1. Accounting for Long-Term Operational Assets
Chapter Eight
Accounting for Long-Term Operational Assets
In Chapter Eight we will examine the acquisition of long-term operational assets including intangible assets. We will learn three different methods of depreciating long-term assets and how to amortize the cost of intangible assets. Finally, we will look at accounting for natural resources and the related depletion of these assets. This will be a busy chapter.

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

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.
We can distinguish between tangible and intangible assets by our ability to see and feel tangible assets. Intangible assets normally represent rights or privileges and are difficult to evaluate.

4. Tangible Long-Term Assets
Property, Plant, and Equipment – Sometimes called plant assets or fixed assets. We depreciate these assets over their useful life.
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.
Land – Has an infinite life and is not subject to depreciation.
Part One Property, plant, and equipment is sometimes called fixed assets or plant assets. Once we acquire a fixed asset we depreciate its cost over its estimated useful life. Depreciation is a systematic and rational method of allocating the cost of an asset over the periods benefited by the use of the asset. Depreciation is a cost allocation scheme and has nothing to do with market value of the asset.
Part Two Natural resources are usable assets provided by nature. Examples include oil and gas and coal deposits. The process of allocating cost of a natural resource is call depletion. The concept is very similar to depreciation, but refers to the treatment of natural resources.
Part Three Land is a productive asset but it has an infinite life and is not subject to depreciation.

5. Intangible Assets
Intangible Assets with Identifiable Useful Lives – These intangibles include patents and copyrights. We amortize the cost of each over its useful life.
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.
Part One Intangible assets are divided into two broad categories: those with identifiable useful lives and those that have indefinite useful lives. Examples of intangible assets with identifiable useful lives include patents and copyrights. These intangible assets are amortized over their useful lives.
Part Two Intangible assets with a indefinite lives include renewable franchises, trademarks or logos, and goodwill. The cost of these assets is adjusted only if the value of the asset is impaired.

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

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.
Equipment –
Purchase price (less discounts),
Sales taxes,
Delivery costs,
Installation costs, and
Costs to adapt to intended use.
The cost of buildings include not only the purchase price but also any sales taxes that must be paid, the costs incurred to secure the title, any realtor’s or attorney’s fees prior to purchase, and remodeling costs.
The cost of equipment includes its net purchase price plus any sales taxes that apply. In addition, delivery and installation costs are part of the cost of the equipment. Finally, the cost to get the equipment ready for its intended use is included in its cost.

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 includes many of the costs we have discussed for other productive assets. In addition, the costs incurred to remove, or raze, any old structures are included in the cost of the land. Grading and land preparation are considered part of the cost of the land.

9. Basket Purchase Allocation
Beatty Company purchased land and a building for $240,000 cash. An independent appraiser estimated that the land has a fair market value of $90,000, and the building has a fair market value of $270,000. How will we assign the $240,000 cost between the land and building?
Part One
Let’s assume that Beatty Company purchases land and a building. We know the building is depreciated but land is not depreciated, so we must separate out the cost of this basket purchase. The company hires an independent appraiser to determine the fair market value of the land without the building and the building without all the adjoining land.
Part Two Based upon the appraisal, Beatty Company has determined that seventy-five percent of the cost should be assigned to the building and the remaining twenty-five percent should be assigned to the land. We are allocating cost on the basis of relative fair market value.
Part Three Given this information, we will assign one hundred eighty thousand dollars to the building and the remaining sixty thousand dollars is assigned to the land.

10. Life Cycle of Operational Assets
Acquire Funding
Buy Asset
Retire Asset
The life cycle of any operational asset begins with acquiring the funds necessary to purchase that asset. Next, we purchase the asset -- being sure we include all appropriate costs in the cost of the asset. After acquisition, we use the asset and begin the process of depreciating it. Finally, for any number of reasons, we may elect to retire the asset. The cycle starts all over again.
Use Asset

11. Learning Objective 3
Explain how different depreciation methods affect financial statements.
Learning Objective Three:
Explain how different depreciation methods affect financial statements.

12. Depreciation Method
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.
Straight-line method - the same amount of depreciation is taken each accounting period.
Units-of-Production – produces varying amounts of depreciation in different accounting periods depending upon the number of units produced.
Part One We have three methods of calculating depreciation expense of long-term, tangible assets. The first method is known as the straight-line method. Using this method produces the same amount of depreciation each period we use the asset. This is probably the most popular method in business practice today.
Part Two The next method is known as the double-declining balance method. Using this method produces greater depreciation expense early in the asset’s life and less depreciation in later years of the asset’s life.
Part Three The final method is known as the units-of-production method. The amount of depreciation expense recognized in any given accounting period depends upon the number of units produced by the asset.

13. Asset to be Depreciated
We will use this example van purchase to demonstrate all three methods of depreciation. The van has a net cost to the company of twenty-four thousand dollars. It has a useful life of four years and an estimated salvage value at the end of its useful life of four thousand dollars. Let’s start with the first phase in the operational asset cycle: acquiring sufficient funds to purchase the van.
The van has a salvage value of $4,000, and an estimated useful life of four years.

14. Straight-Line Depreciation
Life Cycle Phase 1 Acquire $25,000 cash from the sale of common stock to purchase the van.
Part One The company elects to issue twenty-five thousand dollars of common stock and use the proceeds to purchase the van.
Part Two This transaction increases our cash account and our common stock account. On the statement of cash flows we show an inflow from the issuance of the common stock. There is no income statement impact of this transaction.

15. Straight-Line Depreciation
Life Cycle Phase 2 Purchase the van on January 1, 2005, for a net cost of $24,000.
Part One On January 1st, 2005, the company purchases the van for its net cost of twenty-four thousand dollars.
Part Two Our cash account decreases by twenty-four thousand dollars while the van account, also an asset, increases by the same amount. On the statement of cash flows, the investing activities section shows a cash outflow for the purchase of the van.

16. Straight-Line Depreciation
Life Cycle Phase 3 Use the van to generate $8,000 revenue for the period. Depreciation expense calculated under straight-line is determined as follows:
(Asset Cost – Salvage Value) ÷ Useful Life
($24,000 – $4,000) ÷ 4 = $5,000 depreciation
Part One In the third phase of the cycle we put the van to use producing revenue. During the year the van helps produce eight thousand dollars in revenue. When we placed the van in service, we began the depreciation.
Part Two Under straight-line depreciation we calculate the periodic depreciation expense by subtracting the asset’s salvage value from its cost and dividing the total by the estimated useful life.
Part Three In our case the annual deprecation is five thousand dollars as shown in the calculation.
Part Four
As the van helps produce revenue, income increases and so does the equity section of the balance sheet. In addition, we have an increase in the cash account and a cash inflow from customers in the operating section of the statement of cash flows. We record the depreciation expense which reduces income and the equity section of the balance sheet. There is no cash flow impact of recording depreciation expense.

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

18. Straight-Line Depreciation
Life Cycle Phase 4 On January 1, 2009, the van is sold for $4,500 cash.
Part One At the end of the asset’s useful life we determine its book value as cost minus accumulated depreciation. In our case the book value is four thousand dollars. We are able to sell the van for four thousand five hundred dollars cash, so we recognize a gain of five hundred dollars.
Part Two The cash account increases by four thousand five hundred dollars, and we remove the van and related accumulated deprecation from our books. The five hundred dollar gain increases income and the equity section of the balance sheet. In the investing activities section of the statement of cash flows, we show an inflow from the sale of an asset of four thousand five hundred dollars.

19. Straight-Line Depreciation Journal Entries
Part One Let’s look at the journal entries for straight-line depreciation from the beginning to the end of the cycle. First we issued stock and recorded a debit to cash and credit to common stock for twenty five thousand dollars.
Part Two Next, we purchased the van with a debit to the van account and credit to cash for twenty-four thousand dollars.
Part Three
In each of the next four years the van helped the company reach revenue of eight thousand dollars. The journal entry each year is to debit cash and credit revenue for eight thousand dollars.
Part Four
In each of the next four years we will record depreciation of five thousand dollars. The entry is to debit depreciation expense and credit accumulated depreciation for five thousand dollars.
Part Five Finally, at the end of the van’s useful life, we sell it for four thousand five hundred dollars. The journal entry is to debit cash for four thousand five hundred dollars, debit accumulated depreciation for twenty thousand dollars, remove the van with a credit of twenty-four thousand dollars, and credit gain on sale of van for five hundred dollars.

20. Financial Statements under Straight-Line Depreciation
Part One Notice the uniform charge for deprecation expense during each year of the asset’s useful life.
Part Two Accumulated depreciation grows by five thousand dollars each year. At the end of four years, the book value of the van is four thousand dollars.
Part Three There is no cash flow impact of recording depreciation expense. Depreciation expense is referred to as a non-cash charge to income.

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.
Determine the straight-line rate of depreciation.
Multiply the straight-line rate times two.
Multiply the double-declining rate by the book value of the asset at the beginning of the period.
Determining depreciation expense under the double-declining-balance method is a three-step process.
First we calculate the straight-line rate of depreciation. We do this by dividing the useful life into one.
Next, we multiply the straight-line rate times two to get the double-declining balance rate.
Finally, we multiply the double-declining rate of deprecation times the book value of the asset. Remember, book value is cost less accumulated deprecation. We ignore salvage value in our computation.

22. Double-Declining-Balance Method
Let’s see how double-declining-balance depreciation works on our van.
(1 ÷ 4) = (25% straight-line rate × 2) = 50%
Part One
Let’s calculate depreciation expense under the double-declining-balance method.
Part Two Here we combine the first two steps. We determine the straight-line rate of depreciation by dividing four into one and getting twenty-five percent. Next, we multiply the straight-line rate by two and get the double-declining rate of fifty percent.
Part Three In our table we multiply the double-declining rate by the book value of the asset. In the first year there is no accumulated deprecation (so depreciation expense is equal to twenty-four thousand dollars), by fifty percent and get deprecation of twelve thousand dollars. Notice that at the end of the asset’s useful life we have over-depreciated its cost less salvage value. The maximum depreciation we can take is twenty thousand dollars.
Part Two Under double-declining-balance depreciation we must adjust the later years to make depreciation equal a total of twenty thousand dollars. With an asset cost of twenty thousand dollars and accumulated depreciation of twenty thousand dollars, the book value is four thousand dollars which we know is correct. The schedule on your screen shows the necessary adjustment to depreciation expense.

23. Financial Statements under Double-Declining-Balance Depreciation
Part One Notice the decreasing charge for deprecation expense during each year of the asset’s useful life.
Part Two Accumulated depreciation grows each year. At the end of four years, the book value of the van is four thousand dollars.
Part Three There is no cash flow impact of recording depreciation expense. Depreciation expense is referred to as a non-cash charge to income.

24. Units-of-Production Depreciation
Cost – Salvage value Total estimated units of production =
Depreciation charge per unit of production
Depreciation charge per unit of production ×
Units of production in current accounting period =
Periodic Depreciation Expense
Part One Under the units-of-production method of deprecation we first calculate the depreciation charge per unit of production. To do this we divide cost less salvage value by the total estimated units of production.
Part Two To calculate the depreciation expense for the period, we multiply the depreciation charge per unit of production by the number of units actually produced during the accounting period.

25. Units-of-Production Depreciation
Here is the depreciation charge per mile driven in our van:
$24,000 – $4,000
100,000 miles =
$0.20 per mile
Here is the calculation of depreciation expense based on miles driven:
Part One We expect our van to last for one hundred thousand miles. The depreciation charge per mile driven is twenty cents.
Part Two In this table we show the actual miles driven each of the four years. In 2005, we multiply the twenty cent rate times the forty thousand miles actually driven to get total depreciation expense of eight thousand dollars.
As pointed out in our discussion of the double-declining balance method, an asset cannot be depreciated below its salvage value. Thus only two thousand dollars remains to be charged to depreciation in the fourth year.

26. Financial Statements under Units-of-Production Depreciation
Part One Notice the varying charge for deprecation expense during each year of the asset’s useful life.
Part Two Accumulated depreciation grows each year. At the end of four years, the book value of the van is four thousand dollars.
Part Three There is no cash flow impact of recording depreciation expense. Depreciation expense is referred to as a non-cash charge to income.

27. Graph of Depreciation Expense
Here is a graph of the depreciation expense in each year under all three methods of depreciation. The total amount of depreciation expense recognized using each of the three methods is twenty thousand dollars. The different methods affect the timing, but not the total amount, of expense recognized. A company should use the method that most closely matches expenses with revenues.

28. Learning Objective 5
Identify some of the tax issues which affect long-term operational assets.
Learning Objective Five:
Identify some of the tax issues which affect long-term operational assets.

29. Income Tax Considerations
The maximum depreciation currently allowed by tax law is computed using the modified accelerated cost recovery system (MACRS). The rate of depreciation depends on the class life of the asset and the period in which we are calculating depreciation. There are currently six categories for property, excluding real estate. They are 3-year, 5-year, 7-year, 10-year, 15-year, and 20-year property.
When companies file their tax returns, most elect to use the modified accelerated cost recovery system or MAKERS. Assets are placed into a class life that determines the amount of deprecation expense allowed on the tax return. The tax depreciation system uses what is known as the half-year convention. The company takes one-half year’s depreciation in the first and last year of its class life. Thus, it takes six years to fully depreciate a five-year class life asset. Let’s look more closely at tax deprecation.

30. Income Tax Considerations
Here are the tax rates for 5-year and 7-year property:
Part One
Here are the schedules for five-year and seven-year class life property. For five-year property, you are permitted to take twenty percent of the cost of the asset as depreciation in the first year. Notice that under the tax laws we depreciate one hundred percent of the cost of the asset.
Part Two Assume our van is classified as a five-year class life asset. Let’s calculate depreciation expense.
Let’s assume our van is classified as 5-year property and calculate depreciation for our tax return.

31. Income Tax Considerations
Let’s assume our van is classified as 5-year property and calculate depreciation for our tax return.
We take the rate from the proper table and multiply it times the cost of the asset. Notice that we are allowed to depreciate the full cost of the asset even though it may have an estimated salvage value at the end of its useful life.

32. Learning Objective 6
Show how revising estimates affects financial statements.
Learning Objective Six:
Show how revising estimates affects financial statements.

33. Revision of Estimates
Estimates are frequently revised when new information surfaces. Assume we purchased equipment on January 1, 2003, 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
Part One Depreciation is based on several estimates. It is not uncommon to learn new information about the asset that necessitates a revision to depreciation. Here is an asset that has an eight-year life and the company uses the straight-line method. Depreciation expense is five thousand eight hundred seventy-five dollars per year.
Part Two On January 1st, 2007, four years after we began to depreciate the asset, we learn that the machine has a remaining useful life of ten more years. If all the facts had been known at the date of acquisition, we would have used a fourteen-year useful life. Let’s see how we handle this revision.
On January 1, 2007, after four years of depreciation, it was determined that the machine has a remaining useful life of 10 more years for a total estimated useful life of 14 years.

34. Revision of Life Estimates
We determine the remaining annual depreciation like this:
$26,500 – $3,000 = $23,500 ÷ 10 years = $2,350 per year
Part One Up to the date of learning the new information, we had recorded twenty-three thousand five hundred dollars of depreciation expense. The book value of the asset is twenty-six thousand five hundred dollars.
Part Two
We calculate the new depreciation expense by taking the book value of twenty-six thousand five hundred dollars and subtracting the salvage value, then dividing by the remaining useful life of ten years. This produces depreciation expense of two thousand three hundred fifty dollars per year for the next ten years.
Part Three You can see that if we record two thousand three hundred fifty dollars in the last ten years, the book value of the asset will equal salvage value at the end of the asset’s useful life. Once again, revisions of estimates are very common in business.

35. Revision of Salvage Estimates
We determine the remaining annual depreciation like this:
$26,500 – $6,000 = $20,500 ÷ 4 years = $5,125 per year
Part One Up to the date of learning the new information, we had recorded twenty-three thousand five hundred dollars of depreciation expense. The book value of the asset is twenty-six thousand five hundred dollars.
Part Two
We calculate the new depreciation expense by taking the book value of twenty-six thousand five hundred dollars, subtracting the new six thousand dollar salvage value, then dividing by the remaining useful life of four years. This produces depreciation expense of five thousand one hundred twenty-five dollars per year for the remaining four years.
Part Three You can see that if we record five thousand one hundred twenty-five dollars in the last four years, the book value of the asset will equal the new salvage value at the end of the asset’s useful life. Once again, revisions of estimates are very common in business.

36. Learning Objective 7
Explain how continuing expenditures for operational assets affect financial statements.
Learning Objective Seven:
Explain how continuing expenditures for operational assets affect financial statements.

37. 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.
Part One The cost of routine maintenance and minor repairs are charged to expense as incurred.
Part Two Assume McGraw spent five hundred dollars cash for routine maintenance on a piece of machinery it uses in the production process. The five hundred dollar expense reduces income and stockholders’ equity and our cash account. The expenditure represents a cash outflow in the operating activities section of the statement of cash flows.
Part Three The proper journal entry is to debit, or increase, maintenance expense and credit, or decrease, cash by five hundred dollars.

38. 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 overall of equipment to improve efficiency.
Part One Expenditures on long-term assets that improve the quality of the asset are not charged to expense but rather to the cost of the asset. These expenditures increase the cost basis of the asset.
Part Two McGraw spent four thousand dollars cash for a major overall that dramatically improved the efficiency of a piece of machinery it owns. The cash account decreases, and the machine account increases by four thousand dollars. We show a cash outflow for the additional investment in the machine in the investing activities section of the statement of cash flows
Part Three The journal entry to record the expenditure is to debit, or increase, the machine account and credit, or reduce, the cash account by four thousand dollars.

39. 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.
Part One Still other types of expenditures on productive assets extend their useful lives. These expenditures are shown as a reduction in accumulated depreciation which, in effect, increases the book value of the assets.
Part Two McGraw spends four thousand dollars to extend the life of a piece of equipment it owns. Our cash account goes down and we reduce the balance in accumulated depreciation by four thousand dollars. The investing activities section of the statement of cash flows shows an outflow of four thousand dollars for the expenditure.
Part Three McGraw prepares a journal entry to debit, or reduce, accumulated depreciation on the equipment and credit, or reduce, cash for four thousand dollars.
Note: Depreciation expense must also be revised due to the change in the years of useful life.

40. Learning Objective 8
Explain how expense recognition for natural resources (depletion) affects financial statements.
Learning Objective Eight:
Explain how expense recognition for natural resources (depletion) affects financial statements.

41. Cost – Salvage value Total estimated units recoverable
Natural Resources
Cost – Salvage value Total estimated units recoverable =
Depletion charge per unit of resource
Depletion charge per unit of resource ×
Number of units extracted and sold this period =
Periodic Depletion Expense
Part One We deplete, rather than depreciate, the cost of natural resources owned. The method used is similar to the units-of-production method of depreciation. First, we calculate the depletion charge per unit of resource by dividing cost less salvage value by the total estimated units recoverable. If we are developing a coal mine, the estimate would be the estimated total tons of coal to be recovered on the site.
Part Two To determine the depletion expense for the period, we multiply the depletion charge per unit of resource times the number of units extracted and sold in the current period.

42. 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. During 2006, 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
Part One
Here is some information concerning a coal mine being developed by Apex Coal Mining. The company paid four million dollars for the site and expects to extract sixteen million tons of coal before the site is exhausted. In the first year of operation, Apex extracts and sells three hundred sixty thousand tons of coal. The first step in the process is to determine the depletion charge per ton of coal.
Part Two
Because there is no salvage value, the depletion charge is twenty-five cents per ton extracted and sold in the period.

43. 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. During 2006, the company extracted and sold 360,000 tons of coal.
Part One To show the acquisition of the site, the cash account decreases and the coal mine asset increases by four million dollars. The investing activities section of the statement of cash flows shows a four million dollar outflow for the acquisition of the mine.
Part Two The journal entries required in the first year are to record the acquisition of the mine site and related depletion. The acquisition is recorded with a debit to the coal mine and credit to cash for four million dollars.
Next, we debit depletion expense for ninety thousand dollars and credit the coal mine for the same amount. The ninety thousand dollar amount is determined by multiplying the twenty-five cent depletion charge per ton times the three hundred sixty thousand tons extracted and sold during the year.

44. Learning Objective 9
Explain how expense recognition for intangible assets (amortization) affects financial statements.
Learning Objective Nine:
Explain how expense recognition for intangible assets (amortization) affects financial statements.

45. 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 17 years.
A trademark is a name or symbol that identifies a company or product like the words Coca-Cola or Pepsi. Any time a company spends money defending its trademark, those costs are charged to the cost of the trademark.
A patent is an exclusive legal right to produce and sell a product. In the United States a patent has a legal life of seventeen years. In today’s increasingly global economy it is becoming more and more difficult to enforce patent rights. In many countries we find wholesale reproduction of computer software and music.

46. 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 50 years.
Franchise The exclusive right to sell products or perform services in certain geographic areas.
A copyright protects the rights of the creator of intellectual property for an extended period of time. In the United States protection extends for the life of the creator plus fifty years.
A franchise is the exclusive right to sell a product within certain geographical areas. For example, you may have the franchise to sell BMWs within a credit area. BMW will not sell cars to others in that area of protection.

47. Intangible Assets
Goodwill The excess of cost over fair value of net tangible assets acquired in a business acquisition.
Assume that your company is willing to pay $350,000 to acquire Seller Company. Let’s look at the accounting.
Part One Goodwill is the excess of cost over fair value of net tangible assets acquired in a business combination.
Part Two Your company is willing to pay three hundred fifty thousand dollars to acquire Seller Company. Here is a balance sheet of Seller Company just prior to the transaction.

48. Goodwill
Assume that your company is willing to pay $350,000 cash to acquire Seller Company. Let’s look at the accounting.
As purchaser, our cash account decreases by three hundred thousand dollars, but we receive the assets of Seller of two hundred eighty thousand dollars. In addition to getting the assets, we must assume the liabilities of Seller.
We paid three hundred thousand dollars to acquire Seller Company’s net assets of two hundred eighty thousand dollars. The excess of the purchase price over the net assets acquired is called goodwill. Goodwill is recorded on our books as an asset.
In the investing activities section of the statement of cash flows we show a cash outflow of three hundred thousand dollars, the acquisition price of the company.

49. Goodwill
Assume that your company is willing to pay $300,000 cash to acquire Seller Company. Let’s look at the accounting.
The journal entry to record the acquisition of Seller Company shows a debit to Restaurant assets for two hundred eighty thousand dollars and a debit to goodwill for seventy thousand dollars. We credit Liabilities for fifty thousand dollars and credit cash for three hundred thousand dollars. We have used the account Restaurant assets and Liabilities rather than list all the individual assets acquired and liabilities assumed.

50. Expensing Intangible Assets
An asset with an identifiable useful life is amortized using the straight-line method over the intangible’s legal life or its useful life.
Assume we purchased a patent that has a 17-year legal life but only an 11-year useful life for $44,000 cash.
Part One
If we have an intangible asset with an identifiable useful life, like a patent, we will amortize the cost of that assets over its legal life or useful life, if shorter. We use the straight-line method of amortization.
Part Two We purchase a patent for forty-four thousand dollars cash that has a legal life of seventeen years but a useful life of eleven years. The asset cash decreases by forty-four thousand dollars and the asset patents increases by the same amount. In the investing activities section of the statement of cash flows we show an outflow of forty-four thousand dollars for the acquisition of the patent.
At the end of the first year we recognize amortization expense of four thousand dollars which reduces income and the equity section of the balance sheet. We also directly reduce the cost of the patent by four thousand dollars rather than use an accumulated amortization account.
Part Three The entries required in the first year are, first, to debit the asset patents and credit cash for forty-four thousand dollars. Next, we debit amortization expense dash patent and credit the patent account for four thousand dollars.

51. 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 at the end of 2006, we determine that goodwill has suffered a $30,000 impairment in value.
Part One Intangible assets with indefinite lives, like goodwill, are carried at unimpaired value on our books.
Part Two After our analysis of the goodwill account we conclude the balance is impaired by thirty thousand dollars. The goodwill account is reduced by thirty thousand dollars and an impairment loss reduces income by thirty thousand dollars. There is no cash flow impact to this transaction.
Part Three The proper journal entry is to debit, or increase, the impairment loss and credit, or decrease, the asset goodwill by thirty thousand dollars.

52. Balance Sheet Presentation
On this partial balance sheet of Dorey Company, we demonstrate how property, plant, and equipment, natural resources, and intangible assets are shown in the financial statement.

53. Learning Objective 10
Understand how expense recognition choices and industry characteristics affect financial performance measures.
Learning Objective Ten:
Understand how expense recognition choices and industry characteristics affect financial performance measures.

54. 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.
When we attempt to compare the financial position and results of operations of two different companies it is essential that we are aware of any differences in the accounting principles used. In this example, Alpha Company uses straight-line depreciation, and Zeta Company uses the double-declining-balance method of deprecation. Notice that the income of Alpha tends to be rather smooth because the same amount of depreciation is taken each year. The reported income of Zeta is lower than that reported by Alpha in both 2005 and 2006.

55. 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.
Because the method used by Zeta recognizes more depreciation in the early years and less in later years, the book value of its long-term assets will be lower than Alpha in the early years.
To promote meaningful analysis, public companies are required to disclose all significant accounting policies used to prepare their financial statements.

56. Effect of Industry Characteristics
Industry characteristics affect financial performance measures. The table indicates Manpower, Incorporated produced fifty-six dollars and twenty cents of sales for every one dollar invested in property, plant and equipment.
Comcast Corporation and Delta Airlines produced sixty-six cents and eighty cents respectively for each one dollar invested in property, plant, and equipment.
Does this mean that Manpower, Incorporated is doing a better job at management than Comcast Corporation and Delta Airlines? Not necessarily. It means that these companies operate in different economic environments.
It takes more equipment to run an airline and a cable company than to run an employment agency.
Does this mean that management of Manpower Inc. is doing a better job than the management of Comcast or Delta?

57. End of Chapter Eight
We have covered a wide range of assets in the discussion. We discussed accounting for and depreciation of property, plant, and equipment, as well as natural resources and intangible assets. You need to be sure that you thoroughly understand how to depreciate an asset using each of the three methods we described in the discussion.