenditure Any material expenditure that will benefit several accounting periods. To capitalize an expenditure means to charge it to an asset account. Expenditure for ordinary repairs and maintenance. To expense an expenditure means to charge it to an expense account. Capital Expenditures and Revenue Expenditures

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 9-12 The allocation of the cost of a plant asset to expense in the periods in which services are received from the asset. Cost of plant assets Balance Sheet Assets: Plant and equipment Assets: Plant and equipment Income Statement Revenues: Expenses: Depreciation Revenues: Expenses: Depreciation as the services are received Depreciation

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 9-13 Book Value Cost – Accumulated Depreciation Accumulated Depreciation Contra-asset Represents the portion of an asset’s cost that has already been allocated to expense. Causes of Depreciation Physical deterioration Obsolescence Book Value Cost – Accumulated Depreciation Accumulated Depreciation Contra-asset Represents the portion of an asset’s cost that has already been allocated to expense. Causes of Depreciation Physical deterioration Obsolescence Depreciation

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 9-14 Cost - Residual Value Years of Useful Life Depreciation Expense per Year = Straight-Line Depreciation

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 9-15 On January 1, 2005, Bass Co. buys a new boat. Bass Co. pays $24,000 for the boat. The boat has an estimated residual value of $3,000 and an estimated useful life of 5 years. Compute depreciation for 2005 using the straight-line method. On January 1, 2005, Bass Co. buys a new boat. Bass Co. pays $24,000 for the boat. The boat has an estimated residual value of $3,000 and an estimated useful life of 5 years. Compute depreciation for 2005 using the straight-line method. Straight-Line Depreciation

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 9-16 Bass Co. will record $4,200 depreciation each year for five years. Total depreciation over the estimated useful life of the boat is: Salvage Value Straight-Line Depreciation

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 9-17 When an asset is acquired during the year, depreciation in the year of acquisition must be prorated. Half-Year Convention In the year of acquisition, record six months of depreciation. Half-Year Convention In the year of acquisition, record six months of depreciation. ½ Depreciation for Fractional Periods

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 9-18 Half-Year Convention Using the half-year convention, calculate the straight-line depreciation on December 31, 2005, for equipment purchased in The equipment cost $75,000, has a useful life of 10 years and an estimated salvage value of $5,000. Depreciation= ($75,000 - $5,000) ÷ 10 = $7,000 for a full year Depreciation = $7,000 × 1 / 2 = $3,500 Depreciation= ($75,000 - $5,000) ÷ 10 = $7,000 for a full year Depreciation = $7,000 × 1 / 2 = $3,500

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 9-19 Depreciation in the early years of an asset’s estimated useful life is higher than in later years. The double-declining balance depreciation rate is 200% of the straight-line depreciation rate of 1/Useful Life. Declining-Balance Method

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 9-20 On January 1, 2005, Bass Co. buys a new boat. Bass Co. pays $24,000 for the boat. The boat has an estimated residual value of $3,000 and an estimated useful life of 5 years. Compute depreciation for 2005 using the double-declining balance method. On January 1, 2005, Bass Co. buys a new boat. Bass Co. pays $24,000 for the boat. The boat has an estimated residual value of $3,000 and an estimated useful life of 5 years. Compute depreciation for 2005 using the double-declining balance method. Declining-Balance Method

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 9-21 Compute depreciation for the rest of the boat’s estimated useful life. Declining-Balance Method Total depreciation over the estimated useful life of an asset is the same using either the straight-line method or the declining-balance method.

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 9-22  Estimates of Useful Life and Residual Value May differ from company to company. The reasonableness of management’s estimates is evaluated by external auditors.  Principle of Consistency Companies should avoid switching depreciation methods from period to period.  Estimates of Useful Life and Residual Value May differ from company to company. The reasonableness of management’s estimates is evaluated by external auditors.  Principle of Consistency Companies should avoid switching depreciation methods from period to period. Financial Statement Disclosures

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 9-23 So depreciation is an estimate. Predicted salvage value Predicted useful life Over the life of an asset, new information may come to light that indicates the original estimates need to be revised. Revising Depreciation Rates

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 9-24 Revising Depreciation Rates On January 1, 2002, equipment was purchased that cost $30,000, has a useful life of 10 years and no salvage value. During 2005, the useful life was revised to 8 years total (5 years remaining). Calculate depreciation expense for the year ended December 31, 2005, using the straight- line method. On January 1, 2002, equipment was purchased that cost $30,000, has a useful life of 10 years and no salvage value. During 2005, the useful life was revised to 8 years total (5 years remaining). Calculate depreciation expense for the year ended December 31, 2005, using the straight- line method.

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 9-25 When our estimates change, depreciation is: Book value at date of change Salvage value at date of change Remaining useful life at date of change – Revising Depreciation Rates

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 9-26 If the cost of an asset cannot be recovered through future use or sale, the asset should be written down to its net realizable value. Impairment of Plant Assets

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 9-27 Update depreciation to the date of disposal. Recording cash received (debit). Removing accumulated depreciation (debit). Removing the asset cost (credit). Recording a gain (credit) or loss (debit). Recording a gain (credit) or loss (debit). Disposal of Plant and Equipment Journalize disposal by:

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 9-28 If Cash > BV, record a gain (credit). If Cash < BV, record a loss (debit). If Cash = BV, no gain or loss. If Cash > BV, record a gain (credit). If Cash < BV, record a loss (debit). If Cash = BV, no gain or loss. Recording cash received (debit). Removing accumulated depreciation (debit). Removing the asset cost (credit). Recording a gain (credit) or loss (debit). Recording a gain (credit) or loss (debit). Disposal of Plant and Equipment

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 9-29 On September 30, 2005, Evans Map Company sells a machine that originally cost $100,000 for $60,000 cash. The machine was placed in service on January 1, It has been depreciated using the straight-line method with an estimated salvage value of $20,000 and an estimated useful life of 10 years. Let’s answer the following questions. Disposal of Plant and Equipment

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 9-30 The amount of depreciation recorded on September 30, 2005, to bring depreciation up to date is: a.$8,000. b.$6,000. c.$4,000. d.$2,000. The amount of depreciation recorded on September 30, 2005, to bring depreciation up to date is: a.$8,000. b.$6,000. c.$4,000. d.$2,000. Annual Depreciation: ($100,000 - $20,000) ÷ 10 Yrs. = $8,000 Depreciation to Sept. 30: 9/12 × $8,000 = $6,000 Disposal of Plant and Equipment

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 9-31 After updating the depreciation, the machine’s book value on September 30, 2005, is: a.$54,000. b.$46,000. c.$40,000. d.$60,000. After updating the depreciation, the machine’s book value on September 30, 2005, is: a.$54,000. b.$46,000. c.$40,000. d.$60,000. Disposal of Plant and Equipment

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 9-32 The machine’s sale resulted in: a.a gain of $6,000. b.a gain of $4,000. c.a loss of $6,000. d.a loss of $4,000. The machine’s sale resulted in: a.a gain of $6,000. b.a gain of $4,000. c.a loss of $6,000. d.a loss of $4,000. Disposal of Plant and Equipment

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 9-33 Disposal of Plant and Equipment Prepare the journal entry to record the sale.

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 9-34 Accounting depends on whether assets are similar or dissimilar. Airplane for Airplane Truck for Airplane Only situations where cash is paid will be demonstrated. Trading in Used Assets for New Ones

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 9-35 Trading in Used Assets for New Ones

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 9-36 On May 30, 2005, Essex Company exchanged a used airplane and $35,000 cash for a new airplane. The old airplane originally cost $40,000, had up-to-date accumulated depreciation of $30,000, and a fair value of $4,000. SIMILAR Trading in Used Assets for New Ones – Similar Assets

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 9-37 The exchange resulted in a: a.gain of $6,000. b.loss of $6,000. c.loss of $4,000. d. gain of $4,000. The exchange resulted in a: a.gain of $6,000. b.loss of $6,000. c.loss of $4,000. d. gain of $4,000. Prepare a journal entry to record the exchange. Trading in Used Assets for New Ones – Similar Assets

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 9-38 Trading in Used Assets for New Ones – Similar Assets Prepare the journal entry to record the trade.

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 9-39 Noncurrent assets without physical substance. Useful life is often difficult to determine. Usually acquired for operational use. Often provide exclusive rights or privileges. Intangible Assets Characteristics

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 9-40  Patents  Copyrights  Leaseholds  Leasehold Improvements  Goodwill  Trademarks and Trade Names Record at current cash equivalent cost, including purchase price, legal fees, and filing fees. Intangible Assets

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 9-41  Amortization is the systematic write-off to expense of the cost of intangible assets over Their useful life or legal life, whichever is shorter.  Use the straight-line method to amortize most intangible assets.  Amortization is the systematic write-off to expense of the cost of intangible assets over Their useful life or legal life, whichever is shorter.  Use the straight-line method to amortize most intangible assets. Amortization

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 9-42 The amount by which the purchase price exceeds the fair market value of net assets acquired. Occurs when one company buys another company. Only purchased goodwill is an intangible asset. Goodwill Goodwill is NOT amortized. It is tested annually to determine if there has been an impairment loss.

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 9-43 Exclusive right granted by federal government to sell or manufacture an invention. Cost is purchase price plus legal cost to defend. Amortize cost over the shorter of useful life or 20 years. Patents

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 9-44 A symbol, design, or logo associated with a business. Purchased trademarks are recorded at cost, and amortized over shorter of legal or economic life, or 40 years. Internally developed trademarks have no recorded asset cost. Trademarks and Trade Names

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 9-45 Legally protected right to sell products or provide services purchased by franchisee from franchisor. Purchase price is intangible asset which is amortized over the shorter of the protected right or useful life. Franchises

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 9-46 Exclusive right granted by the federal government to protect artistic or intellectual properties. Amortize cost over period benefited. Legal life is life of creator plus 70 years. Copyrights

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 9-47 The FASB ruled that all R&D expenditures should be charged to expense when incurred. Research and Development Costs All of these R&D costs will really reduce our net income this year!

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 9-48 Total cost, including exploration and development, is charged to depletion expense over periods benefited. Examples: oil, coal, gold Extracted from the natural environment and reported at cost less accumulated depletion. Natural Resources

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 9-49 Depletion is calculated using the units-of-production method. Unit depletion rate is calculated as follows: Total Units of Natural Resource Cost – Residual Value Depletion of Natural Resources

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 9-50 Total depletion cost for a period is: Unit Depletion Rate Number of Units Extracted in Period × Total depletion cost Inventory for sale Unsold Inventory Cost of goods sold Depletion of Natural Resources

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 9-51 Specialized plant assets may be required to extract the natural resource. These assets should be depreciated over their normal useful lives or over the life of the natural resource, whichever is shorter. Depletion of Natural Resources

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 9-52 Comparative Use of Depreciation Methods

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 9-53 End of Chapter 9