1. ACG 2021 Financial Accounting Plant Assets, Natural Resources, and Intangibles

2. Learning Objectives Determine the cost of a plant asset Account for depreciation Select the best depreciation method Analyze the effect of a plant asset disposal Account for natural resources and depletion Account for intangible assets and amortization Report plant asset transactions on the statement of cash flows

3. The Asset Rules How To Determine Cost of the Asset

4. Types of Assets Land –Cost, commissions, survey fees, legal fees, taxes, costs for grading land, demolish buildings Buildings, machinery, equipment –Cost, taxes, interest (if building vs. buying), architectural fees, permits, commissions, taxes, repairs, etc. Land improvements and leasehold improvements –Fences, pavement, additions to leased property Lump-sum (or basket) purchases of assets –Multiple Assets are purchased together for ONE overall price For example, Building and the equipment inside it

5. Determining the Cost of Land A business signs a $300,000 note payable to purchase land for a new store site. It also pays: –$10,000 in back property tax –$8,000 in transfer taxes –$5,000 for removal of an old building –$1,000 survey fee –$260,000 to pave the parking lot. What is the cost of the land?

6. Determining the Cost of Land Purchase price of land$300,000 Add related costs: Back property taxes$10,000 Transfer taxes8,000 Removal of buildings5,000 Survey fees 1,000 24,000 Total cost of land$324,000 –What about $260,000 for Paving? –Land Improvements Land 324,000 Note Payable 300,000 Cash 24,000

7. Determining the Cost of Buildings: Construction Architectural fees Building permits Contractor’s charges Materials Labor Overhead Cost of interest

8. Determining the Cost of Buildings: Purchase Purchase price Brokerage commissions Sales and other taxes Repairing or renovating building for its intended purpose

9. Determining the Cost of Machinery and Equipment Purchase price less discounts Transportation charges Insurance in transit Sales and other taxes Purchase commission Installation costs Expenditures to test the asset Special platforms

10. Determining the Cost of Land and Leasehold Improvements Land improvements –Paving –Fences –Sprinkler systems –Lights in parking lot

11. Leasehold Improvement: Cost of improvements to leased assets Depreciate (amortize) over term of the lease. Determining the Cost of Land and Leasehold Improvements

12. Exercise 7-1 Allocate Costs

13. Lump-Sum (or Basket) Purchase of Assets Multiple Asset Purchases –One Price paid for set of assets Land and Building Land, Building, Equipment, etc. A Corporation paid $2,800,000 for a combined purchase of land and a building. The land is appraised at $300,000 and the building at $2,700,000. How much of the purchase price is allocated to land and how much to the building?

14. Steps to Calculate Lump-Sum Purchase 1.Determine Separate Market Value of each Asset 2.Calculate Total Market Value of all assets purchased 3.Divide each Asset’s Market Value by Total Market Value 4.Multiply % calculated in #3 for each asset, by the Total Cost Paid for the Asset 5.Allocate the Result of #4 to that Asset

15. Lump-sum Purchases Total cost divided among assets based on their relative sales value. Land280,000 Purchased land and building Cash2,800,000 Building2,520,000

16. ACG 2021 Financial Accounting The Expense Rules How To Account for the Asset Deterioration

17. Depreciation Depreciation results from –Physical wear and tear –Obsolescence Depreciation is an allocation of the cost of an asset over its useful life. We accumulate the assets depreciation in a Contra-Asset account –Accumulated Depreciation or Accumulated Depletion –The Asset account minus the Accumulated account = Book Value of the Asset Depreciation MATCHES the reduction in usefulness of Assets (Depreciation Expense) with Revenue that the Assets produced Depreciation is NOT a process of valuation. Depreciation does NOT mean setting aside cash to replace assets as they wear out.

18. Asset Deterioration BUILDINGBUILDING Assets = Liabilities + Paid In Capital + Revenue – Expenses - Dividends Balance Sheet (Assets) Income Statement (Expenses) BUILDINGBUILDING USEDUSED Depreciation

19. Accumulated Depreciation Contra-Asset Account –Opposite normal balance from assets Credit Balance –Related to normal Asset Account Property, Plant & Equipment Reduction in Usefulness –Does not lower value of Asset –Increases Accumulated Depreciation Contra Asset Book Value of Asset –Asset Value – Accumulated Depreciation Always can tell the historical cost of PP&E

20. Depreciation To estimate depreciation expense you need to know: –Cost –Estimated useful life –Estimated residual value

21. Depreciation Methods Straight-line Units-of-production Double-declining-balance

22. Recording Entries Depreciation Debit Depreciation Expense Credit Accumulated Depreciation Depletion Debit Depletion Expense Credit Accumulated Depletion Amortization Debit Amortization Expense Credit Intangible Asset (e.g. Patents)

23. Straight-Line Depreciation Straight-line depreciation per year = Cost – Residual Value Useful Life in years

24. Units-of-Production Units-of-production depreciation per unit of output = Cost – Residual Value Useful life in units of production

25. Double-Declining Balance DDB Depreciation rate per year = 1 Useful life years X2 Rate X Book Value = Annual Depreciation Expense

26. Depreciation Example Data ItemsAmount Cost of truck$41,000 Estimated residual value( 1,000) Depreciable cost$40,000 Estimated useful life 5 years Units of production 100,000 miles

27. (Cost – Residual value) ÷ Years of useful life ($41,000 – $1,000) ÷ 5 = $8,000 Year 1 depreciation:$ 8,000 Year 2 depreciation:8,000 Year 3 depreciation:8,000 Year 4 depreciation:8,000 Year 5 depreciation: 8,000 Total depreciation:$40,000 Straight-Line Method

28. ($41,000 – $1,000) ÷ 100,000 = $.40/mile Year 1: 20,000 miles × $.40 =$ 8,000 Year 2: 30,000 miles × $.40 = 12,000 Year 3: 25,000 miles × $.40 = 10,000 Year 4: 15,000 miles × $.40 = 6,000 Year 5: 10,000 miles × $.40 = 4,000 $40,000 Units-of-Production Method

29. Double-Declining-Balance Method Straight-line rate per year: 100% ÷ 5 = 20% Book value of truck at the end of the first year: $41,000 × 40% = $16,400 $41,000 – $16,400 = $24,600 What is Depreciation at the end of year 2? What is Book Value at the end of year 2? Year 3? Year 4? Year 5? Double-declining balance: 2 times the straight-line rate = 40%

30. Comparing Depreciation Methods Year 1 2 3 4 5 Total SL $ 8,000 8,000 $40,000 UOP $ 8,000 12,000 10,000 6,000 4,000 $40,000 DDB $16,400 9,840 5,904 3,542 4,314 $40,000 Amount of Depreciation per Year

31. Depreciation Methods Used by 600 Companies 84% Straight-line 5% Units-of-production 10% Accelerated 1% Other

32. ACG 2021 Financial Accounting PP&E Other Issues: Tax Consequences Changes in Estimates Disposal or Exchange of Asset

33. Plant Assets - Other Issues Depreciation for Tax Purposes –Companies may use different depreciation methods for tax and book. –MACRS (Modified Accelerated Cost Recovery System) is an accelerated method used for tax. Depreciation for partial years Changing the useful life of a depreciable asset (change in accounting estimate) Fully depreciated assets

34. Relationship Between Depreciation and Taxes Cash revenues$400,000$400,000 Cash operating expenses 300,000 300,000 Cash provided by operations before tax$100,000$100,000 Depreciation expense 8,000 16,400 Income before income tax$ 92,000$ 83,600 Income tax expense (30%) 27,600 25,080 Net income$ 64,400$ 58,520 Straight-lineAccelerated

35. Relationship Between Depreciation and Taxes Cash-flow analysis$100,000$100,000 Income tax expense 27,600 25,080 Cash provided by operations after taxes$ 72,400$ 74,920 Extra cash available for investment if DDB is used ($74,920 – $72,400)$ 2,520 Straight-lineAccelerated

36. Partial-year depreciation: $21,000 × 9/12 = $15,750 Depreciation for Partial Years Full-year depreciation: ($500,000 – $80,000) ÷ 20 = $21,000

37. Assume an asset cost $50,000, has a ten-year useful life with no residual value, and we use the straight-line method. $50,000 ÷ 10 = $5,000 depreciation per year Changing the Useful Life of a Depreciable Asset What is the book value after four years? $50,000 – $20,000 = $30,000 5,000 x 4 = 20,000

38. Changing the Useful Life of a Depreciable Asset Management determines that the asset will be useful for an additional ten years. How much depreciation expense would be recognized each year starting in year five? $30,000 / 10 years = $3,000 Book value at end of year 4

39. Steps for Disposal of Plant Assets First, record depreciation to the date of disposal. Remove the asset and related accumulated depreciation from the books. Record the asset received in exchange (may be cash or other assets). Record the gain or loss on the disposal.

40. Disposing of an Asset To dispose of a fully depreciated asset with cost and accumulated depreciation of $60,000: Accumulated Depreciation - Machinery60,000 To dispose of fully depreciated machine Machinery60,000 To dispose of an asset with cost of $60,000 and accumulated depreciation of $50,000: Accumulated Depreciation - Equipment50,000 To dispose of equipment Equipment60,000 Loss on Disposal of Equipment10,000

41. Selling an Asset UPS sells equipment on Sep 30, 20X4 for $7,000 cash. The equipment cost $10,000 when purchased on Jan 1, 20X1 and has been depreciated on a straight-line basis (10 year useful life, no residual value). First update depreciation then record the sale. Depreciation expense (10,000 / 10 x 9/12)750 To update depreciation Accumulated Depreciation – Equipment750 Accumulated Depreciation - Equipment$3,750 Gain on sale of equipment750 Equipment10,000 Cash7,000 To dispose of equipment

42. Exercise 7-11 Selling an Asset Computing Gain or Loss

43. Exchanging an Asset Delivery Auto (new)11,000 Cash10,000 Delivery Auto (old)9,000 Accumulated Depreciation (old)8,000 Traded in old delivery car for new auto. Mazzio Pizzeria traded its delivery car with cost of $9,000 and accumulated depreciation of $8,000 and $10,000 cash for a new car.

44. ACG 2021 Financial Accounting Capitalizing Asset Costs vs. Expensing Costs Directly

45. YES Capital Expenditure versus an Immediate Expense NO YES NO

46. Capital Expenditures - Vehicle Record an Asset for Capital Expenditures Extraordinary repairs: –major engine overhaul –modification of body for new use of truck –addition to storage capacity of truck Record Repair and Maintenance Expense for an expense: –Repair of transmission or other mechanism –Oil change, lubrication, etc. –Replacement of tires and windshield or a paint job

47. Capital Expenditures General rule: –Capitalize the cost if it increases an asset’s capacity or efficiency or extends its useful life

48. ACG 2021 Financial Accounting Natural Resources & Intangible Assets

49. Natural Resources Natural resources are expensed through depletion. Depletion rate is calculated similar to units-of-production method for depreciation. Accumulated depletion is the contra account used for natural resources.

50. Accounting for Natural Resources and Depletion Assume an oil lease cost $100,000 and contains an estimated 10,000 barrels of oil. If 3,000 barrels are extracted during the year, depletion expense is $30,000. Accumulated Depletion is a contra account similar to Accumulated Depreciation Depletion rate: $100,000 ÷ 10,000 = $10 per barrel.

51. Exercise 7-13 Depletion

52. Intangible Assets Intangible assets are long-lived assets with no physical form. –patents –copyrights –trademarks –franchises –goodwill Intangible assets are expensed through amortization over the expected useful life of the intangible.

53. Intangible Assets Amortization expense - can be written off directly against asset account –That is, there is no contra-asset for accumulated Amortization Assets with an indefinite useful life are not amortized. All intangible assets are subject to impairment

54. Types of Intangible Assets Patents – amortized over useful life Copyrights – amortized over useful life Trademarks and Trade Names – not amortized, review for impairment Franchises and Licenses – not amortized, review for impairment Goodwill - not amortized, review for impairment

55. Intangible Assets: Patents Federal government grants giving holder the right to produce and sell an invention. Suppose a company pays $170,000 to acquire a patent on January 1. The company believes that its expected useful life is 5 years.

56. Intangible Assets: Patents Jan 1Patents170,000 Cash170,000 To record acquisition of patent. Dec 31Amortization Expense34,000 Patents34,000 To amortize cost of patent ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

57. Exercise 7-14 Amortizing Intangibles

58. Research and Development Costs R&D costs are expensed as incurred.

59. Statement of Cash Flows Acquisition cost (cash paid) is reflected in the investing section. Sales price (cash received) is reflected in the investing section. Depreciation expense is not a cash flow, but would appear in operating section if indirect method is used. Gains and losses related to disposals appear in the operating section if the indirect method is used.

60. End of Chapter 7