1. Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

2. Chapter 9 Reporting and Interpreting Long-Lived Tangible and Intangible Assets PowerPoint Authors: Susan Coomer Galbreath, Ph.D., CPA Charles W. Caldwell, D.B.A., CMA Jon A. Booker, Ph.D., CPA, CIA Fred Phillips, Ph.D., CA

3. Learning Objective 1 Define, classify, and explain the nature of long-lived assets. 9-3

4. Tangible Physical Substance Intangible No Physical Substance Will not be used up within the next year Actively Used in Operations Definition and Classification Land Assets subject to depreciation Buildings and equipment Furniture and fixtures Examples Value represented by rights that produce benefits. Intangibles with a limited life, such as patents and copyrights, are subject to amortization. Intangibles with an unlimited (or indefinite) life, such as goodwill and trademarks, are not amortized. 9-4

5. Learning Objective 2 Apply the cost principle to the acquisition of long-lived assets. 9-5

6. Acquisition of Tangible Assets Recording costs as assets is called capitalizing the costs. Acquisition cost includes: 1.purchase price, and 2.all expenditures needed to prepare the asset for its intended use. 9-6

7. Acquisition of Tangible Assets Purchase cost Purchase cost Legal fees Legal fees Surveying fees Surveying fees Broker’s commissions Broker’s commissions Purchase cost Purchase cost Legal fees Legal fees Surveying fees Surveying fees Broker’s commissions Broker’s commissions LandLand Purchase/construction cost Purchase/construction cost Sales taxes Sales taxes Transportation costs Transportation costs Installation costs Installation costs Purchase/construction cost Purchase/construction cost Sales taxes Sales taxes Transportation costs Transportation costs Installation costs Installation costs Equipment Purchase/construction cost Purchase/construction cost Legal fees Legal fees Appraisal fees Appraisal fees Architectural fees Architectural fees Purchase/construction cost Purchase/construction cost Legal fees Legal fees Appraisal fees Appraisal fees Architectural fees Architectural fees BuildingsBuildings 9-7

8. The total cost of a combined purchase of land and building is allocated in proportion to their relative market values. Acquisition of Tangible Assets Basket Purchase On January 1, Jones purchased land and building for $400,000 cash. The appraised values are building, $325,000, and land, $175,000. On January 1, Jones purchased land and building for $400,000 cash. The appraised values are building, $325,000, and land, $175,000. How much of the $400,000 purchase price will be charged to the building and land accounts? On January 1, Jones purchased land and building for $400,000 cash. The appraised values are building, $325,000, and land, $175,000. On January 1, Jones purchased land and building for $400,000 cash. The appraised values are building, $325,000, and land, $175,000. How much of the $400,000 purchase price will be charged to the building and land accounts? 9-8

9. Cash Purchase Cedar Fair purchased a new ride for $26,000,000 less a $1,000,000 discount. Cedar Fair paid $125,000 for transportation and $625,000 for installation of the ride. Prepare the journal entry for the acquisition assuming Cedar Fair paid cash for the new ride. 2 Record 1 Analyze 9-9

10. Credit Purchase Instead of paying cash, assume that Cedar Fair issued a note for the new ride, but paid cash for the transportation and installation of the ride. Prepare the journal entry for the acquisition. 1 Analyze 2 Record 9-10

11. Maintenance Costs Incurred during Use 9-11

12. Depreciation is a cost allocation process that matches costs of operational assets with periods benefited by their use. Cost Allocaton Balance Sheet Income Statement Expense Acquisition Cost Depreciation Expense Income Statement Depreciation for the current year Balance Sheet Accumulated Depreciation Total of depreciation to date for an asset 9-12

13. Depreciation Expense Depreciation calculations require three amounts for each asset:  Acquisition cost.  Estimated useful life.  Estimated residual value. The effects of $130 of depreciation on the accounting equation and the journal entry to record them follow: 1 Analyze 2 Record 9-13

14. Depreciation Expense 2008 Depreciation Includes $130 for 2008 Book value 2008 9-14

15. Learning Objective 3 Apply various depreciation methods as economic benefits are used up over time. 9-15

16.  Straight-line  Units-of-production  Declining balance Depreciation Methods At the beginning of the year, Cedar Fair purchased a new Go-Cart Ride for $62,500 cash. The ride has an estimated useful life of 3 years and an estimated residual value of $2,500. We will use the following information to illustrate the three methods of depreciation: 9-16

17. Straight-Line Method = $20,000 per year ($62,500 - $2,500) × 1313 9-17

18. Units-of-Production Method = $18,000 ($62,500 - $2,500) × 30,000 100,000 The ride has a 100,000-mile estimated useful life. If the ride is used 30,000 miles in the first year, what is the amount of depreciation expense? 9-18

19. Units-of-Production Method 9-19

20. Declining-Balance Method = $41,667 ($62,500 - $0) × 2323 First Year Second Year = $13,889 ($62,500 - $41,667) × 2323 What is the amount of amount of depreciation for each of the first two years? Annual computation ignores residual value. Cost – Accumulated Depreciation 9-20

21. Below residual value Double-Declining-Balance Method Third Year = $4,629 ($62,500 - $55,556) × 2323 Depreciation expense is limited to the amount that reduces book value to the estimated residual value. 9-21

22. When a plant asset is acquired during the year, depreciation is calculated for the fraction of the year the asset is owned. June 30 Partial Year Depreciation Calculations 9-22

23. Summary of Depreciation Methods 9-23

24. For tax purposes, most corporations use the Modified Accelerated Cost Recovery System (MACRS). MACRS depreciation provides for rapid write-off of an asset’s cost in order to stimulate new investment. Tax Depreciation 9-24

25. Learning Objective 4 Explain the effect of asset impairment on the financial statements. 9-25

26. Asset Impairment Losses Cedar Fair recorded a write-down of $3,200,000 on equipment. Impairment is the loss of a significant portion of the utility of an asset through...  Casualty.  Obsolescence.  Lack of demand for the asset’s services. A loss should be recognized when an asset suffers a permanent impairment. Impairment is the loss of a significant portion of the utility of an asset through...  Casualty.  Obsolescence.  Lack of demand for the asset’s services. A loss should be recognized when an asset suffers a permanent impairment. 1 Analyze 2 Record 9-26

27. Learning Objective 5 Analyze the disposal of long- lived tangible assets. 9-27

28.  Update depreciation to date of disposal.  Record the disposal. dr Cash (+A) dr Accumulated Depreciation (-xA) cr Equipment (-A) Book value Disposal of Tangible Assets cr Gain on Disposal (+R, +SE) Gain if cash received is greater than asset’s book value 9-28

29. dr Cash (+A) dr Accumulated Depreciation (-xA) cr Equipment (-A) Book value Disposal of Tangible Assets  Update depreciation to date of disposal.  Record the disposal. dr Loss on Disposal (+E, -SE) Loss if cash received is less than asset’s book value 9-29

30. The amount of depreciation per year is: a.$0. b.$500,000. c.$1,000,000. d.$2,000,000. Disposal of Tangible Assets Cedar Fair sold a hotel for $3,000,000 cash at the end of its 16 th year of use. The hotel originally cost $20,000,000, and was depreciated using the straight-line method with zero residual value and a useful life of 20 years. The amount of depreciation per year is: a.$0. b.$500,000. c.$1,000,000. d.$2,000,000. Annual Depreciation: ($20,000,000 - $0) ÷ 20 Years = $1,000,000 per year 9-30

31. Cedar Fair sold a hotel for $3,000,000 cash at the end of its 16 th year of use. The hotel originally cost $20,000,000, and was depreciated using the straight-line method with zero residual value and a useful life of 20 years. The equipment’s book value at date of sale is: a.$4,000,000. b.$3,000,000. c.$17,000,000. d.$16,500,000. Disposal of Tangible Assets The equipment’s book value at date of sale is: a.$4,000,000. b.$3,000,000. c.$17,000,000. d.$16,500,000. Accumulated Depreciation = (16 yrs. × $1,000,000) = $16,000,000 BV = Cost - Accumulated Depreciation BV = $20,000,000 - $16,000,000 = $4,000,000 9-31

32. Cedar Fair sold a hotel for $3,000,000 cash at the end of its 16 th year of use. The hotel originally cost $20,000,000, and was depreciated using the straight-line method with zero residual value and a useful life of 20 years. The equipment’s sale resulted in: a.a loss of $1,000,000. b.a gain of $3,000,000. c.a gain of $1,000,000. d.a loss of $5,000,000. Disposal of Tangible Assets The equipment’s sale resulted in: a.a loss of $1,000,000. b.a gain of $3,000,000. c.a gain of $1,000,000. d.a loss of $5,000,000. Loss = Cash Received - Book Value Loss = $3,000,000 - $4,000,000 = $1,000,000 9-32

33. Analyze and prepare the journal entry to record Cedar Fair’s sale of the hotel. Disposal of Tangible Assets 2 Record 1 Analyze 9-33

34. Learning Objective 6 Analyze the acquisition, use, and disposal of long-lived intangible assets. 9-34

35. 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 9-35

36. Intangible Assets Record at current cash equivalent cost, including purchase price, legal fees, and filing fees. Amortize intangibles with limited lives over the shorter of their economic lives or legal lives using the straight-line method. 9-36

37. Trademarks and Copyrights A trademark is a symbol, design, or logo associated with a business. Internally developed trademarks have no recorded asset cost. Purchased trademarks are recorded at cost. Amortize cost over the period benefited. Legal life is life of creator plus 70 years. A copyright is an exclusive right granted by the federal government to protect artistic or intellectual properties. 9-37

38. Cost is purchase price plus legal cost to defend. Amortize cost over the shorter of useful life or 20 years. Patents and Licensing Rights A patent is an exclusive right granted by the federal government to sell or manufacture an invention. You may be using computer software that is made available to you through a campus licensing agreement. Licensing rights grant limited permission to use a product or service according to specific terms and conditions. 9-38

39. Franchises A franchise provides legally protected rights to sell products or provide services purchased by a franchisee from the franchisor. 9-39

40. Goodwill Occurs when one company buys another company. Purchase Price > Fair Market Value of Net Assets Acquired Only purchased goodwill is an intangible asset. Is not amortized. Is impairment tested and may be written down. 9-40

41. Amortization of Limited Life Intangible Asset Assume Cedar Fair purchased a patent for an uphill water-coaster for $800,000 and intends to use it for 20 years. Each year, the company would record $40,000 in Amortization Expense ($800,000 ÷ 20 years). Assume Cedar Fair purchased a patent for an uphill water-coaster for $800,000 and intends to use it for 20 years. Each year, the company would record $40,000 in Amortization Expense ($800,000 ÷ 20 years). 1 Analyze 2 Record 9-41

42. Summary of Accounting Rules for Long-Lived Assets 9-42

43. Learning Objective 7 Interpret the fixed asset turnover ratio. 9-43

44. This ratio measures the sales dollars generated by each dollar invested in fixed assets. For the year 2008, Cedar Fair had $1,000,000 of revenue. End-of-year fixed assets were $1,800,000 and beginning-of-year fixed assets were $1,940,000. (All numbers in millions.) Turnover Analysis Fixed Asset Turnover Net Sales Revenue Average Net Fixed Assets = 9-44

45. Turnover Analysis Fixed Asset Turnover $1,000,000 ($1,800,000 + $1,940,000) ÷ 2 == 0.53 Fixed Asset Turnover Net Sales Revenue Average Net Fixed Assets = 9-45

46. Learning Objective 8 Describe the factors to consider when comparing companies’ long-lived assets. 9-46

47. Impact of Depreciation Differences Accelerated depreciation, in the early years of an asset’s useful life, results in higher depreciation expense, lower net income, and lower book value than would result using straight-line depreciation. Selling an asset with a low book value, resulting from accelerated depreciation, might result in a gain. Selling the same asset with a higher book value, resulting from straight-line depreciation, might result in a loss. 9-47

48. Supplement 9A Natural Resources

49. Total depletion cost Inventory for sale Unsold Inventory Cost of goods sold Natural Resources Depletion is the process of allocating a natural resource’s cost over the period of its extraction. Depletion is similar in concept to depreciation. Depletion that is computed for a period is first added to inventory and then expensed when the inventory is sold. 9-49

50. Supplement 9B Changes in Depreciation Estimates

51. estimate So depreciation is an estimate. residual value Predicted residual value useful life Predicted useful life Over the life of an asset, new information may come to light that indicates the original estimates need to be revised. Changes in Depreciation Estimates 9-51

52. Cedar Fair purchased equipment that cost $60,000,000 with an estimated useful life of 20 years and an estimated salvage value of $3,000,000. During year 5, Cedar Fair changed the estimated useful life to 25 years and lowered the estimated salvage value to $2,400,000. Calculate depreciation expense for year 5 and thereafter using the straight-line method. Cedar Fair purchased equipment that cost $60,000,000 with an estimated useful life of 20 years and an estimated salvage value of $3,000,000. During year 5, Cedar Fair changed the estimated useful life to 25 years and lowered the estimated salvage value to $2,400,000. Calculate depreciation expense for year 5 and thereafter using the straight-line method. Changes in Depreciation Estimates 9-52

53. Book value at date of change Residual value at date of change Remaining useful life at date of change – Changes in Depreciation Estimates When our estimates change, the new depreciation is: 9-53

54. Chapter 9 Solved Exercises M9-4, M9-5, M9-6, E9-6, E9-7, E9-11

55. M9-4 Computing Book Value (Straight-Line Depreciation) Calculate the book value of a two-year-old machine that cost $200,000, has an estimated residual value of $40,000, and has an estimated useful life of four years. The company uses straight-line depreciation. = $40,000 per year ($200,000 - $40,000) × 1414 9-55

56. M9-5 Computing Book Value (Units-of-Production Depreciation) Calculate the book value of a two-year-old machine that cost $200,000, has an estimated residual value of $40,000, and has an estimated useful life of 20,000 machine hours. The company uses units-of-production depreciation and ran the machine 3,000 hours in year 1 and 8,000 hours in year 2. = $24,000 ($200,000 - $40,000) × 3,000 20,000 1 st Year Depreciation = $64,000 ($200,000 - $40,000) × 8,000 20,000 2 nd Year Depreciation 9-56

57. M9-5 Computing Book Value (Units-of-Production Depreciation) Calculate the book value of a two-year-old machine that cost $200,000, has an estimated residual value of $40,000, and has an estimated useful life of 20,000 machine hours. The company uses units-of-production depreciation and ran the machine 3,000 hours in year 1 and 8,000 hours in year 2. 9-57

58. M9-6 Computing Book Value (Double-Declining-Balance Depreciation) Calculate the book value of a two-year-old machine that cost $200,000, has an estimated residual value of $40,000, and has an estimated useful life of four years. The company uses double-declining-balance depreciation. Round to the nearest dollar. = $100,000 ($200,000 - $0) × 2424 1 st Year Depreciation 2 nd Year Depreciation = $50,000 ($200,000 - $100,000) × 2424 9-58

59. M9-6 Computing Book Value (Double-Declining-Balance Depreciation) Calculate the book value of a two-year-old machine that cost $200,000, has an estimated residual value of $40,000, and has an estimated useful life of four years. The company uses double-declining-balance depreciation. Round to the nearest dollar. 9-59

60. E9-6 Computing Depreciation under Alternative Methods PlasticWorks Corporation bought a machine at the beginning of the year at a cost of $12,000. The estimated useful life was five years, and the residual value was $2,000. Assume that the estimated productive life of the machine is 10,000 units. Expected annual production was: year 1, 3,000 units; year 2, 3,000 units; year 3, 2,000 units; year 4, 1,000 units; and year 5, 1,000 units. Required: 1. Complete a depreciation schedule for each of the alternative methods. a. Straight-line. b. Units-of-production. c. Double-declining-balance. 1a. Straight-line 9-60

61. E9-6 Computing Depreciation under Alternative Methods 1b. Units-of-production 1c. Double-declining-balance 9-61

62.  The method that will result in the highest net income is the one that reports the lowest depreciation expense. Straight-line depreciation method yields the lowest depreciation expense in year 2 ($2,000), and therefore results in the highest net income in year 2.  This higher net income does not mean the equipment was used more efficiently. It only means a smaller amount of the asset’s cost was allocated to depreciation expense in year 2 using straight-line depreciation. E9-6 Computing Depreciation under Alternative Methods Required: 2. Which method will result in the highest net income in year 2? Does this higher net income mean the machine was used more efficiently under this depreciation method? 9-62

63. E9-7 Computing Depreciation under Alternative Methods Sonic Corporation purchased and installed electronic payment equipment at its drive-inn restaurants in San Marcos, TX, at a cost of $27,000. The equipment has an estimated residual value of $1,500. The equipment is expected to process 255,000 payments over its three-year useful life. Per year, expected payment transactions are 61,200, year 1; 140,250, year 2; and 53,550, year 3. Required: Complete a depreciation schedule for each of the alternative methods. 1. Straight-line. 2. Units-of-production. 3. Double-declining-balance. = $8,500 per year ($27,000 - $1,500) × 1313 1. Straight-line 9-63

64. E9-7 Computing Depreciation under Alternative Methods 1. Straight-line 9-64

65. E9-7 Computing Depreciation under Alternative Methods 2. Units-of-production = $14,025 ($27,000 - $1,500) × 140,250 255,000 2 nd Year Depreciation = $5,355 ($27,000 - $1,500) × 53,550 255,000 3 rd Year Depreciation = $6,120 ($27,000 - $1,500) × 61,200 255,000 1 st Year Depreciation 9-65

66. E9-7 Computing Depreciation under Alternative Methods 2. Units-of-production 9-66

67. E9-7 Computing Depreciation under Alternative Methods 3. Double-declining-balance = $18,000 ($27,000 - $0) × 2323 1 st Year Depreciation 2 nd Year Depreciation = $6,000 ($27,000 - $18,000) × 2323 3 rd Year Depreciation = $2,000 [$27,000 – ($18,000 + $6,000)] × 2323 9-67

68. Below residual value E9-7 Computing Depreciation under Alternative Methods 3. Double-declining-balance Depreciation expense is limited to the amount that reduces book value to the estimated residual value. 9-68

69. E9-11 Demonstrating the Effect of Book Value on Reporting an Asset Disposal FedEx Corporation is the world’s leading express-distribution company. In addition to the world’s largest fleet of all-cargo aircraft, the company has more than 53,700 ground vehicles that pick up and deliver packages. Assume that FedEx sold a delivery truck for $16,000. FedEx had originally purchased the truck for $28,000, and had recorded depreciation for three years. Required: 1. Calculate the amount of gain or loss on disposal, assuming that Accumulated Depreciation was: (a) $12,000, (b) $10,000, and (c) $15,000. 9-69

70. Case (b) Book Value = $18,000 E9-11 Demonstrating the Effect of Book Value on Reporting an Asset Disposal Case (c) Book Value = $13,000 9-70

71. E9-11 Demonstrating the Effect of Book Value on Reporting an Asset Disposal Required: 2. Using the following structure, indicate the effects (accounts, amounts, and + or -) for the disposal of the truck in each of the three preceding situations. Assets = Liabilities + Stockholders’ Equity Case (a) Book Value = $16,000 9-71

72. E9-11 Demonstrating the Effect of Book Value on Reporting an Asset Disposal Required: 3. Based on the three preceding situations, explain how the amount of depreciation recorded up to the time of disposal affects the amount of gain or loss on disposal. The gain or loss reported on disposal is directly affected by the book value of the asset, which itself is affected by the amount of depreciation recorded before the disposal. With the same sale price of $16,000 in each case...  A larger amount of depreciation recorded before disposal results in lower book value and a gain on disposal (case 1c).  A smaller amount depreciation recorded before disposal results in higher book value and a loss on disposal (case 1b). 9-72

73. E9-11 Demonstrating the Effect of Book Value on Reporting an Asset Disposal Required: 4. Prepare the journal entry to record the disposal of the truck for each situation in requirement 1. Case (a) Book value = $16,000 Case (b) Book value = $18,000 9-73

74. Case (c) Book value = $13,000 E9-11 Demonstrating the Effect of Book Value on Reporting an Asset Disposal Required: 4. Prepare the journal entry to record the disposal of the truck for each situation in requirement 1. 9-74

75. End of Chapter 9