1. Property, Plant, and Equipment, Natural Resources,
Chapter 8
Operating Assets:
Property, Plant, and Equipment, Natural Resources,
and Intangibles
Financial Accounting 4e by Porter and Norton

2. Johnson Controls, Inc. Property, Plant, and Equipment
Book Value At
Cost
Buildings and improvement $ 1,242.9
Machinery and equipment 3,191.1
Construction in progress
$ 4,744.7
Land
$ 4,968.5
Less accumulated depreciation (2,588.7)
Property, plant, and equipment (net) $ 2,379.8

3. Acquisition Cost of P,P&E
All costs necessary to acquire asset and prepare for intended use
Transportation Charges
Purchase
Price +
Taxes
Installation
Costs

4. Group Asset Purchases
Allocate cost of lump-sum purchase based on fair market values
$75,000
$25,000
Allocated
Cost
Land =
$30,000
Building =
$90,000
Fair Market
Value
75%
25%
% of
Market
Value
Cost
$100,000

5. Capitalization of Interest
Interest can be included as part of the cost of an asset if:
company constructs asset over time, and
borrows money to finance construction

6. via Depreciation of P,P & E Match cost of with periods assets
benefited
via
Straight-Line
Accelerated
Methods
Units of
Production

7. Straight-Line Method
Allocates cost of asset evenly over its useful life
$9,000
3-year life
$3,000
Year 1
Year 2
Year 3

8. Units-of-Production Method
Allocate asset cost based on number of units produced over its useful life
depreciation =
per unit

9. Double-Declining-Balance Method
Double the straight-line rate on a declining balance (book value)
Accelerated method - higher amount of depreciation in early years
Straight-line
Rate

10. Depreciation Example
On January 1, Kemp Company purchases a machine for $20,000. The life of the machine is estimated at five years, after which it is expected to be sold for $2,000.

11. $20,000 cost - $2,000 residual value = $18,000 to be depreciated
Depreciation Example
Calculate Kemp's depreciation of the machine for years using the straight-line, units-of-production and double-declining-balance depreciation methods.
$20,000 cost - $2,000 residual value = $18,000 to be depreciated

12. Straight-Line Depreciation
Depreciation = Cost - Residual Value Life
= $20,000 - $2,000
5 years
= $3,600
$18,000
5-year life
$3,600
Year 1
$3,600
Year 2
$3,600
Year 3
$3,600
Year 4
$3,600
Year 5

13. Units-of-Production Depreciation
Kemp’s estimated machine production:
Yr ,600 units
Yr ,600 units
Yr ,600 units
Yr ,600 units
Yr ,600 units
Total 18,000 units

14. Units-of-Production Depreciation
Depreciation = Cost - Residual Value per unit Life in Units
= $20,000 - $2, ,000
= $ 1.00

15. Units-of-Production Depreciation
Kemp’s depreciation in 2004:
4,000 units x $1/unit = $ 4,000

16. Double-Declining-Balance Depreciation
DDB rate = (100% / useful life) x 2
= (100% / 5 years) x 2
= 40%
.40
Initially
ignore
residual value

17. Double-Declining-Balance Depreciation
Year 1 Depreciation = Beginning book value x rate
= $20,000 x 40%
= $8,000
Beginning Ending
Year Rate Book Value Depreciation Book Value
1 40% $20, $8, $12,000

18. Double-Declining-Balance Depreciation
Year 2 Depreciation = Beginning book value x rate
= $12,000 x 40%
= $4,800
Beginning Ending
Year Rate Book Value Depreciation Book Value
1 40% $20, $8, $12,000
2 40% $12, , ,200

19. Double declining-balance Depreciation
Beginning Ending
Year Rate Book Value Depreciation Book Value
1 40% $20, $8, $12,000
2 40% 12, , ,200
3 40% , , ,320
4 40% , , ,592
5 40% , ,000
$18,000
Final year’s depreciation = amount needed to equate book value with salvage value
= Residual
Value

20. Straight-line vs. DDB Depreciation

21. Reasons for Choosing Straight-Line Depreciation
Simplicity
Reporting to stockholders
Comparability
Bonus plans

22. Reasons for Choosing Accelerated Methods
Technological rate of change and competitiveness
Minimize taxable income
Comparability
Income Taxes

23. Changes in Depreciation Estimates
Recompute depreciation schedule using new estimates
Record prospectively (i.e. change should affect current and future years only)
Useful life is
7 years vs. 5?

24. Change in Estimate
Example:
$20,000 machine originally expected to be depreciated over 5 years. After 2 years, useful life is increased to 7 years.
planned
$3,600
$3,600
$3,600
Yr. 1
Yr. 2
Yr. 3
Yr. 4
Yr. 5
revise
estimate
Depreciation

25. Change in Estimate
Example:
$12,800 remaining book value allocated prospectively over remaining life
$3,600
$2,160
$2,160
$2,160
Yr. 1
Yr. 2
Yr. 3
Yr. 4
Yr. 5
Yr. 6
Yr. 7
revise
estimate
Depreciation

26. Capital vs. Revenue Expenditures
Balance
Sheet
Capital Expenditure
Treat as asset addition to be depreciated over a period of time
Income
Statement
Revenue Expenditure
Expense immediately

27. Capital vs. Revenue Expenditures
General Guidelines:
Increase asset life
Increase asset productivity
Normal maintenance
Material expenditures
Capitalize
Expense

28. Capital Expenditures Example:
$20,000 machine originally expected to be depreciated over 5 years. After 2 years, overhaul machine at cost of $3,000. Machine life is increased by 3 years.
planned
$3,600
$3,600
$3,600
Yr. 1
Yr. 2
Yr. 3
Yr. 4
Yr. 5
replace
engine

29. Capital Expenditures
Example:
$12,800 remaining book value + $3,000 capital expenditure depreciated prospectively over remaining life
$3,600
$2,300
$2,300
$2,300
Yr. 1
Yr. 2
Yr. 3
Yr. 4
Yr. 5
Yr. 6
Yr. 7
replace
engine

30. Disposal of Operating Assets
Record depreciation up to date of disposal
Compute gain or loss on disposal
Proceeds > Book Value = Gain
Proceeds < Book Value = Loss

31. Disposal of Operating Assets
Example:
Sell truck (cost $20,000; accumulated depreciation $9,000) for $12,400
Sale price $ 12,400
Less book value:
Asset cost $20,000
Less: accumulated
depreciation 9, ,000
= Gain on sale $ 1,400

32. Boise Cascade Corporation Partial Balance Sheet
(in thousands)
Property and Equipment:
Land and land improvements $ 68,482
Buildings and improvements ,905
Machinery and equipment 4,606,102
Less: accumulated depreciation (2,742,650) 2,607,839
Timber, timberlands, and
timber deposits ,132
$2,929,971
Natural Resources

33. Natural Resources Resource consumed as it is used
Expense called depletion vs. depreciation
Depletion method similar to units of production

34. AOL Time Warner, Inc. Partial Balance Sheet
(in millions)
Operating Assets:
Property, plant and equipment, net $ 12,684
Music catalogues and copyrights ,927
Film library ,363
Cable television and sports franchises 27,109
Brands, trademarks, and other 10,684
Goodwill and other intangibles 128,338
Intangible
Assets

35. Intangible Assets Long-term assets with no physical properties
Trademarks
Patents
Goodwill
Copyrights

36. (i.e. legal fees, registration fees, etc.)
Intangible Assets
Includes cost to acquire and prepare for intended use
Purchase Price
Acquisition Costs
(i.e. legal fees, registration fees, etc.) +

37. Research & Development
Must be expensed in period incurred
Difficult to identify future benefits

38. Amortization of Intangibles
Normally recorded using straight-line method
Reported net of accumulated amortization
Amortized over legal or useful life, whichever is shorter

39. Amortization of Intangibles
Example:
ML Company developed a patent for $10,000. The patent’s legal life is 20 years, but its anticipated useful life is 5 years.

40. Amortization of Intangibles
ML Company’s annual amortization:
Patent approval costs $10,000
Divide by:
Lesser of legal or useful life 5 years
Annual amortization $ 2,000

41. Amortization of Intangibles
ML Company’s Balance Sheet Presentation:
Upon End of acquisition Yr. 1 Yr. 5
Long-term Assets:
Intangible assets,
net of accum.
amortization $10,000 $8,000 $ 0

42. Analyzing Long-term Assets
Average Life = Property, Plant & Equipment
Depreciation Expense
What is the average depreciable period (or life) of the company’s assets?

43. Analyzing Long-term Assets
Average Age = Accumulated Depreciation Depreciation Expense
Are assets old or new?

44. Analyzing Long-term Assets
Asset Turnover = Net Sales
Average Total Assets
How productive are the company’s assets?

45. Long-term Assets and the Statement of Cash Flows
Operating Activities
Net income xxx
Depreciation and amortization
Gain on sale of asset
Loss on sale of asset
Investing Activities
Purchase of asset
Sale of asset
Financing Activities

46. End of Chapter 8