1. Chapter 8 Accounting for Long-Term Operational Assets
This chapter explains accounting for long-term operational assets from the date of purchase through the date of disposal.

2. LO 8-1: Identify and determine the cost of long-term operational assets.
Learning Objective 8-1: Identify and determine the cost 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 very 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 I 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 II 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 called depletion. The concept is very similar to depreciation, but refers to the treatment of natural resources.
Part III 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: patents and copyrights. Amortize the cost of each over its useful life.
Intangible Assets with Indefinite Useful Lives: 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 I 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 II Intangible assets with an indefinite life 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. Cost of Long-Term Assets
Buildings
Equipment
Purchase price
Purchase price (less discounts)
Sales taxes
Title search and transfer document costs
Delivery costs
Realtor’s and attorney’s fees
Installation costs
Costs to adapt for intended use
Remodeling costs
The cost of buildings includes 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, as well as delivery and installation costs and the cost to get the equipment ready for its intended use.

7. Cost of Long-Term Assets (Continued)
Land
Purchase price
Sales taxes
Title search and transfer document costs
Realtor’s and attorney’s fees
Costs of removal of old buildings
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.

8. Basket Purchase Allocation
Beatty Co. purchased land and a building for $240,000 cash. An appraiser estimated that the land has a market value of $90,000, and the building has a market value of $270,000.
Amount %
Market Value of Building
$270,000 75
Market Value of Land
90,000 25
Total Fair Market Value
$360,000
100
Cost %
Allocation
Assign to Building
$240,000 75
$180,000
Assign to Land 25
60,000
100
Part I
Let’s assume that Beatty 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 market value of the land without the building and the building without all the adjoining land.
Part II Based upon the appraisal, Beatty has determined that 75% of the cost should be assigned to the building and the remaining 25% should be assigned to the land. We are allocating cost on the basis of relative market value.
Part III Given this information, we will assign $180,000 to the building and the remaining $60,000 to the land.

9. Exhibit 8.1: Life Cycle of Operational Assets
The life cycle of operational assets has four phases in a continuous loop that are used to account for and define the operational asset throughout its lifetime. These functions, in order, are:
Acquiring funding
Buying the asset
Using the asset
Retiring the asset
Then, the cycle begins again with acquisition of additional operational assets.
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.

10. Depreciation Methods
Straight-line method: The same amount is depreciated each accounting period.
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.
Units-of-production: Produces varying amounts of depreciation in different accounting periods depending upon the number of units produced.
Part I We have three methods of calculating depreciation expense of productive 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 II 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 III 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.

11. LO 8-2: Calculate straight-line depreciation and show how it affects financial statements.
Learning Objective 8-2: Calculate straight-line depreciation and show how it affects financial statements.

12. Asset to be Depreciated
The van has a salvage value of $4,000 and an estimated useful life of four years.
List Price of Van
$23,500
Cash Discount (10%)
(2,350)
Transportation Cost
250
Cost of Customization
2,600
Cost of Van
$24,000
We will use this example of a van purchased by Dryden Enterprises. Dryden plans to use the van as rental property. The van had a list price of $23,500. Dryden obtained a 10 percent cash discount from the dealer. The van was delivered FOB shipping point, and Dryden paid an additional $250 for transportation costs. Dryden also paid $2,600 for a custom accessory package to increase the van’s appeal as a rental vehicle.

13. Straight-Line Depreciation: Life Cycle Phase 1
Purchase the van on January 1, Year 1, for a net cost of $24,000.
Date
Account Title
Debit
Credit
Phase 1
Cash
25,000
Common Stock
Assets =
Liab. +
Stockholders' Equity
Cash
Van
Accum. Deprec.
Common Stock
Retained Earnings
Revenue −
Expenses
Net Income
Cash Flow
25,000
n/a FA
Part I The company elects to issue $25,000 of common stock and use the proceeds to purchase the van.
Part II 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.
Part III
The journal entry is a debit to Cash and a credit to Common Stock.

14. Straight-Line Depreciation: Life Cycle Phase 2
Purchase the van on January 1, Year 1, for a net cost of $24,000.
Date
Account Title
Debit
Credit
Phase 2
Van
24,000
Cash
Assets =
Liab. +
Stockholders' Equity
Cash
Van
Accum. Deprec.
Common Stock
Retained Earnings
Revenue −
Expenses
Net Income
Cash Flow
(24,000)
24,000
n/a IA
Part I On January 1, Year 1, the company purchases the van for its net cost of $24,000.
Part II Our Cash account decreases by $24,000 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.
Part III
The journal entry is a debit to the Van asset and a credit to Cash.

15. 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 followed:
(Asset Cost − Salvage Value) ÷ Useful Life
($24,000 − $4,000) ÷ 4 = $5,000 depreciation
Assets =
Liab. +
Stockholders' Equity
Cash
Van
Accum. Deprec.
Common Stock
Retained Earnings
Revenue −
Expenses
Net Income
Cash Flow
8,000
n/a OA
(5,000)
5,000
Part I In the third phase of the cycle we put the van to use producing revenue. During the year the van helps produce $8,000 in revenue. When we placed the van in service, we began the depreciation.
Part II 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 III In our case the annual depreciation is $5,000 as shown in the calculation.
Part IV
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.

16. Straight-Line Depreciation: Life Cycle Phase 3 (Continued)
Use the van to generate $8,000 revenue for the period. Depreciation expense calculated under straight-line is determined as followed:
Date
Account Title
Debit
Credit
Phase 3
Cash
8,000
Rent Revenue
Depreciation Expense
5,000
Accumulated Depreciation
Assets =
Liab. +
Stockholders' Equity
Cash
Van
Accum. Deprec.
Common Stock
Retained Earnings
Revenue −
Expenses
Net Income
Cash Flow
8,000
n/a OA
(5,000)
5,000
Part I The journal entry to recognize the revenue is a debit to Cash and a credit to Rent Revenue. The journal entry to recognize depreciation expense is a debit to Depreciation Expense and a credit to Accumulated Depreciation. Notice that the increase in accumulated depreciation results in a decrease to the book value of the van.
Part II
The account analysis shows a positive $8,000 is received as rent revenue, which increases retained earnings on the balance sheet and increases net income by $8,000. The cash flow for operating activities is increased by the $8,000 received. The contra asset of accumulated depreciation related to the van is increased or credited for $5,000 on the balance sheet, while the offset is a debit or increase in depreciation expense on the income statement; thus, there is a reduction to net income, but there is no affect on cash flow as a result of recording depreciation.

17. Book Value Dec. 31, Year 1 Van $24,000 Accumulated depreciation
(5,000)
Book Value
$19,000
Depreciation expense is recognized each year the van is used. Like other expense accounts, the Depreciation Expense account is a temporary account that is closed to retained earnings at the end of each accounting cycle. In other words, each year $5,000 is recognized in the Depreciation Expense account and then closed to the Retained Earnings account. As a result, the Depreciation Expense account will never have a balance that is larger than $5,000.

18. Exhibit 8.3: Financial Statements under Straight-line Depreciation
DRYDEN ENTERPRISES
Financial Statements
December 31
Income Statement
Year 1
Year 2
Year 3
Year 4
Revenue
$ ,000
Depreciation Expense
(5,000)
Net Income
$ ,000
Balance Sheets
Assets
Cash
$ 9,000
$17,000
$25,000
$33,000
Van
24.000
Accumulated Depreciation
(10,000)
(15,000)
(20,000)
Total Assets
 $28,000
$31,000
$34,000
$37,000
Stockholders’ Equity
Common Stock
Retained Earnings
3,000
6,000
9,000
12,000
Total Stockholders’ Equity
Statement of Cash Flow
Cash Flows from operating activities
Inflow from Customers
$8,000
Cash Flows from investing activities
Outflow to purchase van
(24,000) --
Cash Flows from financing activities
Inflow from stock issue
25,000
Net change in Cash
Plus Beginning Cash Balance
17,000
Ending Cash Balance
$9,000
Exhibit 8.3 displays a vertical statements model that shows the financial results for the Dryden illustration from Year 1 through Year 4.

19. LO 8-3: Calculate double-declining-balance depreciation and show how it affects financial statements.
Learning Objective 8-3: Calculate double-declining-balance depreciation and show how it affects financial statements.

20. 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 to determine the double-declining rate.
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 depreciation times the book value of the asset. Remember, book value is cost less accumulated depreciation. Salvage value is not used in calculating expense for this method. It is only used for finding a limit on the expense in later years.

21. Double-Declining-Balance Method (Continued)
See how double-declining-balance depreciation works.
(1 ÷ 4) = (25% straight-line rate × 2) = 50%
Part I
Let’s calculate depreciation expense under the double-declining-balance method.
Part II Here we combine the first two steps. We determine the straight-line rate of depreciation by dividing 4 into 1 and getting 25%. Next, we multiply the straight-line rate by 2 and get the double-declining rate of 50%.
Part III In our table we multiply the double-declining rate by the book value of the asset. In the first year there is no accumulated depreciation (so book value is equal to $24,000), by 50% and get depreciation of $12,000. 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 $20,000, or $24,000 less $4,000.
Part IV
Under double-declining-balance depreciation we must adjust the later years to make the balance of accumulated depreciation equal $20,000. With an asset cost of $20,000 and accumulated depreciation of $20,000, the book value is $4,000. An asset cannot be depreciated below its salvage value. The schedule on your screen shows the necessary adjustment to depreciation expense. Depreciation expense recognized in the third year is therefore $2,000, even though double-declining-balance computations suggest that $3,000 should be recognized. Similarly, zero depreciation expense is recognized in the fourth year even though the computations indicate a $2,000 charge.

22. Exhibit 8.4: Financial Statements under Double-Declining Depreciation
DRYDEN ENTERPRISES
Financial Statements
December 31
Income Statement
Year 1
Year 2
Year 3
Year 4
Revenue
$ ,000
$ ,000
$ ,000
$ ,000
Depreciation Expense
(12,000)
(6,000)
(2,000)
Net Income
$ ,000
Balance Sheets
Assets
Cash
$ 16,000
$25,000
$30,000
$33,000
Van
24.000
Accumulated Depreciation
(18,000)
(20,000)
Total Assets
 $28,000
$31,000
$34,000
$37,000
Stockholders’ Equity
Common Stock
Retained Earnings
3,000
6,000
9,000
12,000
Total Stockholders’ Equity
Statement of Cash Flow
Cash Flows from operating activities
Inflow from Customers
$15,000
$9,000
$5,000
$3,000
Cash Flows from investing activities
Outflow to purchase van
(24,000) --
Cash Flows from financing activities
Inflow from stock issue
25,000
Net change in Cash
16,000
Plus Beginning Cash Balance
30,000
Ending Cash Balance
Exhibit 8.4 displays financial statements for the life of the asset assuming Dryden uses double-declining-balance depreciation.

23. LO 8-4: Calculate units-of-production depreciation and show how it affects financial statements.
Learning Objective 8-4: Calculate units-of-production depreciation and show how it affects financial statements.

24. Units-of-Production Depreciation
There are two steps to calculate units-of-production depreciation:
Find the depreciation charge per unit of production.
Multiply the resulting depreciation charge per unit of production by units in the current period to find the periodic depreciation expense.
Cost – Salvage value
Total estimated units of production =
Depreciation charge per unit of production
Part I Under the units-of-production method of depreciation 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 II 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.
Depreciation charge per unit of production ×
Units of production in current accounting period =
Annual or Periodic Depreciation Expense

25. Units-of-Production Depreciation (Continued)
Here is the depreciation charge per mile driven in our van:
Here is the calculation of depreciation expense based on miles driven:
$24,000 – $4,000
100,000 miles =
$0.20 per mile
Part I We expect our van to last for 100,000 miles. The depreciation charge per mile driven is $0.20.
Part II In this table we show the actual miles driven each of the 4 years. In the first year of depreciation, we multiply the $0.20 rate times the 40,000 miles actually driven to get total depreciation expense of $8,000.
Because $18,000 of the $20,000 ($24,000 cost − $4,000 salvage) depreciable cost is recognized in the first three years of using the van, only $2,000 ($20,000 − $18,000) remains to be charged to depreciation in the fourth year, even though the depreciation computations suggest the charge should be $3,000.

26. Exhibit 8.5: Financial Statements under Units-of-Production Depreciation
DRYDEN ENTERPRISES
Financial Statements
December 31
Income Statement
Year 1
Year 2
Year 3
Year 4
Revenue
$11,000
$ ,000
$ ,000
$ ,000
Depreciation Expense
(8,000)
(4,000)
(6,000)
(2,000)
Net Income
$3,000
$ ,000
Balance Sheets
Assets
Cash
$ 12,000
$19,000
$28,000
$33,000
Van
24.000
Accumulated Depreciation
(12,000)
(18,000)
(20,000)
Total Assets
 $28,000
$31,000
$34,000
$37,000
Stockholders’ Equity
Common Stock
$25,000
Retained Earnings
3,000
6,000
9,000
12,000
Total Stockholders’ Equity
Statement of Cash Flow
Cash Flows from operating activities
Inflow from Customers
$7,000
$9,000
$5,000
Cash Flows from investing activities
Outflow to purchase van
(24,000) --
Cash Flows from financing activities
Inflow from stock issue
25,000
---
Net change in Cash
Plus Beginning Cash Balance
19,000
28,000
Ending Cash Balance
$12,000
Exhibit 8.5 displays financial statements that assume Dryden uses units-of-production depreciation.

27. LO 8-5: Show how gains and losses on disposals of long-term operational assets affect financial statements.
Learning Objective 8-5: Show how gains and losses on disposals of long-term operational assets affect financial statements.

28. Asset Disposals On January 1, Year 5, the van is sold for $4,500 cash.
Cost of Asset
$24,000
Accumulated Depreciation
(20,000)
4 years x $5,000
Book Value
$4,000
Cash Proceeds
4,500
Gain on Disposal
$500
Account Title
Debit
Credit
Cash
4,500
Accumulated Depreciation
20,000
Van
24,000
Gain on Disposal
500
Part I At the end of the asset’s useful life we determine the van’s book value as cost minus accumulated depreciation. In our case, the book value is $4,000. We are able to sell the van for $4,500 cash, so we recognize a gain of $500.
Part II
The journal entry is a debit to Cash for $4,500, a debit to Accumulated Depreciation for $20,000, a credit to the Van asset for $24,000, and a credit to Gain on Sale of Van for $500.
Part II The Cash account increases by $4,500, and we remove the van and related accumulated depreciation from our books. The $500 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 of cash proceeds from the sale of an asset of $4,500.
Assets =
Liab. +
Stockholders' Equity
Cash
Book Value on Van
Common Stock
Retained Earnings
Revenue −
Expenses
Net Income
Cash Flow
4,500
(4,000)
n/a
500 IA

29. Exhibit 8.6: Depreciation Expense under Different Depreciation Methods
This line graph shows plots for: straight-line depreciation, units-of-production depreciation, and double-declining depreciation. On the x-axis are Years from 1 to 4 and on the y-axis are thousands of dollars from zero to 12, in increments of 2.
Straight-line: $5,000 + $5,000 + $5,000 + $5,000 = $20,000; this is shown as a green horizontal line that is parallel to the x-axis that starts at $5,000 at the y- intercept and remains at the $5,000 for years 1 to 4.
Units-of-production: $8,000 + $4,000 + $6,000 + $2,000 = $20,000; this is shown as a red line that begins at the y-intercept of Year 1 at $8,000 and drops to $4,000 at Year 2, then rises to $6,000 at Year 3 and then drops again to $2,000 at Year 4.
Double-declining-balance: $12,000 + $6,000 + $2,000 + $0 = $20,000; this is shown as a blue line that begins at the y-intercept of Year 1 at $12,000 and then drops to $6,000 at Year 2,and then drops to $2,000 at year 2. The line finally ends at the x-intercept of 4 years for zero dollars.
This exhibit shows a line graph of the depreciation expense in each year under all three methods of depreciation. A company should use the method that most closely matches expenses with revenues.

30. LO 8-6: Identify some of the tax issues that affect long-term operational assets.
Learning Objective 8-6: Identify some of the tax issues that affect long-term operational assets.

31. 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 (MACRS), pronounced “MAKERS.” Assets are placed into a class life that determines the amount of depreciation 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. It takes 6 years to fully depreciate a 5-year class life asset. Let’s look more closely at tax depreciation.

32. Income Tax Considerations (Continued)
Here are the tax rates for 5-year and 7-year property:
Here are the schedules for 5-year and 7-year class life property. For 5-year property, you are permitted to take 20% of the cost of the asset as depreciation in the first year. Notice that under the tax laws we depreciate 100% percent of the cost of the asset.

33. Income Tax Considerations (Concluded)
To illustrate computing depreciation using MACRS, assume that Wilson Company purchased furniture (7-year property) for $10,000 cash on July 21. Tax depreciation charges over the useful life of the asset are computed as:
Year
Table factor % ×
Cost =
Depreciation Amount 1
14.29
$10,000
$1,429 2
24.49
10,000
2,449 3
17.49
1,749 4
12.49
1,249 5
8.93
893 6
8.92
892 7 8
4.46
446
Total over useful life
To illustrate computing depreciation using MACRS, assume that Wilson Company purchased furniture (7-year property) for $10,000 cash on July 21. Tax depreciation charges over the useful life of the asset are computed as shown.
As an alternative to MACRS, the tax code permits using straight-line depreciation.
For certain types of assets such as real property (buildings), the tax code requires using straight-line depreciation.
There is no requirement that depreciation methods used for financial reporting be consistent with those used in preparing the income tax return.

34. LO 8-7: Show how revising estimates affects financial statements.
Learning Objective 8-7: Show how revising estimates affects financial statements.

35. ($50,000 – $3,000) ÷ 8 = $5,875 depreciation per year
Revision of Estimates
Estimates are revised when new information surfaces.
To illustrate, assume that McGraw Company purchased a machine on January 1, Year 1, for $50,000. McGraw estimated the machine would have a useful life of eight years and a salvage value of $3,000.
($50,000 – $3,000) ÷ 8 = $5,875 depreciation per year
Estimates are revised when new information surfaces.
To illustrate, assume that McGraw Company purchased a machine on January 1, Year 1, for $50,000. McGraw estimated the machine would have a useful life of eight years and a salvage value of $3,000. Here is an asset that has a 8-year life and the company uses the straight-line method. Depreciation expense is $5,875 per year.

36. ($26,500 − $3,000) ÷ 10 = $2,350 depreciation per year
Revision of Life
At the beginning of the fifth year, accumulated depreciation on the machine is $23,500 ($5,875 × 4). The machine’s book value is $26,500 ($50,000 − $23,500). Assume McGraw revises the expected life to 14 years, rather than 8. The machine’s remaining life would then be 10 more years instead of 4 years.
($26,500 − $3,000) ÷ 10 = $2,350 depreciation per year
At the beginning of the fifth year, we began to depreciate the asset, we re-estimate that the machine has a useful life of 14 years. That means that 10 years of useful life remains at the date of the revision. On January 1, Year 5, the book value of the equipment is $26,500. Subtract the salvage value of $3,000 and divide by the 10 years of remaining life to determine that $2,350 of depreciation expense will be recognized each year beginning in Year 5. Here, the salvage value remained the same as before. If the salvage value estimate changes, that would be used for the new depreciation calculation.

37. Revision of Salvage
Assume the original expected life remained 8 years, but McGraw revised its estimate of salvage value to $6,000.
Depreciation for each of the remaining 4 years would be: ($26,500 book value − $6,000 salvage) ÷ 4-year remaining life = $5,125
The revised amounts are determined for the full year, regardless of when McGraw revised its estimates.
For example, if McGraw decides to change the estimated useful life on October 1, Year 3, the change would be effective as of January 1, Year 3.
The year-end adjusting entry for depreciation would include a full year’s depreciation calculated on the basis of the revised estimated useful life.
Assume the original expected life remained 8 years, but McGraw revised its estimate of salvage value to $6,000.
Depreciation for each of the remaining 4 years would be ($26,500 book value − $6,000 salvage ) ÷ 4-year remaining life = $5,125
The revised amounts are determined for the full year, regardless of when McGraw revised its estimates. For example, if McGraw decides to change the estimated useful life on October 1, Year 3, the change would be effective as of January 1, Year 3.
The year-end adjusting entry for depreciation would include a full year’s depreciation calculated on the basis of the revised estimated useful life.

38. LO 8-8: Show how continuing expenditures for operational assets affect financial statements.
Learning Objective 8-8: Show how continuing expenditures for operational assets affect financial statements.

39. 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 the company spent $500 cash for routine maintenance on machinery.
Date
Account Title
Debit
Credit
Repairs Expense
500
Cash
Assets =
Liab. +
Stockholders' Equity
Cash
Accounts Rec.
Common Stock
Retained Earnings
Revenue −
Expenses
Net Income
Cash Flow
(500)
n/a
500 OA
Part I The cost of routine maintenance and minor repairs are charged to expense as incurred.
Part II Assume a company spent $500 cash for routine maintenance on a piece of machinery it uses in the production process. The $500 expense reduces net 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 III The proper journal entry is to debit, or increase, Expense and Repairs credit, or decrease Cash by $500.

40. Continuing Expenditures for Plant Assets (Continued)
Costs That Are Capitalized
McGraw Company Example: Machine originally cost $50,000, with an estimated salvage value of $3,000, and a predicted life of 8 years. Accumulated depreciation at the beginning of the fifth year is $23,500 ($5,875 × 4), so the book value is $26,500 ($50,000 − $23,500). Assume McGraw makes an overhaul expenditure of $4,000 in the machine’s fifth year.
Account Title
Debit
Credit
Machine
4,000
Cash
Assets =
Liab. +
Stockholders' Equity
Cash
Machine
Common Stock
Retained Earnings
Revenue −
Expenses
Net Income
Cash Flow
(4,000)
4,000
n/a IA
Part I Expenditures on productive 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 II A company spent $4,000 cash for a major overhaul that dramatically improved the efficiency of a machine it owns. The Cash account decreases, and the Machine account increases by $4,000. We show a cash outflow for the additional investment in the machine in the investing activities section of the statement of cash flows.
Part III The journal entry to record the expenditure is to debit, or increase, the Machine account and credit, or reduce, the Cash account by $4,000.
Calculation of depreciation for the remaining 4 years: Machine account balance is $54,000 and the asset’s book value is $30,500 ($54,000 − $23,500). Therefore, ($30,500 book value − $3,000 salvage) ÷ 4-year remaining life = $6,875.
Depreciation for the remaining 4 years: Asset book value ($54,000 − $23,500)
($30,500 book value − $3,000 salvage) ÷ 4-year remaining life = $6,875

41. Continuing Expenditures for Plant Assets (Concluded)
Costs That Extend the Life of an Asset
The amount of the expenditure should reduce the balance in the accumulated depreciation account. Assume the company spent $4,000 cash for improvements that extended the life of the machine by two years.
Account Title
Debit
Credit
Accumulated Depreciation - Machine
4,000
Cash
Assets =
Liab +
Stockholders' Equity
Cash
Machine
Accum. Deprec
Common Stock
Retained Earnings
Revenue −
Expense
Net Income
Cash Flow
(4,000)
n/a IA
Part I 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 II A company spends $4,000 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 $4,000. The investing activities section of the statement of cash flows shows an outflow of $4,000 for the expenditure.
Part III A company prepares a journal entry to debit, or reduce, Accumulated Depreciation on the equipment and credit, or reduce Cash for $4,000.

42. ($30,500 book value − $3,000 salvage) ÷ 6-year remaining life = $4,583
Extending Life
After the expenditure is recorded, the book value is the same as if the $4,000 had been added to the Machine account ($50,000 cost − $19,500 adjusted balance in Accumulated Depreciation = $30,500). Depreciation expense for each of the remaining 6 years follows:
($30,500 book value − $3,000 salvage) ÷ 6-year remaining life = $4,583
After the expenditure is recorded, the book value is the same as if the $4,000 had been added to the Machine account ($50,000 cost − $19,500 adjusted balance in Accumulated Depreciation = $30,500). Depreciation expense for each of the remaining 6 years follows:
($30,500 book value − $3,000 salvage) ÷ 6-year remaining life = $4,583.

43. LO 8-9: Calculate depletion and show how it affects financial statements.
Learning Objective 8-9: Calculate depletion and show how it affects financial statements.

44. Natural Resources
There are two steps to calculate depletion, beginning with finding the depletion charge per unit of resource.
Then multiply the resulting depletion charge per unit of resource by units extracted and sold in the current period to find the periodic depletion expense.
Cost − Salvage Value
Total estimated units recoverable =
Depletion charge per unit of resource
Part I 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 an oil site, the estimate would be the estimated total barrels of oil to be recovered on the site.
Part II 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.
Depletion charge per unit of resource ×
Number of units extracted and sold this period =
Periodic Depletion Expense

45. Natural Resources (Continued)
Apex Coal Mining paid $4,000,000 cash to purchase a mine expected to yield 16,000,000 tons of coal. After all coal is extracted the mine is not expected to have any salvage value. During the 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
Part I
Here is some information concerning a coal mine being developed by Apex Coal Mining. The company paid $4,000,000 for the site and expects to extract 16,000,000 tons of coal before the site is exhausted. In the first year of operation, Apex extracts and sells 360,000 tons of coals. The first step in the process is to determine the depletion charge per ton of coal.
Part II
Because there is no salvage value, the depletion charge is $0.25 per ton extracted and sold in the period.

46. Natural Resources (Concluded)
If Apex mines 360,000 tons of coal in the first year, the depletion charge is: 360,000 tons ÷ $0.25 per ton = $90,000
Account Title
Debit
Credit
Coal Mine
4,000,000
Cash
Depletion Expense
90,000
Assets =
Liab. +
Stockholders' Equity
Cash
Coal Mine
Common Stock
Retained Earnings
Revenue −
Expense
Net Income
Cash Flow
(4,000,000)
4,000,000
n/a IA
(90,000)
90,000
Part I
If Apex mines 360,000 tons of coal in the first year, the depletion charge is: 360,000 tons ÷ $0.25 per ton = $90,000.
Part II To show the acquisition of the site, the cash account decreases and the coal mine asset increases by $4,000,000. The investing activities section of the statement of cash flows shows a $4,000,000 outflow for the acquisition of the mine.
Part III 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 $4,000,000.
Next, we debit Depletion Expense for $90,000 and credit the Coal Mine for the same amount. The $90,000 amount is determined by multiplying the $0.25 depletion charge per ton times the 360,000 tons extracted and sold during the year.

47. LO 8-10: Identify and determine the cost of intangible assets.
Learning Objective 8-10: Identify and determine the cost of intangible assets.

48. Intangible Assets
Trademark: 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.
Patent: 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.
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 successfully 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 20 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.

49. Intangible Assets (Continued)
Copyright: Protection of writings, musical compositions, works 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.
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 70 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 certain area. BMW will not sell cars to others in that area of protection.

50. Intangible Assets: Example
Goodwill: The excess of cost over fair value of net tangible assets acquired in a business acquisition.
Assume that a buyer is willing to pay $300,000 cash to acquire Bendigo’s. Let’s look at the accounting.
Part I Goodwill is the excess of cost over fair value of net tangible assets acquired in a business combination.
Part II Assume a buyer is willing to pay $300,000 cash to acquire Bendigo’s. Here is a balance sheet of Bendigo’s Restaurant just prior to the transaction.

51. Goodwill The buyer is willing to pay $300,000
cash to acquire Bendigo’s to
purchase assets with a fair value
of $280,000. The buyer will also
assume the $50,000 liabilities.
Assets =
Liab +
Stockholders' Equity
Cash
Seller Assets
Good-will
Seller Liab. 
Common Stock
Retained Earnings
Revenue −
Expense
Net Inc.
Cash Flow
(300,000)
280,000
70,000
50,000
n/a IA
The buyer’s cash account decreases by $300,000, but receives assets of Bendigo of $280,000 fair value. In addition to getting the assets, the buyer must assume the $50,000 liabilities of Bendigo.
Therefore, $300,000 cash plus assumed liabilities of $50,000 equals $350,000 less the acquired Bendigo assets of $280,000, means that the excess of the acquisition price over the net assets acquired is goodwill of $70,000, which is recorded in the books as an asset.
In the investing activities section of the statement of cash flows we show a cash outflow of $300,000, the acquisition price of the company.

52. Goodwill (Continued) Bendigo Assets 280,000 Goodwill 70,000
Account Title
Debit
Credit
Bendigo Assets
280,000
Goodwill
70,000
Bendigo Liabilities
50,000
Cash
300,000
The journal entry to record the acquisition of buyer shows a debit to Bendigo Assets for $280,000 and a debit to goodwill for $70,000. There is a credit to Bendigo Liabilities for $50,000 and credit Cash for $300,000. We have used the accounts Bendigo Assets and Bendigo Liabilities rather than list all the individual assets acquired and liabilities assumed.

53. LO 8-11: Show how the amortization of intangible assets affects financial statements.
Learning Objective 8-11: Show how the amortization of intangible assets affects financial statements.

54. Expensing Intangible Assets
Flowers Industries purchased a newly granted patent for $44,000 cash. Although the patent has a legal life of 20 years, Flowers estimates that it will be useful for only 11 years. The annual amortization charge is therefore $4,000 ($44,000 ÷ 11 years).
Date
Account Title
Debit
Credit
Patent
44,000
Cash
Amortization Expense – Patent
4,000
Assets =
Liab. +
Stockholders' Equity
Cash
Patent
Common Stock
Retained Earnings
Revenue −
Expenses
Net Income
Cash Flow
(44,000)
44,000
n/a IA
(4,000)
4,000
Part I
If we have an intangible asset with an identifiable useful life, like a patent, we will amortize the cost of that asset over its legal life or useful life, if shorter. We use the straight-line method of amortization. In this case, Flowers Industries purchased a newly granted patent for $44,000 cash. Although the patent has a legal life of 20 years, Flowers estimates that it will be useful for only 11 years. The annual amortization charge is therefore $4,000 ($44,000 ÷ 11 years).
Part II The asset Cash decreases by $44,000 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 $44,000 for the acquisition of the patent.
At the end of the first year, recognize amortization expense of $4,000, which reduces net income and the equity section of the balance sheet. Directly reduction of the cost of the patent is by $4,000 rather than using an accumulated amortization account.
Part III The entries required in the first year require a debit to the asset, Patents, and a credit to Cash for $44,000. There is also a debit to Amortization Expense—Patent and a credit to the Patent account for $4,000.

55. 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 we determine that goodwill has suffered a $30,000 impairment in value.
Date
Account Title
Debit
Credit
Impairment Loss
30,000
Goodwill
Part I Intangible assets with indefinite lives, like goodwill, are carried at unimpaired value on our books.
Part II After our analysis of the Goodwill account we conclude the balance is impaired by $30,000. The Goodwill account is reduced by $30,000 and an impairment loss reduces net income by $30,000. There is no cash flow impact from this transaction.
Part III The proper journal entry is to debit, or increase, the Impairment Loss account and credit, or decrease, the asset Goodwill by $30,000.
Assets =
Liab. +
Stockholders' Equity
Cash
Goodwill
Common Stock
Retained Earnings
Revenue −
Expenses
Net Income
Cash Flow
n/a
(30,000)
30,000

56. Exhibit 8.7: Balance Sheet Presentation
Balance Sheet Presentation of Operational Assets
Partial Balance Sheet
Long-Term Assets
Plant and Equipment
Buildings
$4,000,000
Less: Accum. Deprec.
(2,500,000)
$1,500,000
Equipment
1,750,000
(1,200,000)
550,000
Total Plant and equipment
$2,050,000
 Land
850,000
Natural Resources
Mineral Deposits (Less Depletion)
2,100,000
  Oil reserves (Less: Depletion)
890,000 
Total Natural Resources
2,990,000
Intangibles
Patents
38,000 
Goodwill
175,000 
Total intangible assets
213,000
Total Long-term Assets
$6,103,000
On this partial balance sheet we demonstrate how property, plant, and equipment, natural resources, and intangible assets are shown.

57. LO 8-12: Show how expense recognition choices and industry characteristics affect financial performance measures.
Learning Objective 8-12: Show how expense recognition choices and industry characteristics affect financial performance measures.

58. Effect of Judgment and Estimates
Assume that Alpha Company uses straight-line depreciation and Zeta Company uses the double-declining-balance method. Let’s look at their partial financial statements.
Income Statements
Year 1
Year 2
Alpha Co.
Zeta Co.
Sales
$50,000
COGS
(30,000)
Gross Margin
20,000
Depr. Exp.
(4,000)
(8,000)
(4,800)
Net Income
$16,000
$12,000
$15,200
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 depreciation. 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 Year 1 and Year 2.

59. Effect of Judgment and Estimates (Continued)
Plant Assets
Year 1
Year 2
Alpha Co.
Zeta Co.
Asset
$20,000
Accum. Deprec.
(4,000)
(8,000)
(12,800)
Book Value
$16,000
$12,000
$7,200
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 depreciation. Notice that the book value for Zeta decreases at a more rapid rate than that for Alpha, since Zeta is accelerating the depreciation with the double-declining-balance method.

60. Sales ÷ Prop., Plant & Equip.
Exhibit 8.8: Industry Data Reflecting the Use of Long-Term Tangible Assets
Industry
Company
Sales ÷ Prop., Plant & Equip.
Broadband Communications
Comcast Corp.
2.39
Verizon Communications
1.49
Airlines
Alaska Air Group
1.04
Southwest Airlines
1.20
Employment Agencies
Kelly Services
65.31
Manpower Inc.
132.43
As indicated in previous chapters, industry characteristics affect financial performance measures. For example, companies in manufacturing industries invest heavily in machinery, while insurance companies rely more on human capital.
To illustrate how the type of industry affects financial reporting, examine Exhibit 8.8. This exhibit compares the ratio of sales to property, plant, and equipment for two companies in each of three different industries. These data are for 2016.
The table indicates that companies operate in different economic environments. In other words, it takes significantly more equipment to operate a cable company or an airline than it takes to operate an employment agency.
Effective financial analysis requires careful consideration of industry characteristics, accounting policies, and the reasonableness of assumptions such as useful life and salvage value.

61. End of Chapter 8
End of Chapter 8. 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.