2. Chapter 9: Long-lived Assets and Cost Allocation

3. Capitalize vs Expense Debit Expense Debit Asset Revenue Expenditures
Merely maintain a given level of services
Should be Expensed
Capital Expenditures
Provide future benefits (useful life > 1 year)
Should be Capitalized
Debit Expense
Debit Asset

4. Overview of Accounting for Property, Plant, and Equipment

5. 1. Acquisition - What Costs to Capitalize?
General Rule:
Capitalize (add to an asset account) the costs to acquire the asset and to prepare it for its intended use.
Dr. Asset (purchase price, sales tax, delivery, installation, etc)
Cr. Cash, Notes Payable, etc

6. Machinery, Equipment, Furniture & Fixtures
Land
Has indefinite life and therefore is not depreciated
Historical Cost includes:
Purchase price, Closing costs, Cost to get ready for intended use (Note: Sale of salvaged materials reduces cost)
Land Improvements
Have definite life and therefore are depreciated
Fences, walls, parking lots, driveways
Buildings
Proportionate share of purchase price, or construction cost, Closing Cost, Architect & Attorney fees
Machinery, Equipment, Furniture & Fixtures
Purchase price (net of cash discounts), Freight & handling, Insurance while in transit, Installation

7. Self Constructed Assets What to Capitalize?
Direct Materials & Labor
Variable Overhead
Apply Fixed Overhead
Interest During Construction, if constructed
for company’s own use
by someone else and progress payments &/or deposit are required

8. 2. Depreciation (Cost Allocation)
Depreciation is a method of cost allocation.
it is used to allocate the capitalized cost of PP&E over the years benefited (matching)
Note: depreciation will decrease the carrying value of the asset, but it is not a valuation technique (i.e., book value is not market value)

9. 2. Depreciation (Cost Allocation)
Useful Life
Salvage Value
Depreciation methods
(1) Activity (units-of-production)
(2) Straight-line
(3) Double-declining balance
(4) 150 percent declining balance
(5) Sum-of-the-years digits
(6) MACRS (income tax depreciation)

10. Class Example
Given the following information regarding an automobile purchased by the company on January 2, 2007:
Cost to acquire = $10,000
Estimated life = 4 years
Estimated miles = 100,000 miles
Salvage value = $2,000
Calculate depreciation expense for the first two years under each of the following methods.

11. (1) Units-of-Production (Activity)
Assume that the car was driven 20,000 miles in the year 2007, and 30,000 miles in 2008.
Annual depreciation =
Cost - Salvage Value x Current Activity
Total expected activity
For 2007= 10, ,000 x 20,000 = $1, ,000 miles
For 2008 = 10, ,000 x 30,000 = $2,400
100,000 miles

12. (2) Straight-Line Annual depreciation =
Cost - Salvage
Estimated Life
Annual depreciation =
= $10, $2,000 = $2,000 per year
4 years

13. (3) Double-Declining Balance
DDB is an accelerated depreciation technique. It generates more expense in the early years and less in the later years.
Annual depreciation = % (Cost - A/D)
where A/D is the accumulated depreciation for all prior years, and the percentage is double the straight line rate, or 2 x 1/Estimate life. In the example, the % = 2 x 1/4 = 2/4 = 50%.
Depreciation expense (D.E.)for:
2005 = 50% x (10, ) = $5,000
2006 = 50% x(10,000-5,000) = $2,500

14. (4) 150% Declining Balance
150%DB is another accelerated depreciation technique. It also generates more expense in the early years and less in the later years.
Annual depreciation = % (Cost - A/D)
where A/D is the accumulated depreciation for all prior years, and the percentage is 1.5 times the straight line rate, or
1.5 x 1/Estimate life. In the example, the % =
1.5 x 1/4 = 37.5%.
Depreciation expense (D.E.)for:
2005 = 37.5% x (10, ) = $3,750
2006 = 37.5% x(10,000-3,750) = $2,344

15. (5) Sum-of-the-years Digits
SYD is another accelerated technique that calculates more expense in early years and less in later years.
Annual depreciation = Fraction x (Cost-Salvage)
where the fraction is calculated as follows:
Numerator = declining years (highest first)
Denominator = sum of the years digits
In the class example, the denominator is
= 10
D.E. for 2005 =4/10(10,000-2,000) = $3,200
D.E. for 2006 = 3/10(10,000-2,000) = $2,400

16. (6) MACRS
MACRS (modified accelerated cost recovery system) is a technique developed by the IRS for tax reporting. It utilizes combinations of DDB, 150%DB, and SL to calculate a table of percentages that can be applied to any depreciable asset.
Additionally, the IRS assumes no salvage value, and a half year in the first and last year of depreciation (some limitations on fourth quarter purchases).

17. Change in Estimate
The change in estimate affects only the current and future years; we do not go back and change the previous years that have already been posted.
To calculate the new depreciation expense, first find out how much depreciation has been posted (the Accumulated Depreciation to date).
Then use the following formula (to modify the straight-line depreciation rate):
Remaining Book Value - New Est. Salvage
Remaining Estimated Life

18. Class Problem: Problem 9-7
(a)Book Value at 1/1/08:
First: annual depr. expense =
(180-30)/10 = 15/yr.
Then Accumulated Depr. to 1/1/08:
15 x 5 yrs = $75,000
So BV = 180, ,000 = 105,000

19. Class Problem: Problem 9-7
(b) Estimate for 2008, assuming revised useful life:
BV - SV = 105, ,000 = $9,375 per yr.
Remaining life
Journal entry:
Depreciation Expense 9,375
Accum. Depreciation 9,375

20. 3. Postacquisition Expenditures: Betterments or Maintenance?
Increase asset’s useful life
Improve quality of asset’s output
Increase quantity of asset’s output
Reduce asset’s operating costs
Maintenance
maintain existing productivity or useful life
Accounting treatment
Betterments are capitalized
Maintenance expenditures are expensed

21. 4. Disposal: Retirement, Sale or Trade-In
Dr. Loss (if not fully depreciated)
Dr. Acc Dep
Cr. Asset
Sale:
Dr. Cash
Dr. Loss if BV > Cash or Cr. Gain if BV < Cash
Trade-ins (for dissimilar assets): asset received should be valued at
the fair market value of assets given up, or
the fair market value of the asset received,
whichever is more evident and objectively determined

22. 4. Disposal - continued
Using earlier example (cost = $10,000, salvage = $2,000). After 4 years straight-line, $8,000 would be in A/D.
1. Assume the asset is retired (no cash received)
Loss on retirement 2,000
Accumulated Depr. 8,000
Automobiles 10,000
2. Assume the asset is sold for $3,000:
Cash 3,000
Gain on sale 1,000

23. Class Exercise: Exercise 9-15
First calculate depreciation:
DDB % = 1/5 x 2 = 2/5 = 40%
Depr. Book
Date % Cost - A/D Expense Value
1/1/ ,000
12/31/06 40% (25, ) = 10,000 15,000
12/31/07 40% (25,000-10,000) = 6, ,000
12/31/08 40% (25,000-16,000) = 3, ,400
12/31/ * 5,000=SV
12/31/ ,000
*formula will exceed salvage value limit in 2009; just depreciate $400, to salvage of $5,000.

24. Exercise 9-15, continued
(a) JE to scrap after 3 years, at 12/31/08, assumes that no cash is received:
Dr. Loss on Disposal ,400
Dr. Acc Dep 19,600
Cr. Equipment 25,000
(b) JE to scrap after 5 years, assumes that no cash is received:
Dr. Loss on Disposal ,000
Dr. Acc Dep 20,000

25. Exercise 9-15, continued (c) JE to sell for $8,000 after 3 years:
Dr. Cash ,000
Dr. Acc Dep ,600
Cr. Equipment 25,000
Cr. Gain ,600
(d) JE if, after 5 years, the equipment and $28,000 traded for a dissimilar asset with a fair market value of $30,000:
Dr. Asset (new) ,000
Dr. Acc Dep ,000
Dr. Loss ,000
Cr. Equipment (old) 25,000
Cr. Cash 28,000

26. B. Intangible Assets
Intangible assets are characterized by (1) lack of physical evidence, and
(2) high uncertainty about future benefits.
Cost is amortized over useful life (or legal life, if less), but not to exceed 40 years.
Exception is Goodwill, which is no longer amortized.

27. (1) Patents (20 year legal life)
A company may capitalize the following
the cost of acquiring an externally developed patent.
filing fees for internally or externally developed patents.
the legal fees for acquiring and successfully defending a patent (internal or external).
A company cannot capitalize the following:
legal fees for unsuccessfully defending a patent.
Most research and development costs for an internally developed patent.

28. Research and Development Costs (for internally developed patents)
Prior to 1974, most companies capitalized research and development costs, then amortized the cost to future periods.
The FASB stated in SFAS 2 that, because “future benefits” were uncertain, companies should expense all R&D costs, unless they were related to tangible assets (like buildings and equipment) that had multi-year lives.
Companies complied with the standard, but for several years many companies actually reduced their R&D activities, because of concern for excess expense on the income statement.

29. Other Intangible Assets
(2) Copyrights
granted for the life of the creator plus 70 years.
capitalization rules similar to patents: costs of internally developed copyright material cannot be capitalized.
(3) Trademarks and Trade Names
granted for 10 year periods, but indefinite renewals.
some of design costs may be capitalized.
(4) Organization Costs
costs related to the creation of a company including underwriting fees, legal and accounting, licenses, titles, etc.
treatment similar to R&D costs; even though there may be some future benefit, costs are expensed in the period incurred.

30. Other Intangible Assets - continued
(5) Software Development Costs
Capitalize the costs of developing software for sale or lease.
Expense software development costs if for internal use.
(6) Goodwill (also discussed in Chapter 8)
Recognized when one company purchases another company.
Causes include reputation, good customer relations, superior product development, etc.
To calculate:
Purchase price paid for the company versus the fair market value of the net assets acquired
= Goodwill (the excess amount paid)
No longer amortized, instead subjected to an impairment test

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