1. Operating Assets: Property, Plant, and Equipment, and Intangibles
Chapter 8
Operating Assets: Property, Plant, and Equipment, and Intangibles

2. Learning Objectives
LO1 Understand balance sheet disclosures for operating assets. LO2 Determine the acquisition cost of an operating asset. LO3 Explain how to calculate the acquisition cost of assets purchased for a lump sum. LO4 Describe the impact of capitalizing interest as part of the acquisition cost of an asset. LO5 Compare depreciation methods and understand the factors affecting the choice of method. LO6 Understand the impact of a change in the estimate of the asset life or residual value.

3. Learning Objectives (continued)
LO7 Determine which expenditures should be capitalized as asset costs and which should be treated as expenses. LO8 Analyze the effect of the disposal of an asset at a gain or loss. LO9 Understand the balance sheet presentation of intangible assets. LO10 Understand the proper amortization of intangible assets. LO11 Explain the impact that long-term assets have on the statement of cash flows. LO12 Understand how investors can analyze a company’s operating assets.

4. Module 1 Acquisition of Operating Assets
Operating assets appear on the balance sheet and companies account for the acquisition of assets
Module 1

5. Operating Assets Presented in two categories on the balance sheet:
Property, Plant and Equipment
Intangible Assets
Essential to a company’s long-term future
Used to produce the goods or services the company sells to customers
Presented at their acquisition cost
Module 1: LO 1

6. Balance Sheet Presentation of Property, Plant, and Equipment
Balance sheet uses one line item for property, plant, and equipment and presents the details in the notes
Module 1: LO 1

7. Acquisition of Property, Plant, and Equipment
Initially recorded at acquisition cost or original cost
Includes all cost normally necessary to acquire an asset and prepare it for its intended use
Purchase price
Taxes paid at time of purchase (for example, sales tax)
Transportation charges
Installation costs
Module 1: LO 2

8. Group Purchase
Firm purchases several assets as a group and pays a lump-sum amount
Acquisition cost of each asset is separately measured on the basis of the proportion of the fair market value of each
Module 1: LO 3

9. Example 8-1—Determining Cost When a Group of Assets Is Purchased
Assume that on January 1, ExerCo purchased a building and the land on which it is situated for $100,000
The accountant established the assets’ fair market value on January 1 as follows:
Land $30,000
Building 90,000
Total 120,000
Based on the estimated market values, the purchase price should be allocated as follows:
To land $100,000 × $30,000/$120,000 = $25,000
To building $100,000 × $90,000/$120,000 = $75,000
Module 1: LO 3

10. Example 8-1—Determining Cost When a Group of Assets Is Purchased (continued)
The journal entry to record the purchase in Example 8-1 would be as follows:
Module 1: LO 3

11. Capitalization of Interest
The interest on borrowed money should be treated as an expense of the period
If a company constructs an asset over a period of time and borrows money to finance the construction
The interest incurred during the construction period is not treated as interest expense
The interest must be included as part of the acquisition cost of the asset
Module 1: LO 4

12. Land Improvements
The acquisition cost of land should be kept in a separate account because land has an unlimited life and is not subject to depreciation
Costs associated with land should be recorded in an account such as Land Improvements
Example: costs of paving a parking lot and landscaping costs
Have a limited life
Should be depreciated over their useful lives
Module 1: LO 4

13. Module 2 Depreciation and Disposal of Operating Assets
A company records depreciation of operating assets and certain factors affect the choice of depreciation method
A company accounts for repairs of the asset and there is an effect of disposal of an asset at a gain or loss
Module 2

14. Use and Depreciation of Property, Plant, and Equipment
Depreciation: the allocation of the original cost of an asset to the periods benefited by its use
Methods of depreciation:
Straight-line
Units-of-production
Accelerated depreciation
The method chosen should be one that best matches the expense to the revenue generated by the asset
Module 2: LO 5

15. Straight-Line Method Allocates the cost of the asset evenly over time
Depreciation = Acquisition Cost – Residual Value
Life
Module 2: LO 5

16. Example 8-2—Computing Depreciation Using the Straight Line Method
Assume that on January 1, 2016, ExerCo, a manufacturer of exercise equipment, purchased a machine for $20,000
The machine’s estimated life would be five years, and its residual value at the end of 2020 would be $2,000
The annual depreciation should be calculated as follows:
Depreciation = Acquisition Cost – Residual Value
Life
= ($20,000-$2,000)/5
= $3,600
Module 2: LO 5

17. Example 8-2—Computing Depreciation Using the Straight Line Method (continued)
An asset’s book value is defined as its acquisition cost minus its total amount of accumulated depreciation
The book value of the machine in this example is $16,400 at the end of 2016:
Book Value = Acquisition Cost – Accumulated Depreciation
= $20,000-$3,600
= $16,400
Module 2: LO 5

18. Example 8-2—Computing Depreciation Using the Straight Line Method (continued)
An asset’s book value is defined as its acquisition cost minus its total amount of accumulated depreciation
The book value of the machine in this example is $16,400 at the end of 2016:
Book Value = Acquisition Cost – Accumulated Depreciation
= $20,000- (2x $3,600)
= $12,800
Module 2: LO 5

19. Units-of-Production Method
Depreciation is determined as a function of the number of units the asset produces
Depreciation = Acquisition Cost – Residual Value
Total Number of Units in Asset’s Life
The annual depreciation for a given year can be calculated based on the number of units produced during that year, as follows:
Annual Depreciation = Depreciation per Unit x Units Produced in Current Year
Module 2: LO 5

20. Example 8-3—Computing Depreciation Using the Units-of-Production Method
ExerCo has estimated that the total number of units that will be produced during the asset’s five-year life is 18,000
During 2016, ExerCo produced 4,000 units
The depreciation per unit for ExerCo’s machine can be calculated as follows:
Depreciation = Acquisition Cost – Residual Value
Total Number of Units in Asset’s Life
= ($20,000 - $2,000)/18,000
= $1 per unit
Module 2: LO 5

21. Example 8-3—Computing Depreciation Using the Units-of-Production Method (continued)
The amount of depreciation that should be recorded as an expense for 2016 is $4,000
Annual Depreciation = Depreciation per Unit x Units Produced in Current Year
= $1 per Unit x 4,000 Units
= $4,000
Module 2: LO 5

22. Accelerated Depreciation Method
Higher amount of depreciation is recorded in the early years than in later years
Double-declining-balance method: recorded at twice the straight-line rate, but the balance is reduced each period
Module 2: LO 5

23. Example 8-4—Computing Depreciation Using the Double- Declining-Balance Method
Assume that ExerCo wants to depreciate its asset using the double-declining-balance method
The straight-line rate for the ExerCo asset with a five-year life is as follows:
100% / 5 Years = 20%
The second step is to double the straight-line rate, as follows:
2 x 20% = 40%
Module 2: LO 5

24. Example 8-4—Computing Depreciation Using the Double-Declining-Balance Method (continued)
This rate will be applied in all years to the asset’s book value at the beginning of each year
As depreciation is recorded, the book value declines and a constant rate is applied to a declining amount
However, the machine cannot be depreciated below its residual value
The amount of depreciation for 2016 would be calculated as follows:
Depreciation = Beginning Book Value x Rate
= $20,000 x 40%
= $8,000
Module 2: LO 5

25. Example 8-4—Computing Depreciation Using the Double-Declining-Balance Method (continued)
The amount of depreciation for 2017 would be calculated as follows:
Depreciation = Beginning Book Value x Rate
= ($20,000 - $8,000) x 40%
= $4,800
Module 2: LO 5

26. Exhibit 8-1—Comparision of Depreciation and Book Values of Straight-Line and Double-Declining Balance Methods
Module 2: LO 5

27. Exhibit 8-2—Management’s Choice of Depreciation Method
Module 2: LO 5

28. Change in Depreciation Estimate
Change in the life of the asset or in its residual value
Recorded prospectively
The depreciation recorded in prior years is not corrected or restated
The new estimate should affect the current year and future years
Module 2: LO 6

29. Example 8-5—Calculating a Change in Depreciation Estimate
ExerCo purchased a machine on January 1, 2016, for $20,000 and estimates that the machine’s life would be five years and its residual value at the end of five years would be $2,000
At the beginning of 2018, ExerCo believes that the total machine life will be seven years, or another five years beyond the two years the machine has been used
The amount to be depreciated over that time period should be calculated as follows:
Module 2: LO 6

30. Example 8-5—Calculating a Change in Depreciation Estimate (continued)
The remaining depreciable amount should be recorded as depreciation over the remaining life of the machine
The depreciation amount for 2018 and the following four years would be $2,160:
Depreciation = Remaining Depreciable Amount/Remaining Life
= $10,800/5 Years
= $2,160
Module 2: LO 6

31. Example 8-5—Calculating a Change in Depreciation Estimate (continued)
The journal entry to record depreciation for the year 2018 is as follows:
Module 2: LO 6

32. Capital versus Revenue Expenditures
Capital expenditure: a cost that improves the asset and is added to the asset account (item treated as asset)
Revenue expenditure: a cost that keeps an asset in its normal operating condition and is treated as an expense (item treated as an expense of the period)
Module 2: LO 7

33. Capital versus Revenue Expenditures
Module 2: LO 7

34. Example 8-6—Capitalizing Costs of a Major Repair
At the beginning of 2018, ExerCo made a $3,000 overhaul to the machine, extending its life by three years
The amount to be depreciated over that time period should be calculated as follows:
Module 2: LO 7

35. Example 8-6—Capitalizing Costs of a Major Repair (continued)
Beginning in 2018, the company should record depreciation of $2,300 per year, computed as follows:
Depreciation = Remaining Depreciable Amount/Remaining Life
= $13,800/6 Years
= $2,300
Module 2: LO 7

36. Example 8-6—Capitalizing Costs of a Major Repair (continued)
The journal entry to record the overhaul in Example 8-6 is as follows:
Module 2: LO 7

37. Example 8-6—Capitalizing Costs of a Major Repair (continued)
The entry to record depreciation for the year 2018 is as follows:
Module 2: LO 7

38. Disposal of Property, Plant, and Equipment
Occurs when the asset is sold, traded, or discarded
Update depreciation to the date of disposal and calculate gain or loss
A gain occurs when the selling price of the asset exceeds its book value
A loss occurs when the selling price of the asset is less than its book value
Gain or loss is reported in the Other Income or Expense category of the income statement
Module 2: LO 8

39. Example 8-7—Calculating the Gain on Sale of an Asset
Assume that ExerCo purchased a machine on January 1, 2016, for $20,000, estimating its life to be five years and the residual value to be $2,000
ExerCo sold the machine on July 1, 2018
Depreciation for the six-month period from January 1 to July 1, 2018, is $1,800 ($3,600 per year 1/2 year ¼ $1,800) and should be recorded as follows:
Module 2: LO 8

40. Example 8-7—Calculating the Gain on Sale of an Asset (continued)
After the July 1 entry, the balance of the Accumulated Depreciation—Machine account is $9,000, which reflects depreciation for the 2½ years from the date of purchase to the date of sale
The entry to record the sale is as follows:
Module 2: LO 8

41. Loss on Sale of Assets
The calculation of a loss on the sale of an asset is similar to that of a gain
Depreciation must be recorded to the date of sale, July1
Following is the entry to record the sale of the asset:
Module 2: LO 8

42. Example 8-8—Calculating the Loss on Sale of an Asset
Assume that ExerCo sold the asset on July 1, 2018, for $10,000. The loss could be calculated as follows:
Module 2: LO 8

43. IFRS and Property, Plant, and Equipment
IFRS requires estimates of residual value and the life of the asset be reviewed at least annually
FASB standards does not require the annual review
The international standards also indicate that companies should determine the components of an asset and depreciate each component separately
International Standards allow companies to revalue the assets to reflect their fair market values
FASB does not allow the revaluing to fair market value
Module 2: LO 8

44. Module 3 Intangible Assets
Intangible assets on the balance sheet are important
Module 3

45. Intangible Assets Assets with no physical properties
Recorded as assets, because they provide future economic benefits to the company
Long-term assets and should be shown separately from property, plant, and equipment
Module 3: LO 9

46. Exhibit 8-3—Most Common Intangible Assets
Module 3: LO 9

47. Acquisition Cost of Intangible Assets
Includes costs to acquire and prepare it for its intended use
Includes:
Purchase Price
Acquisition costs
Costs that are incurred after acquisition and that are necessary to the existence of the asset
Module 3: LO 9

48. Exhibit 8-4—The Nike, Inc., Consolidated Assets Section and Intangibles Notes
Module 3: LO 9

49. Research and Development Costs
Costs incurred in the discovery of new knowledge
According to FASB, all such expenditures must be treated as expenses in the period incurred
Patent account should not include the costs of research and development of a new product
Module 3: LO 9

50. Amortization of Intangibles
Intangibles with finite life must be amortized
Recorded over the legal life or the useful life, whichever is shorter
Mostly recorded using the straight-line method
Intangibles with indefinite life are not amortized
Example: trademark, goodwill, and broadcast license
Module 3: LO 10

51. Example 8-9—Calculating the Amortization of Intangibles
Assume that Nike developed a patent for a new shoe product on January 1, 2016
Costs involved with patent approval were $10,000, and the company wants to record amortization on the straight-line basis over a five-year life with no residual value
Nike should record amortization over the useful life as $10,000/5 years ¼ $2,000
Module 3: LO 10

52. Example 8-9—Calculating the Amortization of Intangibles (continued)
The accounting entry to record the amortization for 2016 is as follows:
Module 3: LO 10

53. Example 8-9—Calculating the Amortization of Intangibles (continued)
Rather than use an accumulated amortization account, some companies decrease (credit) the intangible asset account directly
In that case, the preceding transaction is recorded as follows:
Module 3: LO 10

54. Goodwill and Impairments
As per the FASB, goodwill should be treated as an intangible asset with an indefinite life and that companies should not record amortization expense related to goodwill
Each year, assets with indefinite life should be checked for impairment
If an impairment has occurred, a loss should be recognized
Module 3: LO 10

55. Goodwill and Impairments
Assume that Nike learns on January 1, 2017, when accumulated amortization is $2,000 (or the book value of the patent is $8,000), that a competing company has developed a new product that renders Nike’s patent worthless
Nike has a loss of $8,000 and should record an entry to write off the asset as follows:
Module 3: LO 10

56. IFRS and Intangible Assets
International standards are more flexible than the FASB standards in allowing the use of fair market values for intangible assets
Active market must exist
Fair value must be possible to determine
Research and development costs
FASB: all such costs should be treated as an expense
IFRS: Research costs be treated as an expense and development costs can be capitalized as an asset
Module 3: LO 10

57. Module 4 Cash Flow and Analysis Issues
Operating assets can impact the cash flows of the company and investors analyze a company’s operating assets
Module 4

58. Exhibit 8-5—Long-Term Assets and the Statement of Cash Flows
Module 4: LO 11

59. Analyzing Long-Term Assets for Average Life
What is the average depreciable period (or life) of the company’s assets?
Average Life = Property, Plant, and Equipment
Depreciation Expense
Module 4: LO 12

60. Analyzing Long-Term Assets for Average Age
Are assets old or new?
Average Age = Accumulated Depreciation
Depreciation Expense
Module 4: LO 12

61. Analyzing Long-Term Assets for Asset Turnover
How productive are the company’s assets?
Asset Turnover = Net Sales
Average Total Assets
Module 4: LO 12

62. Review LO1 Understand balance sheet disclosures for operating assets.
Operating assets are the major productive assets of many companies, and investors must be able to evaluate the long-term potential of these assets for a return on their investments.
Operating assets may be classified as either tangible or intangible assets.
Tangible assets are referred to as property, plant, and equipment (or fixed assets).
Intangible assets include goodwill, patents, copyrights, and various types of intellectual property.

63. Review LO2 Determine the acquisition cost of an operating asset.
Assets classified as property, plant, and equipment (or fixed assets) are initially recorded at the cost to acquire the assets, also referred to as historical cost or original cost.
Acquisition costs include those costs that are normal and necessary to acquire the asset and prepare it for its intended use. Generally, acquisition costs include purchase price, taxes paid at time of purchase, transportation charges, and installation costs.

64. Review
LO3 Explain how to calculate the acquisition cost of assets purchased for a lump sum.
If more than one asset is purchased for a single sum of money, the acquisition costs must be allocated between the assets.
In these cases, the purchase price should be allocated between the assets acquired based on the proportion of the fair market value each asset represents of the total purchase price.
LO4 Describe the impact of capitalizing interest as part of the acquisition cost of an asset.
Generally, the interest on borrowed money used to acquire assets should not be capitalized; instead, it should be treated as an expense of the period.

65. Review
LO5 Compare depreciation methods and understand the factors affecting the choice of method.
Several depreciation methods are available, including straight-line, units-of-production, and accelerated depreciation methods.
In theory, the depreciation method that best allocates the original cost of the asset to the periods benefited by the use of the asset should be chosen.
LO6 Understand the impact of a change in the estimate of the asset life or residual value.
Occasionally, an estimate of the asset’s life or residual value must be modified after the depreciation process has begun. This is an example of an accounting change that is referred to as a change in estimate.

66. Review
LO7 Determine which expenditures should be capitalized as asset costs and which should be treated as expenses.
Capital expenditures are added to the acquisition cost of an asset and are depreciated over time.
Revenue expenditures are not treated as part of the cost of the asset, but as an expense on the income statement in the period incurred.
LO8 Analyze the effect of the disposal of an asset at a gain or loss.
The gain or loss on an asset is the difference between the sales (or exchange) price and the book value of the asset, where book value is the acquisition cost less any accumulated depreciation on the asset.

67. Review
LO9 Understand the balance sheet presentation of intangible assets.
Intangible assets are long-term assets that should be shown separately from property, plant, and equipment on the balance sheet.
LO10 Understand the proper amortization of intangible assets.
The amortization of intangibles is a process similar to that of depreciating capital assets.
If an intangible asset has a finite useful life, amortization expense must be taken on the asset over the legal life or useful life, whichever is shorter.

68. Review
LO11 Explain the impact that long-term assets have on the statement of cash flows.
Long-term assets impact the statement of cash flows when they are acquired, depreciated, and sold.
Cash used to acquire long-term assets or cash received on the sale of long-term assets is reflected in the Investing Activities section of the statement of cash flows.
Depreciation and amortization are noncash expenses recorded on the accrual income statement.
Accordingly, net income on a cash basis must be arrived at by adding depreciation and amortization back to accrual net income.

69. Review
LO12 Understand how investors can analyze a company’s operating assets.
Investors are interested in how productive a company’s operating assets are.
The Ratios are a valuable tool that can be used to examine the productivity of operating assets with the asset turnover ratio.

70. End of Chapter 8