1. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Accounting for Long- Term Operational Assets Chapter Nine

2. 9-2 LO 1 Identify different types of long-term operational assets. LO 1

3. 9-3 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.

4. 9-4 Tangible Long-Term Assets 1.Property, Plant, and Equipment 1.Property, Plant, and Equipment – Sometimes called plant assets or fixed assets. We depreciate these assets over their useful life. 2.Natural Resources 2.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. 3.Land 3.Land – Has an infinite life and is not subject to depreciation.

5. 9-5 Intangible Assets 1.Intangible Assets with Identifiable Useful Lives 1.Intangible Assets with Identifiable Useful Lives – patents and copyrights. amortize the cost of each over its useful life. 2.Intangible Assets with Indefinite Useful Lives 2.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.

6. 9-6 LO 1 Determine the cost of long-term operational assets. LO 2

7. 9-7 Cost of Long-Term Assets Buildings Purchase pricePurchase price Sales taxesSales taxes Title search and transfer document costsTitle search and transfer document costs Realtor’s and attorney’s feesRealtor’s and attorney’s fees Remodeling costsRemodeling costsBuildings Purchase pricePurchase price Sales taxesSales taxes Title search and transfer document costsTitle search and transfer document costs Realtor’s and attorney’s feesRealtor’s and attorney’s fees Remodeling costsRemodeling costs Equipment Purchase price (less discounts)Purchase price (less discounts) Sales taxesSales taxes Delivery costsDelivery costs Installation costsInstallation costs Costs to adapt to intended useCosts to adapt to intended useEquipment Purchase price (less discounts)Purchase price (less discounts) Sales taxesSales taxes Delivery costsDelivery costs Installation costsInstallation costs Costs to adapt to intended useCosts to adapt to intended use

8. 9-8 Cost of Long-Term Assets Land Purchase pricePurchase price Sales taxesSales taxes Title search and transfer document costsTitle search and transfer document costs Realtor’s and attorney’s feesRealtor’s and attorney’s fees Costs of removal of old buildingsCosts of removal of old buildings Grading costsGrading costsLand Purchase pricePurchase price Sales taxesSales taxes Title search and transfer document costsTitle search and transfer document costs Realtor’s and attorney’s feesRealtor’s and attorney’s fees Costs of removal of old buildingsCosts of removal of old buildings Grading costsGrading costs

9. 9-9 Basket Purchase Allocation Beatty Co. purchased land and a building for $240,000 cash. An appraiser estimated that the land has a fair market value of $90,000, and the building has a fair market value of $270,000. How will we assign the $240,000 cost between the land and building? 270000/360000 90000/360000

10. 9-10 Life Cycle of Operational Assets

11. 9-11 LO 1 Explain how different depreciation methods affect financial statements. LO 3

12. 9-12 Depreciation Methods 1.Straight-line method - the same amount is depreciated each accounting period. 2.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. 3.Units-of-Production – produces varying amounts of depreciation in different accounting periods depending upon the number of units produced. 1.Straight-line method - the same amount is depreciated each accounting period. 2.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. 3.Units-of-Production – produces varying amounts of depreciation in different accounting periods depending upon the number of units produced.

13. 9-13 Asset to be Depreciated The van has a salvage value of $4,000, and an estimated useful life of four years.

14. 9-14 Straight-Line Depreciation Life Cycle Phase 1 Acquire $25,000 cash from the sale of common stock to purchase the van. Cash $25,000 Common Stock $25,000

15. 9-15 Straight-Line Depreciation Life Cycle Phase 2 Purchase the van on January 1, 2008, for a net cost of $24,000. Van $24,000 Cash $24,000

16. 9-16 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

17. Journal Entries Cash $8,000 Revenue $8,000 Depreciation Expense $5,000 Accumulated Dep. Van $5000 Accumulated Depreciation is a Contra Asset Account used to track the total loss of value of the attached asset so far. The Asset account in this case the VAN always shows the historical cost. $24,000. After one year the book value is $19,000.

18. 9-18 LO 1 Determine how gains and losses on disposals of long- term operational assets affect financial statements. LO 4

19. 9-19 Straight-Line Depreciation Life Cycle Phase 4 On January 1, 2012, the van is sold for $4,500 cash. The van was purchased on January 1, 2008. Cash $4,500 Accumulated Dep. $20,000 Gain on sale $500 Van $24,000

20. 9-20 Straight-Line Depreciation Journal Entries

21. 9-21 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. 1.Determine the straight-line rate of depreciation. 2.Multiply the straight-line rate times two. 3.Multiply the double-declining rate by the book value of the asset at the beginning of the period. 1.Determine the straight-line rate of depreciation. 2.Multiply the straight-line rate times two. 3.Multiply the double-declining rate by the book value of the asset at the beginning of the period. Divide 1 by the assets useful life = straight line rate

22. 9-22 Double-Declining-Balance Method See how double-declining-balance depreciation works (1 ÷ 4) = (25% straight-line rate × 2) = 50% $20,000Total Depreciation can only be Cost – Salvage Value = Total Depreciation

23. 9-23 Units-of-Production Depreciation Cost – Salvage value Total estimated units of production = Depreciation charge per unit of production × Units of production in current accounting period = Periodic Depreciation Expense

24. 9-24 Units-of-Production Depreciation Here is the depreciation charge per mile driven in our van: $24,000 – $4,000 100,000 miles =$0.20 per mile Here is the calculation of depreciation expense based on miles driven: Can’t depreciate below the salvage value of $20,000

25. 9-25 Graph of Depreciation Expense

26. 9-26 LO 1 Identify some of the tax issues which affect long-term operational assets. LO 5

27. 9-27 Income Tax Considerations modified accelerated cost recovery system 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.

28. 9-28 Income Tax Considerations Here are the tax rates for 5-year and 7-year property: Let’s assume our van is classified as 5-year property and calculate depreciation for our tax return.

29. 9-29 Income Tax Considerations Let’s assume our van is classified as 5-year property and calculate depreciation for our tax return.

30. 9-30 LO 1 Show how revising estimates affects financial statements. LO 6

31. 9-31 Revision of Estimates Estimates are revised when new information surfaces. Assume we purchased equipment on January 1, 2008, for $50,000 cash and estimated salvage value was $3,000. The equipment has an estimated useful life of eight years, and we use straight-line depreciation. ($26,500 – $3,000) ÷ 10 = $2,350 depreciation per year On January 1, 2012, after four years of depreciation, it was determined that the machine has a useful life of 14. ($50,000 – $3,000) ÷ 8 = $5,875 depreciation per year Prior Reports are not corrected!!!

32. Revision of Estimates At the beginning of the 5 th year the machine had Accumulated Depreciation of $23,500. ($5,875 x 4) The machines book value was $26,500. ($50,000-$23,500). At this point it was determined a revision in the life of the machine is expected to be 14 years instead of 8 year. This means the life of the machine now has 10 more years. (14-4) If we assume the salvage value stays at $3,000 the following would be the new depreciation for each year will be $2,350. ($26,500 BV - $3,000 salvage value / 10) OR At this point it was determined the salvage value was changed. The salvage value is now estimated to be $6,000 with the original 4 years remaining. The new depreciation would be $5,125 ($26,500 BV - $6,000 Salvage value / 4)

33. 9-33 LO 1 Explain how continuing expenditures for operational assets affect financial statements. LO 7

34. 9-34 Continuing Expenditures for Plant Assets Costs that Are Expensed 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 $200 cash for routine maintenance on machinery.

35. 9-35 Continuing Expenditures for Plant Assets Costs that Are Capitalized Costs that Are Capitalized Expenditures that improve the quality of an asset are capitalized as part of the cost of that asset. Assume the company spent $5,000 cash for a major overall of equipment to improve efficiency.

36. Depreciation Calculation for Capitalization when a plant asset is improved EX: An asset which originally cost $50,000 and has a salvage value of $3,000 with a life expectancy of 8 years will have its depreciation expense altered if at the beginning of the fifth year the company spends $4,000 money is spent to improve its efficiency. The first four years of depreciation would be $5,875 using the straight line method. ($50,000 - $3000 = $47,000/8 = $5,875 At the end of the fourth year the book value would be $26,500. 4 X $5,875 = $23,500 $50,000 - $23,500 = $26,500. Since the $4,000 improves the efficiency you add the $4,000 to the asset. This would give the asset a new book value of $30,500. $26,500 + $4,000 = $30,500 The new depreciation would be $6,875. ($30,500 - $3,000 salvage / 4 remaining years = $6,875)

37. 9-37 Continuing Expenditures for Plant Assets Costs that Extend the Life of an Asset 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 $8,000 cash for improvements that extended the life of equipment four years.

38. Depreciation Calculation for Capitalization when a plant assets life is extended. When the cost extends the life but does not improve the productivity you reduce the Accumulated Depreciation for that asset. Ex: The company spends $4,000 which will extend the life of the asset two more years. Using the same problem as before. You can use one of two methods. So far the assets accumulated depreciation was $23,500. 4 x $5,875 You now subtract the $4,000 from this to get an adjusted accumulated depreciation of $19,500. The new book value would be $30,500 ($50,000 - $19,500 AD) Then $30,500 Book value - $3,000 salvage value / 6 years (4 remaining + 2 extra) = $4,583.33 depreciation OR Original book value $26,500 + $4,000 = New BV $30,500 - $3,000 salvage value / 6 = $4,583.33

39. 9-39 LO 1 Explain how expense recognition for natural resources (depletion) affects financial statements. LO 8

40. 9-40 Natural Resources Cost – Salvage value Total estimated units recoverable = Depletion charge per unit of resource × Number of units extracted and sold this period = Periodic Depletion Expense

41. 9-41 Natural Resources 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

42. 9-42 Natural Resources 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..25 x 360,000 = $90,000

43. 9-43 LO 1 Explain how expense recognition for intangible assets (amortization) affects financial statements. LO 9

44. 9-44 Intangible Assets Trademarks 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. Patents 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.

45. 9-45 Intangible Assets Copyrights Protection of writings, musical composition, work 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.

46. 9-46 Intangible Assets Goodwill The excess of cost over fair value of net tangible assets acquired in a business acquisition. Assume that your company is willing to pay $450,000 cash to acquire Seller Company. Let’s look at the accounting.

47. 9-47 Goodwill Assume that your company is willing to pay $450,000 cash to acquire Seller Company. Let’s look at the accounting. $500,000 -$100,000 = $400,000 $400,000 equity and you paid $450,000 = $50,000 more than it is worth. This is $50,000 Goodwill A-L=E

48. 9-48 Goodwill Assume that your company is willing to pay $450,000 cash to acquire Seller Company. Let’s look at the accounting.

49. 9-49 Expensing Intangible Assets An asset with an identifiable useful life is amortized using the straight-line method over the intangible’s legal life or its useful life. Assume we purchased a patent that has a 20-year legal and useful life for $20,000 cash. $20,000 / 20 = $1,000

50. 9-50 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 at the end of 2008, we determine that goodwill has suffered a $10,000 impairment in value.

51. 9-51 Balance Sheet Presentation

52. 9-52 LO 1 Understand how expense recognition choices and industry characteristics affect financial performance measures. LO 10

53. 9-53 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.

54. 9-54 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.

55. 9-55 End of Chapter Nine