Accounting for Long-Term Operational Assets Chapter 6 Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

6-2 Learning Objective 1 Identify different types of long- term operational assets.

6-3 Tangible versus Intangible Assets Tangible assets have a physical presence; they can be seen and touched. Intangible assets are rights or privileges. They cannot be seen or touched.

6-4 Tangible Long-Term Assets 1.Property, Plant, and Equipment 1.Property, Plant, and Equipment – Sometimes called plant assets or fixed assets. We depreciate these assets over their useful life. 2.Natural Resources 2.Natural Resources – Mineral deposits, oil and gas reserves, timber stands, coal mines, and stone quarries are some examples of natural resources. We deplete these assets over their useful life. 3.Land 3.Land – Has an infinite life and is not subject to depreciation.

6-5 Intangible Assets 1.Intangible Assets with Identifiable Useful Lives 1.Intangible Assets with Identifiable Useful Lives – These intangibles include patents and copyrights. We amortize the cost of each over its useful life. 2.Intangible Assets with Indefinite Useful Lives 2.Intangible Assets with Indefinite Useful Lives - These intangibles include renewable franchises, trademarks, and goodwill. The cost of these assets is not expensed unless it can be shown that there has been an impairment in value.

6-6 Learning Objective 2 Determine the cost of long-term operational assets.

6-7 Cost of Long-Term Assets Buildings – Purchase price, Sales taxes, Title search and transfer document costs, Realtor’s and attorney’s fees, and Remodeling costs. Buildings – Purchase price, Sales taxes, Title search and transfer document costs, Realtor’s and attorney’s fees, and Remodeling costs. Equipment – Purchase price (less discounts), Sales taxes, Delivery costs, Installation costs, and.Costs to adapt to intended use. Equipment – Purchase price (less discounts), Sales taxes, Delivery costs, Installation costs, and.Costs to adapt to intended use.

6-8 Cost of Long-Term Assets Land – Purchase price, Sales taxes, Title search and transfer document costs, Realtor’s and attorney’s fees, Costs of removal of old buildings, and Grading costs. Land – Purchase price, Sales taxes, Title search and transfer document costs, Realtor’s and attorney’s fees, Costs of removal of old buildings, and Grading costs.

6-9 Basket Purchase Allocation Beatty Company paid $240,000 for land and a building. An independent appraiser provided these fair value estimates: land $90,000, and building $270,000. The $240,000 cost paid is separately assigned based on % of total fair value.

6-10 Basket Purchase Allocation The land and building that Beatty Company are assigned their own allocation of the $240,000 paid based on the individual % of total fair value. The “Allocation” is the amount recorded in the accounting records.

6-11 Learning Objective 3 Explain how different depreciation methods affect financial statements.

6-12 Life Cycle of Operational Assets Acquire Funding Buy Asset Use Asset Retire Asset

6-13 Depreciation Method 1.Straight-line method - the same amount of depreciation is taken each accounting period. 2.Double-declining-balance – produces more depreciation expense in the early years of an asset’s life, with a declining amount of expense in later years. 3.Units-of-Production – produces varying amounts of depreciation in different accounting periods depending upon the number of units produced. 1.Straight-line method - the same amount of depreciation is taken each accounting period. 2.Double-declining-balance – produces more depreciation expense in the early years of an asset’s life, with a declining amount of expense in later years. 3.Units-of-Production – produces varying amounts of depreciation in different accounting periods depending upon the number of units produced.

6-14 Asset to be Depreciated The van has a salvage value of $4,000, and an estimated useful life of four years.

6-15 Straight-Line Depreciation Life Cycle Phase 1 Acquire $25,000 cash from the sale of common stock to purchase the van.

6-16 Straight-Line Depreciation Life Cycle Phase 2 Purchase the van on January 1, 2010, for a net cost of $24,000. = Cash + Van - Acc. Dep. = Com. Stk. + Ret. Earn.Rev.-Exp.= Net Income Cash Flow (24,000) + 24,000 - n/a = + - = 24,000 IA AssetsEquity

6-17 Straight-Line Depreciation Life Cycle Phase 3 Use the van to generate $8,000 revenue for the period. (Asset Cost – Salvage Value) ÷ Useful Life ($24,000 – $4,000) ÷ 4 = $5,000 depreciation Depreciation expense calculated under straight-line is determined as followed:

6-18 Learning Objective 4 Determine how gains and losses on disposals of long-term operational assets affect financial statements.

6-19 Straight-Line Depreciation Life Cycle Phase 4 On January 1, 2014, the van is sold for $4,500 cash.

6-20

6-21 Double-Declining-Balance Method The double-declining-balance method is called an accelerated depreciation method because more depreciation expense is recorded in the early years than in later years. Determining the amount of depreciation expense in any year is the result of a three-step process. 1.Determine the straight-line rate of depreciation. 2.Multiply the straight-line rate times two. 3.Multiply the double-declining rate by the book value of the asset at the beginning of the period. (Book value = Cost minus Accumulated Depreciation.) 1.Determine the straight-line rate of depreciation. 2.Multiply the straight-line rate times two. 3.Multiply the double-declining rate by the book value of the asset at the beginning of the period. (Book value = Cost minus Accumulated Depreciation.)

6-22 Double-Declining-Balance Method The 2012 Expense cannot be $3,000 and 2013 expense is $0. This is because only $20,000 in total depreciation is allowed for this van. (1 ÷ 4) = (25% straight-line rate × 2) = 50% Year Book Value at Beginning of Year Double the Straight-Line Rate Annual Depreciation Expense 2010($24,000 – $ 0)50%12,000$ 2011($24,000 – $12,000)50%6, ($24,000 – $18,000)50%2, ($24,000 - $20,000)50%0 20,000$

6-23

6-24 Units-of-Production Depreciation Cost – Salvage value Total estimated units of production = Depreciation charge per unit of production × Units of production in current accounting period = Annual Depreciation Expense

6-25 Units-of-Production Depreciation Here is the depreciation charge per mile driven in our van: $24,000 – $4, ,000 miles =$0.20 per mile Here is the calculation of depreciation expense based on miles driven: Year Depreciation Charge Per Mile Miles Driven Depreciation Expense $ ×40,000 =8,000$ ×20,000 =4, ×30,000 =6, ($20,000-$18,000)15,000 2, ,000 20,000$

6-26

6-27 Comparison of Methods

6-28 Learning Objective 5 Show how revising estimates affects financial statements.

6-29 Revision of Estimates Estimates are frequently revised when new information surfaces. Assume we purchased equipment on January 1, 2012, for $50,000 cash and estimated salvage value was $3,000. The equipment has an estimated useful life of eight years, and the company uses straight-line depreciation. ($50,000 – $3,000) ÷ 8 = $5,875 depreciation per year On January 1, 2016, after four years of depreciation, it was determined that the machine has a remaining useful life of ten more years for a total estimated useful life of fourteen years.

6-30 Revision of Life Estimates Year Annual Depreciation Accumulated Depreciation Book Value 20125,875$ $ 44,125$ 20135,875 11,750 38, ,875 17,625 32, ,875 23,500 26, We determine the remaining annual depreciation like this: $26,500 – $3,000 = $23,500 ÷ 10 years = $2,350 per year for years 2016 through 2025 Year Annual Depreciation Accumulated Depreciation Book Value 20125,875$ $ 44,125$ 20135,875 11,750 38, ,875 17,625 32, ,875 23,500 26, ,350 25,850 24,150

6-31 Revision of Salvage Estimates We determine the remaining annual depreciation like this: $26,500 – $6,000 = $20,500 ÷ 4 years = $5,125 per year Year Annual Depreciation Accumulated Depreciation Book Value 20125,875$ $ 44,125$ 20135,875 11,750 38, ,875 17,625 32, ,875 23,500 26, ,125 28,625 21, ,125 33,750 16, ,125 38,875 11, ,125 44,000 6,000 Year Annual Depreciation Accumulated Depreciation Book Value 20125,875$ $ 44,125$ 20135,875 11,750 38, ,875 17,625 32, ,875 23,500 26,

6-32 Learning Objective 6 Explain how continuing expenditures for operational assets affect financial statements.

6-33 Continuing Expenditures for Plant Assets Costs that Are Expensed The cost of routine maintenance and minor repairs that are incurred to keep an asset in good working order are expensed as incurred. Assume McGraw spent $500 cash for routine lubrication and minor parts on machinery.

6-34 Continuing Expenditures for Plant Assets Costs that Are Capitalized Expenditures that improve the quality of an asset are capitalized as part of the cost of that asset. Assume McGraw spent $4,000 cash for a major overhaul of equipment to improve efficiency.

6-35 Continuing Expenditures for Plant Assets Costs that Extend the Life of an Asset The amount of the expenditure should reduce the balance in the accumulated depreciation account. Assume McGraw spent $4,000 cash for improvements that extended the life of machine two years.

6-36 Learning Objective 7 Explain how expense recognition for natural resources (depletion) affects financial statements.

6-37 Natural Resources Cost – Salvage value Total estimated units recoverable = Depletion charge per unit of resource × Number of units extracted and sold this period = Periodic Depletion Expense

6-38 Natural Resources Apex Coal Mining paid $4,000,000 cash to purchase land that is expected to yield 16,000,000 tons of coal. After all coal is extracted the land is not expected to have any salvage value. In the first year, the company extracted and sold 360,000 tons of coal. $4,000,000 – $0 16,000,000 tons =$0.25 per ton extracted and sold 360,000 tons extracted and soldX$0.25 = $90,000 The calculation for first year’s depletion is:

6-39 Learning Objective 8 Explain how expense recognition for intangible assets (amortization) affects financial statements.

6-40 Intangible Assets Trademarks A name or symbol that identifies a company or a product. The cost of a trademark may include design, purchase, or defense of the trademark. Patents The exclusive legal right to produce and sell a product that has one or more unique features. The legal life of a patent is 20 years.

6-41 Intangible Assets Copyrights Protection of writings, musical composition, work of art, or other intellectual property. The protection extends for the life of the creator plus 70 years. Franchise The exclusive right to sell products or perform services in certain geographic areas.

6-42 Intangible Assets Goodwill The excess of cost over fair value of net tangible assets acquired in a business acquisition. Assets280,000$ Liabilities50,000$ Stockholders' Equity230,000 Total280,000$ Seller Company Balance Sheet At December 31, 20XX Net Assets are equal to Assets minus Liabilities Seller Company has Net Assets = $230,000

6-43 Goodwill Your company is willing to pay $350,000 ($300,000 cash and assumption of $50,000 liabilities) to acquire Seller Company. Assets280,000$ Liabilities50,000$ Stockholders' Equity230,000 Total280,000$ Seller Company Balance Sheet At December 31, 20XX

6-44 Expensing Intangible Assets An asset with an identifiable useful life is amortized using the straight-line method over the shorter of the intangible’s legal life or its useful life. Assume we purchased a patent that has a 20-year legal life but only an 11-year useful life for $44,000 cash. Annual amortization expense = $44,000 / 11 = $4,000

6-45 Impairment of Intangible Asset Intangible assets with indefinite useful lives must be tested for impairment annually. If the fair value of the intangible asset is less than its book value, an impairment loss is recognized. Assume that the asset goodwill is determined to be impaired and a decline in value of $30,000, The effects on the financial statements would be:

6-46 Balance Sheet Presentation

6-47 Learning Objective 9 Explain how expense recognition choices and industry characteristics affect financial performance.

6-48 Effect of Judgment and Estimates Assume that Alpha Company uses straight-line depreciation and Zeta Company uses double-declining- balance method. Let’s look at their partial financial statements.

6-49 Effect of Judgment and Estimates Assume that Alpha Company uses straight-line depreciation and Zeta Company uses double-declining- balance method. Let’s look at their partial financial statements.

6-50 Effect of Industry Characteristics Does this mean that management of Kelly Services is doing a better job than the management of Cox Communications or United Airlines? Not necessarily, because they operate in different economic environments.

6-51 End of Chapter Six