1. Reporting and Interpreting Property, Plant and Equipment; Natural Resources; and Intangibles Chapter 8

2. 8-2 Ch 8 -- Not tested  Asset impairment (pp. 416-417)  Depletion methodology (pp. 419-420)  Definitions of various intangibles, other than goodwill (pp. 422-423)  Computation of (v. concept of, pp. 412-413) accelerated depreciation (e.g., declining-balance) (p. 412)  Cash flows (pp. 423-425)  Changes in estimates (pp. 428-429)

3. 8-3 Tangible Physical Substance Intangible No Physical Substance Expected to Benefit Future Periods Actively Used in Operations Classifying Long-Lived Assets Land Assets subject to depreciation  Buildings and equipment  Furniture and fixtures Natural resource assets subject to depletion  Mineral deposits and timber Examples Value represented by rights that produce benefits Definite life Patents Copyrights Franchises Indefinite life Trademarks Goodwill Examples

4. 8-4 Measuring and Recording Acquisition Cost Acquisition cost includes the purchase price and all expenditures needed to prepare the asset for its intended use. Acquisition cost is net of any cash discounts taken Acquisition cost does not include finance charges. Acquisition cost includes the purchase price and all expenditures needed to prepare the asset for its intended use. Acquisition cost is net of any cash discounts taken Acquisition cost does not include finance charges. Buildings Purchase price Renovation and repair costs Legal and realty fees Real estate agent commission Title fees Buildings Purchase price Renovation and repair costs Legal and realty fees Real estate agent commission Title fees

5. 8-5 Measuring and Recording Acquisition Cost Equipment Purchase price Installation costs Modification to building necessary to install equipment Transportation costs Equipment Purchase price Installation costs Modification to building necessary to install equipment Transportation costs Land Purchase price Real estate commissions Title insurance premiums Delinquent taxes Surveying fees Title search and transfer fees Land Purchase price Real estate commissions Title insurance premiums Delinquent taxes Surveying fees Title search and transfer fees Land is not depreciable.

6. 8-6 On January 1, Southwest Air Lines purchased aircraft for $70,000,000 cash. Measuring and Recording Acquisition Cost Acquisition for Cash On January 14, Southwest Air Lines purchased aircraft for $1,000,000 cash and a $69,000,000 note payable. Acquisition for Debt

7. 8-7 Acquisition for Noncash Consideration Record at the current market value of the consideration given, or the current market value of the asset acquired, whichever is more clearly evident. On July 7, Southwest gave Boeing 9,000,000 shares of $1.00 par value common stock with a market value of $5.00 per share plus $25,000,000 in cash for aircraft.

8. 8-8 Repairs, Maintenance, and Additions (p. 405)

9. 8-9 Repairs, Maintenance, and Additions

10. 8-10 Depreciation is a cost allocation process (not a valuation method) that systematically and rationally matches acquisition cost of an operational asset with revenue in periods benefited by its use. Cost Allocation Balance Sheet Income Statement Expense Depreciation Concepts Acquisition Cost Depreciation Expense Income Statement Balance Sheet Accumulated Depreciation Depreciation for current year Total depreciation since acquisition of asset

11. 8-11 Depreciation Concepts The calculation of depreciation requires three amounts for each asset:  Acquisition cost.  Estimated useful life.  Estimated residual (salvage) value. The calculation of depreciation requires three amounts for each asset:  Acquisition cost.  Estimated useful life.  Estimated residual (salvage) value. Depreciation methods  Straight-line  Units-of-production  Accelerated, e.g., declining balance Depreciation methods  Straight-line  Units-of-production  Accelerated, e.g., declining balance

12. 8-12 Straight-Line Method Cost - Residual Value Life in Years Depreciation Expense per Year Depreciation Expense per Year == At the beginning of the year, Southwest purchased ground equipment for $62,500 cash. The equipment has an estimated useful life of 3 years and an estimated residual value of $2,500. Depreciation Expense per Year = Depreciation Expense per Year = $20,000 $62,500 - $2,500 3 years

13. 8-13 Residual Value SL More companies use the straight-line method of depreciation in their financial reports than all other methods combined. Straight-Line Method

14. 8-14 Units-of-Production Method Depreciation Rate = Cost - Residual Value Life in Units of Production Step 1: Step 2: Depreciation Expense = Depreciation Rate × Number of Units Produced for the Year At the beginning of the year, Southwest purchased ground equipment for $62,500 cash. The equipment has a 100,000 mile useful life and an estimated residual value of $2,500. If the equipment is used 30,000 miles in the first year, what is the amount of depreciation expense?

15. 8-15 Units-of-Production Method $62,500 - $2,500 100,000 miles = $.60 per mile Depreciation Rate = Step 1: Step 2: $.60 per mile × 30,000 miles = $18,000 Depreciation Expense = Residual Value

16. 8-16 Accelerated Depreciation Depreciation Repair Expense Early Years High Low Later Years Low High Accelerated depreciation matches higher depreciation expense with higher revenues in the early years of an asset’s useful life when the asset is more efficient.

17. 8-17 Declining-Balance Method Annual Depreciation expense Net Book Value () Useful Life in Years 2 = × Cost – Accumulated Depreciation Declining balance rate of 2 is double-declining- balance (DDB) rate. Annual computation ignores residual value. At the beginning of the year, Southwest purchased equipment for $62,500 cash. The equipment has an estimated useful life of 3 years and an estimated residual value of $2,500. Calculate the depreciation expense for the first two years.

18. 8-18 Annual Depreciation expense Net Book Value () Useful Life in Years 2 = × () $62,500 × 3 years 2 = $41,667 () ($62,500 – $41,667) × 3 years 2 = $13,889 Declining-Balance Method Year 1 Depreciation: Year 2 Depreciation:

19. 8-19 () ($62,500 – $55,556) × 3 years 2 = $4,629 Below residual value Declining-Balance Method

20. 8-20 Depreciation expense is limited to the amount that reduces book value to the estimated residual value. Declining-Balance Method

21. 8-21 Disposal of Property, Plant, and Equipment  Journalize disposal by Writing off accumulated depreciation (debit). Writing off the asset cost (credit). Recording cash received (debit) or paid (credit). Recording a gain (credit) or loss (debit).  Update depreciation to the date of disposal.

22. 8-22 If Proceeds > BV, record a gain (credit). If Proceeds < BV, record a loss (debit). If Proceeds = BV, no gain or loss. If Proceeds > BV, record a gain (credit). If Proceeds < BV, record a loss (debit). If Proceeds = BV, no gain or loss. Disposal of Property, Plant, and Equipment Southwest Airlines sold flight equipment for $5,000,000 cash at the end of its 17th year of use. The flight equipment originally cost $20,000,000, and was depreciated using the straight-line method with zero residual value and a useful life of 20 years.

23. 8-23 The amount of depreciation expense recorded at the end of the 17th year to bring depreciation up to date is a.$0. b.$1,000,000. c.$2,000,000. d.$4,000,000. The amount of depreciation expense recorded at the end of the 17th year to bring depreciation up to date is a.$0. b.$1,000,000. c.$2,000,000. d.$4,000,000. Annual Depreciation: ($20,000,000 - $0) ÷ 20 Years. = $1,000,000 Disposal of Property, Plant, and Equipment

24. 8-24 After updating the depreciation, the equipment’s book value at the end of the 17th year is a.$3,000,000. b.$16,000,000. c.$17,000,000. d.$4,000,000. After updating the depreciation, the equipment’s book value at the end of the 17th year is a.$3,000,000. b.$16,000,000. c.$17,000,000. d.$4,000,000. Accumulated Depreciation = (17yrs. × $1,000,000) = $17,000,000 BV = Cost - Accumulated Depreciation BV = $20,000,000 - $17,000,000 = $3,000,000 Disposal of Property, Plant, and Equipment

25. 8-25 The equipment’s sale resulted in a.a gain of $2,000,000. b.a gain of $3,000,000. c.a gain of $4,000,000. d.a loss of $2,000,000. The equipment’s sale resulted in a.a gain of $2,000,000. b.a gain of $3,000,000. c.a gain of $4,000,000. d.a loss of $2,000,000. Gain = Cash Received - Book Value Gain = $5,000,000 - $3,000,000 = $2,000,000 Disposal of Property, Plant, and Equipment

26. 8-26 Prepare the journal entry to record Southwest’s sale of the equipment at the end of the 17th year. Disposal of Property, Plant, and Equipment

27. 8-27 Acquisition and Depletion of Natural Resources Examples: oil, coal, gold Extracted from the natural environment. A noncurrent asset presented at cost less accumulated depletion. Total cost of asset is the cost of acquisition, exploration, and development. Total cost is allocated over periods benefited by means of depletion. Depletion is like units-of-production depreciation.

28. 8-28 The unit depletion rate is calculated as follows: Estimated Recoverable Units Acquisition and Residual Development Cost Value – Depletion cost Inventory for sale Unsold Inventory Cost of goods sold Depletion cost for a period is: UNIT DEPLETION RATE NUMBER OF UNITS EXTRACTED IN PERIOD × Acquisition and Depletion of Natural Resources

29. 8-29 Acquisition and Amortization of Intangible Assets Noncurrent assets without physical substance. Useful life is often difficult to determine. Usually acquired for operational use. Often provide exclusive rights or privileges. Intangible Assets Record at current cash equivalent cost, including purchase price, legal fees, and filing fees.

30. 8-30 Definite Life Amortize over shorter of economic life or legal life, subject to rules specified by GAAP. Use straight-line method. Definite Life Amortize over shorter of economic life or legal life, subject to rules specified by GAAP. Use straight-line method. Indefinite Life Not amortized. Tested at least annually for possible impairment, and book value is reduced to fair value if impaired. Indefinite Life Not amortized. Tested at least annually for possible impairment, and book value is reduced to fair value if impaired. Amortization is a cost allocation process similar to depreciation and depletion. Acquisition and Amortization of Intangible Assets Research and development costs that may result in a patent are normally expensed as incurred.

31. 8-31 Patent Woes Threaten Drug Firms By DUFF WILSON Published: March 6, 2011 Pfizer’s multimillion-dollar gamble on a replacement for the popular drug Lipitor, which lowers cholesterol, failed in clinical trials. At the end of November, Pfizer stands to lose a $10-billion-a-year revenue stream when the patent on its blockbuster cholesterol drug Lipitor expires and cheaper generics begin to cut into the company’s huge sales.

32. 8-32 STRATEGIC PLANNING

33. 8-33 Occurs when one company buys another company. Amount by which purchase price exceeds fair market value of net assets acquired. Only purchased goodwill is an intangible asset. Goodwill Acquisition and Amortization of Intangible Assets Goodwill is not amortized. Its value must be reviewed at least annually for possible impairment, and the book value is reduced to fair value if impaired.

34. 8-34 Arpec Company paid $2,000,000 to purchase all of Utek Company’s assets and assumed liabilities of $400,000. The acquired assets were appraised at a fair value of $1,800,000. What amount of goodwill should be recorded on Arpec Company books? a.$200,000 b.$400,000 c.$600,000 d.$800,000 What amount of goodwill should be recorded on Arpec Company books? a.$200,000 b.$400,000 c.$600,000 d.$800,000 Acquisition and Amortization of Intangible Assets

35. 8-35 Trademarks A symbol, design, or logo associated with a business. An exclusive legal right to use a name, image or slogan. Purchased trademarks are recorded at cost. Trademarks A symbol, design, or logo associated with a business. An exclusive legal right to use a name, image or slogan. Purchased trademarks are recorded at cost. Acquisition and Amortization of Intangible Assets Copyrights The exclusive right to publish, use, and sell a literary, musical, or artistic work. Legal life is life of creator plus 70 years. Amortize cost over the period benefited. Copyrights The exclusive right to publish, use, and sell a literary, musical, or artistic work. Legal life is life of creator plus 70 years. Amortize cost over the period benefited.

36. 8-36 Why Isn’t Mickey Mouse in the Public Domain? Why Isn’t Mickey Mouse in the Public Domain? by Karl Smallwood - June 17, 2012 - 11:20 PM

37. 8-37 Expansion of U.S. copyright law

38. 8-38 Acquisition and Amortization of Intangible Assets Patents Exclusive right granted by the federal government to sell or manufacture an invention. Cost is purchase price plus legal cost to defend. Amortize cost over the shorter of useful life or legal life (20 years). Research and development costs that might result in a patent are normally expensed as incurred. Patents Exclusive right granted by the federal government to sell or manufacture an invention. Cost is purchase price plus legal cost to defend. Amortize cost over the shorter of useful life or legal life (20 years). Research and development costs that might result in a patent are normally expensed as incurred. Technology A category of intangible assets that includes a company’s website and any computer programs written by its employees. Technology A category of intangible assets that includes a company’s website and any computer programs written by its employees.

39. 8-39 Franchises Legally protected right purchased by a franchisee to sell products or provide services for a specified period and purpose. Purchase price is an intangible asset that is amortized. Franchises Legally protected right purchased by a franchisee to sell products or provide services for a specified period and purpose. Purchase price is an intangible asset that is amortized. Acquisition and Amortization of Intangible Assets Licenses and Operating Rights Limited permissions to use a product or service according to specific terms and conditions. For example, students may be using computer software made available through a campus licensing agreement. Licenses and Operating Rights Limited permissions to use a product or service according to specific terms and conditions. For example, students may be using computer software made available through a campus licensing agreement.

40. End of Chapter 8