Copyright © 2007 Prentice-Hall. All rights reserved 1 Long-Term Assets: Plant Assets and Intangibles Chapter 9 Part 1

Copyright © 2007 Prentice-Hall. All rights reserved 2 Objective 1 Define and describe the life cycle of long-term assets

Copyright © 2007 Prentice-Hall. All rights reserved 3 Long-lived Assets PlantAssetsPlantAssetsNaturalResourcesNaturalResourcesIntangibleAssetsIntangibleAssets DepreciationDepreciationDepletionDepletionAmortizationAmortization

Copyright © 2007 Prentice-Hall. All rights reserved 4 Internal Controls All plant assets should be labeled Maintain a subsidiary ledger Reconcile the total balance of subsidiary accounts with the controlling account Physically inspect each asset at least once a year

Copyright © 2007 Prentice-Hall. All rights reserved 5 Objective 2 Calculate and record the cost to acquire plant assets

Copyright © 2007 Prentice-Hall. All rights reserved 6 Assets should be recorded at their historical cost Cost of an asset – all costs necessary to acquire the asset and get it ready for its intended use –Also includes costs to improve the asset Costs to extend life of the asset –Does NOT include repairs and maintenance that are anticipated as normal period costs Cost Principle

Copyright © 2007 Prentice-Hall. All rights reserved 7 Land and Land Improvements Land Purchase price Legal fees Costs of grading and clearing Additional permanent improvements Not depreciated Land Improvements - Improvements with limited life Driveways and parking lots Sidewalks Fences Depreciated

Copyright © 2007 Prentice-Hall. All rights reserved 8 BuildingsBuildings Purchase price Legal fees Repairs and renovations If self-constructed –Architectural fees –Building permits –Material –Labor –Overhead –Some interest costs

Copyright © 2007 Prentice-Hall. All rights reserved 9 Machinery and Equipment Purchase price (less any discounts) Transportation charges Insurance while in transit Sales tax Installation costs Cost of testing before asset is used

Copyright © 2007 Prentice-Hall. All rights reserved 10 Furniture and Fixtures Purchase price (less any discounts) Shipping charges Costs to assemble

Copyright © 2007 Prentice-Hall. All rights reserved 11 E9-14E9-14 Land Purchase price$200,000 Property tax2,100 Title insurance2,500 Remove and level10,400 $215,000 Building Cost$800,000 Land improvements Fence$51,000 Signage15,000 Lighting6,000 $72,000

Copyright © 2007 Prentice-Hall. All rights reserved 12 Lump Sum Purchases Assign cost to individual assets based on relative sales values –For example: Cost to build 3 items is $10,000. How do we allocate this cost to the individual items?

Copyright © 2007 Prentice-Hall. All rights reserved 13 E9-16E9-16 BedAppraised Cost Percent of Value CostAllocated Cost 1$3,000X$10,000 25,000X10,000 34,000X10,000 $12,000 $2,500 4,170 3,330 $10,000 $3,000/$12, % $5,000/$12, % $4,000/$12, % 100%

Copyright © 2007 Prentice-Hall. All rights reserved 14 E9-16E9-16 BedAppraised Cost Percent of Value CostAllocated Cost 1$3,000X$10,000 25,000X10,000 34,000X10,000 $12,000 $2,500 4,170 3,330 $10, % 41.7% 33.3% 100%

Copyright © 2007 Prentice-Hall. All rights reserved 15 E9-16E9-16 GENERAL JOURNAL DATEDESCRIPTIONREFDEBITCREDIT Bed 12,500 Bed 24,170 Bed 33,330 Cash5,000 Note Payable5,000

Copyright © 2007 Prentice-Hall. All rights reserved 16 Does the expenditure increase capacity or efficiency or extend useful life? Does the expenditure increase capacity or efficiency or extend useful life? YES NO Capital Expenditure Debit asset account Capital Expenditure Debit asset account Expense Debit repairs and maintenance expense Expense Debit repairs and maintenance expense Capital Expenditures

Copyright © 2007 Prentice-Hall. All rights reserved 17 E9-16E9-16 Capital Expenditures –Purchase price –Lubrication before machine is placed in service –Major overhaul –Sales tax –Transportation and insurance –Installation –Training of personnel Expenses: –Ordinary recurring repairs –Periodic lubrication –Income tax Expenditure benefits more than one period. Debit an asset Expenditure that maintains the asset in its current working condition. Debit an expense

Copyright © 2007 Prentice-Hall. All rights reserved 18 Objective 3 Calculate and record depreciation of plant assets

Copyright © 2007 Prentice-Hall. All rights reserved 19 DepreciationDepreciation Process of allocating the cost of a plant asset to expense over its useful life in a rational and systematic way Matching Principle

Copyright © 2007 Prentice-Hall. All rights reserved POINTPOINT We are spreading the expense of purchasing an asset (its cost) over time (period usually = year, quarter, or month) We are NOT estimating the fair market value 20

Copyright © 2007 Prentice-Hall. All rights reserved ExampleExample Example: Purchase a machine for $1,000 in year 1 that will last 5 years. Make income every year for $1,000 a year for the next 5 years. 21

Copyright © 2007 Prentice-Hall. All rights reserved IllustrationIllustration 22 Income without depreciation Year 1Year 2Year 3Year 4Year 5 Sales$1,000 Less: Equipment Expense$1,000 Total Income$0$1,000 Income with depreciation Year 1Year 2Year 3Year 4Year 5 Sales$1,000 Less: Equipment Expense$200 Total Income$800

Copyright © 2007 Prentice-Hall. All rights reserved 23 Depreciation – Adjusting Entry GENERAL JOURNAL DATEDESCRIPTIONREFDEBITCREDIT Depreciation Expense Accumulated Depreciation Partial balance sheet: Building$120,000 Less Accumulated Depreciation(80,000) $40,000

Copyright © 2007 Prentice-Hall. All rights reserved 24 Factors in Computing Depreciation 1.Cost 2.Estimated Residual Value (what asset is worth at end of life…salvage) Depreciable cost = Cost – Residual Value 3.Estimated Useful Life Physical wear and tear Obsolescence

Copyright © 2007 Prentice-Hall. All rights reserved 25 Depreciation Methods Straight-line Units-of-production Declining balance

Copyright © 2007 Prentice-Hall. All rights reserved 26 Straight-Line Method Cost - Residual Value Useful life in years Depreciation Expense per Year =

Copyright © 2007 Prentice-Hall. All rights reserved 27 E9-19E9-19 Straight-line $30,000 – $6,000 / 4 years = $6,000 per yr Year Depr Exp for Year Total Accum Depr Year-End Book Value $6,000 6,00012,000 6,00018,000 6,00024,000 $24,000 18,000 12,000 6,000

Copyright © 2007 Prentice-Hall. All rights reserved 28 Cost - Residual Value Total Units of Production 1: Compute depreciation per unit: 2: Compute depreciation expense: Depreciation per unit × Number of units produced in the period Units-of-Production Method

Copyright © 2007 Prentice-Hall. All rights reserved 29 E9-19E9-19 Units of Production ($30,000 - $6,000) / 1,000 operations = $24.00 per operation Year Depr Exp for Year $24 x 100 $24 x 300 9,600 4,800 $2,400 7,200 $24 x 400 $24 x 200

Copyright © 2007 Prentice-Hall. All rights reserved 30 E9-19E9-19 Units of Production ($30,000 - $6,000) / 1,000 operations = $24.00 per operation Year Depr Exp for Year Total Accum Depr Year-End Book Value $2,400 9,600 19,200 24,000 $27,600 20,400 10,800 6,000 9,600 4,800 $2,400 7,200

Copyright © 2007 Prentice-Hall. All rights reserved 31 Double-Declining Balance Method Accelerated method – writes off a greater amount of the cost of an asset in earlier years of asset’s useful life Amount of depreciation expense recognized declines each year Cheryl’s observation –Rationale had nothing to do with logic –Rationale was politically driven –Now, IRS just says what you can take (and it is a lot in the first years)

Copyright © 2007 Prentice-Hall. All rights reserved 32 2: Multiply beginning book value by rate Depreciation expense = Double-declining- balance rate × Beginning period book value Double-Declining-Balance Method 1: Compute straight-line rate and multiply it by 2 Ignores residual value 1 Useful life in years X 2

Copyright © 2007 Prentice-Hall. All rights reserved 33 Switchover to Straight Line A method employed by some companies Change from double-declining balance to straight-line during the next-to-last year of asset’s life Eliminates the need to use a plug figure for depreciation expense in last year

Copyright © 2007 Prentice-Hall. All rights reserved 34 E9-19E9-19 Double declining Balance: Life = 4 years Rate = 2 * 1/4 or 50% Year Depr Exp for Year 20x6 20x7 20x8 20x9 $30,000 x 50% $15,00 x 50% 750 $15,000 7,500 ($7,500 – 6,000)/2

Copyright © 2007 Prentice-Hall. All rights reserved 35 E9-19E9-19 Double declining Balance: Cost = $30,000, Life = 4 years Rate = 2 * 1/4 or 50% Year Depr Exp for Year Total Accum Depr Year-End Book Value 20x6 20x7 20x8 20x9 $30,000 x 50% $15,000 $15,00 x 50% 22,500 23,250 24,000 $15,000 7,500 6,750 6, $15,000 7,500 ($7,500 – 6,000)/2 750

Copyright © 2007 Prentice-Hall. All rights reserved 36 Use of Depreciation Methods

Copyright © 2007 Prentice-Hall. All rights reserved 37 Partial Year Depreciation When plant asset is acquired during the year, compute full year’s depreciation and multiply that by the fraction of the year the asset is owned

Copyright © 2007 Prentice-Hall. All rights reserved 38 Revising Depreciation Depreciation is an estimate –Estimated residual value –Estimated useful life Remaining life in years Book valueNew residual value –

Copyright © 2007 Prentice-Hall. All rights reserved 39 E9-20E9-20 Cost$700,000 Residual value100,000 Depreciable base$600,000 /40 years Depreciation expense per year$15,000

Copyright © 2007 Prentice-Hall. All rights reserved 40 E9-20E9-20 Depreciation expense per year$15,000 X 15 years Accumulated depreciation after 15 years$225,000

Copyright © 2007 Prentice-Hall. All rights reserved 41 E9-20E9-20 Book value after 15 years Cost$700,000 Accumulated depreciation(225,000) Cost left to depreciate$475,000 Residual value (Changed)(175,000) New depreciable base$300,000 Life (30 years – 15 years taken)/15 year New depreciation per year$20,000

Copyright © 2007 Prentice-Hall. All rights reserved 42 E9-20E9-20 GENERAL JOURNAL DATEDESCRIPTIONREFDEBITCREDIT Yr 15Depreciation Expense15,000 Accumulated Depreciation15,000 Yr16Depreciation Expense20,000 Accumulated Depreciation20,000

Copyright © 2007 Prentice-Hall. All rights reserved 43 Fully Depreciated Assets If still useful, a company will continue to use it Report book value on balance sheet Record no more depreciation

Copyright © 2007 Prentice-Hall. All rights reserved 44 Depreciation for Tax Reporting Modified Accelerated Cost Recovery System (MACRS) Assets are classified into categories by asset life Depreciation method is specified according to category