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18-2 Property, Plant, and Equipment Section 1: Acquisition and Depreciation Chapter 18 Section Objectives 1.Determine the amount to record as an asset’s cost. 2.Compute and record depreciation of property, plant, and equipment by commonly used methods. 3.Apply the Modified Accelerated Cost Recovery System (MACRS) classes for federal income tax purposes.

18-3 Cost of Tangible Personal Property Gross purchase price less discounts Transportation costs Installation costs Costs of adjustments or modifications needed to prepare the asset for use Cost of Real Property Purchase price Legal costs Other costs related to the acquisition

18-4  Long term assets, like buildings, machinery, equipment, furniture, and fixtures are depreciated because they have a limited life and get used up over time.  Depreciation refers to the loss of usefulness, and not necessarily to a decrease in the market value.  The account depreciation expense is debited, and the account accumulated depreciation is credited to record the depreciation for a period. Depreciation

18-5 Depreciation Methods Straight-Line Declining-Balance Sum-of-the-Years’-Digits Units-of-Output

18-6 Straight-Line Method Formula: Depreciation = Cost – Salvage Value Estimated Useful Life The same dollar amount of depreciation is taken each year as an expense.

18-7 Declining-Balance Method The book value of an asset at the beginning of the year is multiplied by a percentage to determine depreciation for the year. This is an accelerated method of depreciation. This method ignores salvage value.

18-8 Sum-of-the-Years’-Digits Method This is an accelerated depreciation method. The denominator is sum of the useful life years added together. (If the useful life is 5 years, then denominator is 15 ( ). The numerator is the number of years remaining in the useful life of the asset. Year 1: The fraction is 5/15. Year 2: The fraction is 4/15. Year 5: The fraction is 1/15. The fraction is multiplied by the acquisition cost less the net salvage value.

18-9 Units-of-Output Method Calculates depreciation at the same rate for each unit produced. Unit of production can be measured by: Physical quantities of production. Number of hours the asset is used. Other measures.

18-10 Depreciation for Federal Income Tax Purposes A different set of rules is used for depreciation for income tax purposes. MACRS = Modified Accelerated Cost Recovery System “Cost Recovery” refers to the amount of depreciation expense used in computing taxable income Apply the Modified Accelerated Cost Recovery System (MACRS) for federal income tax purposes Objective 3

18-11 Adjustments and the Worksheet Section 2: Disposition of Assets Chapter 18 Section Objectives 4.Record sales of plant and equipment. 5. Record asset trade-ins using financial accounting rules and income tax requirements.

18-12 Businesses routinely sell or dispose of plant assets that are no longer useful to the business. When assets are disposed of, the business often incurs a gain or loss. Proceeds – Book Value = Gain or loss Methods of Disposition

18-13 Methods of Disposition Scrapping or discarding Sale Trade-in for a similar asset

18-14 Disposal by Sale Step 1.Record depreciation to the date of disposition. Step 2.Remove the cost of the asset. Step 3.Remove the accumulated depreciation. Step 4.Record the proceeds. Step 5.Determine and record the gain or loss, if any. Record sales of plant and equipment Objective 4

18-15 Disposal by Trade-In Step 1.Record the depreciation up to the date of trade-in. Step 2.Record the trade-in of the old asset and the purchase of the new asset. Use either: the financial accounting rules, or the income tax rules. Disposing of Fixed Assets by Exchange

18-16 Applying the Financial Accounting Rules if there is a loss on the trade-in: Step 1.Remove the cost of the old asset. Step 2.Remove the accumulated depreciation for the old asset. Step 3.Record the payment. Step 4.Record the new asset at its fair market value. Step 5.Determine and record the loss.

18-17 Gain: (Trade in > Book Value of old) Gain not recognized!! New asset’s recorded cost: Book value of old asset + Cash Payment = Recorded cost of new asset Loss: (Trade in < Book Value of old) Recognize loss in Loss on Trade-in of Plant Asset Financial Accounting Rules

18-18 Income Tax Method Step 1.Remove the cost of the old asset. Step 2.Remove the accumulated depreciation for the old asset. Step 3.Record the payment. Step 4.Determine and record the cost of the new asset.

18-19 Gain: Not recognized. A gain simply reduces the new asset’s cost. Loss: Not recognized. A loss simply increases the tax basis (historical cost for tax purposes). Income Tax Method

18-20 Recall that conservatism requires that the method that is least likely to overstate income should be used. Income Tax Method Therefore, under GAAP, a loss must be recorded. However, some argue that the income tax method is acceptable (no loss recorded) if the loss is not material.

18-21 Property, Plant, and Equipment Section 3: Special Topics in Long-Term Assets Chapter 18 Section Objectives 6.Compute and record depletion of natural resources. 7.Recognize asset impairment and understand the general concepts of accounting for impairment. 8.Compute and record amortization of intangible assets.

18-22 Depletion matches an asset’s costs with the benefits derived from its use Natural Resources: Iron ore Oil Gold Coal Compute and record depletion of natural resources Types of Depletion Depletion for Financial Statement Purposes Depletion for Federal Income Tax Purposes Objective 6

18-23 Impairment of Property, Plant, and Equipment Three steps are used to determine whether an asset is impaired Step 1. Review circumstances that suggest impairment may have occurred Step 2. Apply the recoverability test Step 3. Compute the amount of the impairment Recognize asset impairment and understand the general concepts of accounting for impairment Objective 7

18-24 Types of Intangible Assets Patent Copyright Franchises Trademarks, trade names, brand names Computer software Goodwill Compute and record amortization of intangible assets Objective 8

18-25 Internal Control of Property, Plant, and Equipment Authorize and justify the purchase of assets. Assign identification number to each asset. Maintain an asset register listing. Assign responsibility for safekeeping, maintaining, and operating each asset to a specific person. Take a physical inventory count periodically. Establish procedures to authorize asset retirement, sale, or other disposition.