Plant Assets, Natural Resources, and Intangibles

Plant Assets, Natural Resources, and Intangibles
Chapter 9 Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall
Learning Objectives Measure the cost of a plant asset Account for depreciation using the straight-line, units-of-production, and double-declining-balance methods Journalize entries for the disposal of plant assets Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

Learning Objectives Account for natural resources Account for intangible assets Use the asset turnover ratio to evaluate business performance Journalize entries for the exchange of plant assets (Appendix 9A) Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

Measure the cost of a plant asset
Learning Objective 1 Measure the cost of a plant asset Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

Long-lived, tangible assets used in the operation of the business.
What Are Plant Assets? Long-lived, tangible assets used in the operation of the business. Cost Principle The actual cost of a plant asset is its purchase price plus all the costs necessary to get the asset ready for its intended use. Land Buildings Equipment Furniture Automobiles Plant Assets are sometimes referred to collectively as Property, Plant, and Equipment (PP&E). Plant Assets are long-lived, tangible assets used in the operation of the business. These assets include Land, Buildings, Equipment, Furniture, Fixtures, and Automobiles. When these assets are acquired, they are recorded at cost, in accordance with the Cost Principle. Generally, the cost consists of acquisition price plus all the costs necessary to get the asset in place, and ready for its intended use. Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

Land is not depreciable.
The Cost of Land Includes: Purchase price Brokerage commissions Survey and legal fees Delinquent property taxes Title transfer fees Cost of clearing the land Cost of removing old buildings Land is not depreciable. The cost of land includes the purchase price, brokerage commissions, survey and legal fees, delinquent property taxes, title transfers fees, the cost of clearing the land, and the cost of removing old buildings from the land. Land is a unique kind of plant asset that is never depreciated. Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

The Cost of Land Does Not Include: Fencing Paving Sprinkler systems Lighting Signs These costs are referred to as Land Improvements. Land Improvements ARE depreciated. The cost of land does not include fencing, paving, sprinkler systems, lighting, signs, and other improvements to the land such as landscaping. These costs are collectively referred to as Land Improvements. These costs are separately identified from the land itself and they are depreciated. Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

The Cost of Land Smart Touch Learning purchases land on August 1, 2015, for $50,000 with a note payable. Other costs related to this transaction include $4,000 in delinquent property taxes, $2,000 in transfer taxes, $5,000 to remove an old building, and a $1,000 survey fee. The additional costs are paid in cash. What is the cost of the land on Smart Touch Learning’s books? Assume that Smart Touch Learning buys some land on August 1 for $50,000 and pays for it with a note payable. Other costs related to this transaction include $4,000 in delinquent property taxes, $2,000 in property transfer taxes (or fees), $5,000 to remove an old building from the site, and $1,000 for a survey of the property. What is the cost of the land on Smart Touch Learning’s books? Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

The Cost of Land As you can see from the computation in Exhibit 9-2, the cost of the land is not only the acquisition cost of $50,000. It also includes an additional $12,000 of costs that bring the total cost of the land on the books to $62,000. Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

The Cost of Land Prepare the journal entry to record the purchase of the land. Now, prepare the journal entry to record the acquisition of the land. Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

The Cost of Land Prepare the journal entry to record the purchase of the land. The journal entry to record the acquisition of the land would include a debit to Land for $62,000 and credits to Notes Payable for $50,000 and to Cash for $12,000 (related to the additional costs). Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

When a Building is constructed, the costs include:
The Cost of Buildings When a Building is constructed, the costs include: A company can acquire a building one of two ways: the building can be constructed or a finished building can be purchased. When a building is constructed, the cost of the building includes the excavation of the site to prepare for the construction of the building. In addition, architectural fees are included in the cost of the building. Other costs include building permits, contractor charges, materials, and labor. Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

When a Building is purchased, the costs include:
The Cost of Buildings When a Building is purchased, the costs include: When a building is acquired, the cost includes the purchase price, any brokerage fees and delinquent taxes, and any renovation costs necessary to prepare the building for occupancy. Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

The Cost of Machinery and Equipment and Furniture and Fixtures
The costs include: The cost of machinery and equipment (and furniture and fixtures) includes the purchase price, any purchase commission, transportation costs necessary to get the equipment to the site where it will be used, installation and testing costs once the equipment is on site, insurance on the equipment while it is in transit, and any sales taxes on the purchase of the equipment. Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

Lump-Sum Purchases Purchasing several assets for a single price. Sometimes called a “basket purchase” Each asset must be recorded separately. Allocate total cost to each asset based on relative market value. On August 1, Smart Touch Learning purchased land and building with a $100,000 note. The land is appraised at $30,000 and the building is appraised at $90,000. Sometimes, a company pays one price for several assets. This is sometimes called a “basket purchase.” Accounting principles require that companies must assign a cost to each uniquely identifiable asset that is acquired. In the case of a basket purchase, or lump-sum purchase, the total cost must be allocated to each of the assets acquired. This is accomplished by allocating the cost to each asset based on its market value relative to the total market value of the assets acquired. Smart Touch Learning paid $100,000 on August 1 for land and a building. The $100,000 must be allocated; some to the land and some to the building. The land has an appraised market value of $30,000 and the building is appraised at $90,000, for a total market value of $120,000. How much cost should be allocated to the land and to the building? Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

Lump-Sum Purchases As noted, the total market value is $120,000. The land represents 25% ($30,000 ÷ $120,000) of the purchase, and the building represents 75% ($90,000 ÷ $120,000) of the purchase. Next, we will apply these percentages to allocate the cost of $100,000. Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

Prepare the journal entry.
Lump-Sum Purchases In our example, 25% of the cost should be allocated to the land (25% * $100,000 = $25,000) and 75% of the cost should be assigned to the building (75% * $100,000 = $75,000). Next prepare the journal entry to record the acquisition of the land and building. Prepare the journal entry. Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

Lump-Sum Purchases The journal entry will include a debit of $25,000 to Land, a debit of $75,000 to Building, and a credit of $100,000 to Notes Payable (assuming that the company borrowed the acquisition cost). Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

>TRY IT! In the Try It example, Budget Banners pays $200,000 for a bulk purchase of land, building, and equipment. The land had a market value of $22,000. The building had a market value of $187,000. The equipment had a market value of $11,000. Allocate the $200,000 acquisition cost to the three assets and record the acquisition. Prepare the journal entry. Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

>TRY IT! The total market value of the acquired assets is $220,000. The land represents 10% of the purchase. The building represents 85% of the purchase. The equipment represents 5% of the purchase. The journal entry to record the acquisition includes a debit to Land for $20,000, a debit to Building for $170,000, a debit to Equipment for $10,000, and a credit to Cash for $200,000. Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

What Is Depreciation? Plant assets are recorded as assets when purchased. Depreciation is the process of allocating an asset’s cost to expense over its useful life. Remember, to record depreciation, we debit Depreciation Expense and credit Accumulated Depreciation (a contra-asset). The plant assets are recorded as assets when they are purchased. Over time, the usefulness of those assets is consumed. To account for the “using up” of the plant assets and in accordance with the Matching Principle, we will need to periodically and systematically allocate the cost of the plant assets from the balance sheet to the income statement. This process is referred to as Depreciation. As discussed earlier, the depreciation process is part of the end-of-period adjustment process. Depreciation Expense will be debited and a contra-account called Accumulated Depreciation will be credited. Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

Factors in Computing Depreciation
The Depreciation computation requires three main factors: Estimated useful life Capitalized Cost Estimated residual value The estimated expected use from an asset. The estimated value of the asset at the end of its useful life. To compute depreciation for a period, we will need to consider three primary factors: estimated useful life, the capitalized cost of the asset, and the estimated residual value of the asset at the end of its estimated useful life. Total amount of cost to be allocated. Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

Depreciation Methods Straight-Line Units-of-Production
There are three common depreciation methods: Straight-Line Units-of-Production Declining-Balance Smart Touch Learning purchases a truck on January 1, 2014 There are three common depreciation methods: straight-line depreciation, units-of-production depreciation, and declining-balance depreciation. As we work through each method, we will use the following information. Smart Touch Learning purchases a truck on January 1, The truck has a cost of $41,000 and an estimated residual value of $1,000. The estimated useful life of the truck is 5 years, or 100,000 miles. Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

The most widely used and most easily understood method.
Straight-Line Method The most widely used and most easily understood method. Results in the same amount of depreciation in each year of the asset’s service life. Under the Straight-Line Method, residual value is deducted from the depreciable cost and then divided by the estimated useful life of the asset. Straight-Line is the most widely used method in business today. The result is that, for each year of an asset’s estimated useful life, the depreciation computation will be the same each year of the asset’s estimated useful life. Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

Prepare the journal entry at December 31, 2014.
Straight-Line Method In the Smart Touch Learning example, the depreciable cost is $40,000. Divided by an estimated useful life of 5 years, the annual depreciation for the truck is $8,000 per year. Prepare the journal entry at December 31, 2014. Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

Straight-Line Method The journal entry to record the depreciation for the truck will include a debit to Depreciation Expense for $8,000 and a credit to Accumulated Depreciation for $8,000. Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

Units-of-Production Method
Depreciation is a function of how much an asset is USED, rather than its age. Less predictable than other methods. Smart Touch Learning purchases a truck on January 1, 2014 The Units-of-Production Method requires us to compute depreciation based on how much an asset is actually used relative to its expected productivity over it estimated useful life. This is less predictable than other methods. Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

Assuming Smart Touch Learning drives the truck 20,000 miles in the first year, how much depreciation should be recorded? Assume that in the first year of its use, the truck was driven 20,000 miles. The first step is to compute the depreciation per unit of use. In this case, the asset is expected to have a useful life of 100,000 miles. The depreciable cost of the truck is $40,000. So, the truck will be depreciated $0.40 per mile for every mile driven. Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

Assuming Smart Touch Learning drives the truck 20,000 miles in the first year, how much depreciation should be recorded? In Step 2, we compute the amount of depreciation for the current period based on the depreciation per unit of use and the actual use. In this case, $0.40 per mile for 20,000 miles results in depreciation in year 1 of $8,000. That this is the same depreciation amount as the straight-line method is only a coincidence. Because this method is so unpredictable, we have no idea how much depreciation will be in year 2. It might be as much as $32,000 (if the truck is driven as much as 80,000 miles in year 2) or $0 (if the truck is not used at all in year 2). Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

Double-Declining Balance Method
An accelerated method. More depreciation early in an asset’s life. Total depreciation the same over the asset’s full life. Smart Touch Learning purchases a truck on January 1, 2014 The Double-Declining Balance Method is called an “accelerated” method. Although the total depreciation on the asset over its estimated useful life is the same under all three methods, in the double-declining balance method, more depreciation is taken in the early years of its estimated useful life, while taking less depreciation in the later years of the asset’s estimated useful life. Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

Multiply an asset’s declining book value by twice the straight-line depreciation rate. The book value of the asset as of the beginning of each period is multiplied by twice the straight-line depreciation rate. Each year, the book value of the asset will be lower than the book value the previous year. For example, in year 1, Smart Touch Learning’s truck will have $16,400 of depreciation, compared to only $8,000 depreciation using the straight-line method. Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

Multiply an asset’s declining book value by twice the straight-line depreciation rate. In year 2 of the asset’s useful life, the depreciation will be computed as $9,840. At the beginning of year 1, the book value was $41,000. At the beginning of year 2, the book value is now only $24,600. We will continue to change the book value of the asset each year until book value reaches the estimated residual value. Once book value reaches residual value, we cease computing any additional depreciation. Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

Journalize entries for the disposal of plant assets
Learning Objective 3 Journalize entries for the disposal of plant assets Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

Discarding Plant Assets
When an asset is disposed, sold, or retired, it must be removed from the books. All related Accumulated Depreciation must also be removed from the books. Gains/Losses on disposal are recorded. STEPS Bring depreciation up to date. Remove original cost of asset and accumulated depreciation from the books. Record any cash received. Record the difference between book value and the cash received as a gain or loss. At some point, a plant asset will cease to be useful. Perhaps, it is obsolete, or it is just so old that it no longer runs efficiently. Whatever the reason, a company will discard previously useful long-lived assets. When that happens, the asset must be removed from the books. In addition, any accumulated depreciation related to the discarded asset will also be removed from the books. If cash is received from the discarding of the asset, it is necessary to record the receipt of it. It may be necessary to record either a gain or loss on disposal of the asset. Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

Discarding Plant Assets Example #1
On July 1, Smart Touch Learning discards equipment that cost $10,000. The accumulated depreciation on the asset is $10,000. In this first example, we will examine a case of a simple “retirement” of a long-lived asset. It is not being sold, but rather it is being discarded, not to be used any longer. Smart Touch Learning discards equipment that cost $10,000. The accumulated depreciation on the asset is $10,000. In other words, the asset is fully depreciated. There is no cash involved in this transaction. Prepare the journal entry at July 1, 2013. Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

On July 1, Smart Touch Learning discards equipment that cost $10,000. The accumulated depreciation on the asset is $10,000. The journal entry to record depreciation for the period will include a credit to Equipment to remove its original cost. In addition, a debit to Accumulated Depreciation will remove the related balance from the books. Because there is no cash involved, this journal entry is now balanced. Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

On July 1, Smart Touch Learning discards equipment that cost $10,000. As of December 31 the previous year, the accumulated depreciation on the asset was $8,000. Annual depreciation per year is $1,000. In the second example, Smart Touch Learning discards equipment that cost $10,000. Unlike the previous example, the asset is not already fully depreciated. Because the asset sold in the middle of the year, we must compute and record a half year’s depreciation before recording the asset’s disposal. The asset already had $8,000 accumulated depreciation. There is no cash involved in this transaction. Prepare the journal entry at July 1, 2013. Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

On July 1, Smart Touch Learning discards equipment that cost $10,000. As of December 31 the previous year, the accumulated depreciation on the asset was $8,000. Annual depreciation per year is $1,000. First we have to compute the half year’s depreciation. First, we have to update the depreciation. Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

On July 1, Smart Touch Learning discards equipment that cost $10,000. As of December 31 the previous year, the accumulated depreciation on the asset was $8,000. Annual depreciation per year is $1,000. Depreciation for half a year is computed as the normal annual depreciation x 6/12 ($1,000 * 6/12 = $500). The entry to record the depreciation is a debit to Depreciation Expense for $500 and a credit to Accumulated Depreciation for $500. This will change the Accumulated Depreciation balance from $8,000 to $8,500. Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

On July 1, Smart Touch Learning discards equipment that cost $10,000. As of December 31 the previous year, the accumulated depreciation on the asset was $8,000. Annual depreciation per year is $1,000. Second, we need to record the disposal. Second, record the disposal. Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

On July 1, Smart Touch Learning discards equipment that cost $10,000. As of December 31 the previous year, the accumulated depreciation on the asset was $8,000. Annual depreciation per year is $1,000. The entry will require a debit to Accumulated Depreciation for $8,500 and a credit to Equipment to $10,000. The difference of $1,500 is debited to Loss on Disposal. Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

On July 1, Smart Touch Learning sells equipment for $4,000. The equipment cost $10,000. As of December 31 the previous year, the accumulated depreciation on the asset was $8,000. Annual depreciation per year is $1,000. In the third example, on July 1, Smart Touch Learning sells equipment for $4,000. The equipment originally cost $10,000. As of the previous December 31, the accumulated depreciation on the equipment was $8,000. Annual depreciation expense is normally $1,000 per year. Prepare the journal entries for this transaction. Prepare the journal entries at July 1, 2013. Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

On July 1, Smart Touch Learning sells equipment for $4,000. The equipment cost $10,000. As of December 31 the previous year, the accumulated depreciation on the asset was $8,000. Annual depreciation per year is $1,000. First, because six months have past since the last recording of depreciation, we must make an entry to record depreciation from December 31 to July 1 (6 months). The computation is: $1,000 * 6/12 = $500. First, update depreciation. Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

On July 1, Smart Touch Learning sells equipment for $4,000. The equipment cost $10,000. As of December 31 the previous year, the accumulated depreciation on the asset was $8,000. Annual depreciation per year is $1,000. The entry to record the additional depreciation will require a debit to Depreciation Expense for $500 and a credit to Accumulated Depreciation for $500. This will bring the Accumulated Depreciation balance to $8,500. Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

On July 1, Smart Touch Learning sells equipment for $4,000. The equipment cost $10,000. As of December 31 the previous year, the accumulated depreciation on the asset was $8,000. Annual depreciation per year is $1,000. Next, we need to record the entry to record the sale of the equipment. Second, record the sale. Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

On July 1, Smart Touch Learning sells equipment for $4,000. The equipment cost $10,000. As of December 31 the previous year, the accumulated depreciation on the asset was $8,000. Annual depreciation per year is $1,000. The entry includes a debit to Cash for the amount of cash received ($4,000), a debit to Accumulated Depreciation to take that account off the books ($8,500), and a credit to Equipment for $10,000 to remove the equipment from the books. At this point the journal entry is not balanced. We have $12,500 in debits and $10,000 in credits. To make the entry balance, we record a credit to Gain on Sale of Equipment for $2,500. Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

Account for natural resources
Learning Objective 4 Account for natural resources Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

Natural Resources Assets that come from the earth and are consumed. The value of the “reserves” that a company owns/controls is a long-term asset. Includes: Iron ore Oil Natural Gas Coal Timber Diamonds Gold and silver In addition to long-lived assets, there is another type of asset referred to as Natural Resources. Natural Resources are like inventory because we will sell them. However, they are also a long-term asset that will take years to extract from the environment. Natural Resources include iron ore, oil, natural gas, coal, timber, diamonds, gold and silver, and other important minerals. When the right to extract Natural Resources is acquired, the acquiring company will record the cost of the reserves as a long-lived asset. Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

Natural Resources As the resources are extracted, Depletion Expense is recorded. A contra-asset Accumulated Depletion is also recorded. Steps (similar to Units-of-Production) Compute Depletion per Unit (based on estimated reserves) Compute Depletion for the period (based on actual extraction) As the Natural Resources are extracted, we have to move part of the cost of the reserves to the income statement. This process is called Depletion. Depletion Expense is computed based on the units-of-production method. A cost per unit of resource is determined based on the cost paid for the reserves and the estimated amount of reserves available to be extracted. Once we determine the amount of resources extracted in a period, we can multiply that by the depletion expense per unit of natural resource to arrive at Depletion Expense. The other side of the entry will be a credit to Accumulated Depletion. Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

Prepare the journal entry for Depletion Expense.
Natural Resources A company owns oil reserves that cost $700,000 and is estimated to contain 70,000 barrels of oil. During the year, 3,000 barrels of oil are extracted. A company acquires the rights to 70,000 estimated barrels of oil for $700,000. During the year, 3,000 barrels of oil are extracted from the reserves. Prepare the journal entry for Depletion Expense. Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

Step 1: Compute Depletion per Unit.
Natural Resources The depletion per barrel is computed at $10 per barrel. Step 1: Compute Depletion per Unit. Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

Step 2: Compute Depletion for the Period.
Natural Resources In step 2, we will multiply the depletion per barrel ($10) by the number of barrels extracted during the period (3,000) for Depletion Expense of $30,000. Step 2: Compute Depletion for the Period. Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

Prepare the journal entry for Depletion Expense.
Natural Resources Now record the journal entry to record Depletion Expense. Prepare the journal entry for Depletion Expense. Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

>TRY IT! Amplify Petroleum holds reserves of oil representing an estimated 100 million barrels. The cost of those reserves was $80,000,000. If Amplify Petroleum extracts and sells 20 million barrels in 2015, what is the depletion for the year? In this Try It exercise, Amplify Petroleum has oil reserves of 100 million barrels. They paid $80 million for those reserves. This makes the depletion per barrel $0.80. During the year, Amplify Petroleum extracts 20 million barrels of oil from this site. Prepare the journal entry. Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

>TRY IT! Amplify Petroleum holds reserves of oil representing an estimated 100 million barrels. The cost of those reserves was $80,000,000. If Amplify Petroleum extracts and sells 20 million barrels in 2015, what is the depletion for the year? The amount of depletion expense is $16,000,000 ($0.80 * 20,000,000). The entry will require a debit to Depletion Expense of $16,000,000 and a credit to Accumulated Depletion of $16,000,000. Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

Intangible Assets Assets that have no physical substance. Usual convey rights to the owner. Recorded at cost. Research and development costs are NOT included. Includes Patents Copyrights Trademarks Franchise Agreements Licenses Goodwill The final group of long-lived assets are Intangible assets. These are assets that have no physical substance. In some cases, but not all cases, the intangible asset is represented by a piece of paper that cedes ownership of the intangible asset to the owner. Intangible assets include patents, copyrights, trademarks, franchise agreements, licenses, and goodwill. Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

Intangible Assets As intangible assets “expire,” they must be “amortized.” Amortization expense is recorded: Based on the straight-line method Use the shorter of the useful life or the legal life Only for intangible assets with definite life For purposes of amortization, the life of an intangible asset is usually defined by the shorter of its legal life or useful life. However, only definite-life intangible assets are amortized. Intangible assets with an indefinite life are not amortized. Amortization is similar to straight-line depreciation. Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

Intangible Assets There is no contra-asset account used with the amortization process. The intangible asset is credited directly. Each year the asset’s book value will decrease by the amount of the amortization. Unlike the depreciation or depletion processes, amortization does not utilize a contra-asset account to “store” the accumulated amortization. Rather, as amortization expense is incurred, it is credited directly against the intangible asset. Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

>TRY IT! On January 1, Orange Manufacturing paid $40,000 for a patent. It has a legal life of 20 years. The patent is expected to give legal protection for 8 years. In this Try It exercise, Orange Manufacturing paid $40,000 for a patent. The patent has a legal life of 20 years, but it is expected that the actual useful life of the patent will only be about 8 years. Prepare the amortization journal entry for this patent at the end of the year. Prepare the journal entry. Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

>TRY IT! On January 1, Orange Manufacturing paid $40,000 for a patent. It has a legal life of 20 years. The patent is expected to give legal protection for 8 years. Amortization of this patent is a simple computation of: Cost ÷ Estimated Useful Life In this case, the amortization for the year is $5,000 ($40,000 ÷ 8 years). The entry will require a debit to Amortization Expense for $5,000 and a credit to Patent for $5,000. Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

Use the asset turnover ratio to evaluate business performance
Learning Objective 6 Use the asset turnover ratio to evaluate business performance Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

Asset Turnover Ratio Used to measure how well a company is using its assets to generate sales revenue. The asset turnover ratio is used to measure how well a company utilizes its assets in generating sales. It is a simple calculation of: Net Sales (after deducting sales discounts and sales returns and allowances) ÷ Average Total Assets Average Total Assets = (Beginning of Period Total Assets + End of Period Total Assets) ÷ 2 Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

Journalize entries for the exchange of plant assets (Appendix 9A)
Learning Objective 7 Journalize entries for the exchange of plant assets (Appendix 9A) Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

Exchange Plant Assets An exchange includes aspects of a sale and a disposal. Special accounting is required if the exchange transaction has commercial substance. i.e.; the future cash flows will change as a result of the exchange. Sometimes plant assets are not simply sold or purchased. Sometimes an old asset is included in the transaction as a whole or partial exchange for a new asset. This is common when purchasing a new vehicle, for example. An old vehicle will be traded in to the car dealer as part of the transaction. Most trade-in, or exchange, transactions have “commercial substance”; i.e. the future cash flows of the company do change as a result of the exchange. Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

Exchange Plant Assets If an exchange lacks commercial substance, the new asset is recorded at the book value of the asset that is given up, plus/minus any cash exchanged as part of the transaction. An auto dealer trades a blue sedan to another auto dealer for a similar sedan in black to satisfy a customer’s preference. There is no commercial substance related to this transaction. The future cash flows do not change. When there is no commercial substance, the new asset is recorded as the book value of the asset that is given up plus or minus cash exchanged. For example if a company trades in an old car for a similar old car (perhaps for a different color), then the acquired car would be recorded on the books at the book value of the old car that is traded in plus the cash paid minus the cash received. Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

Exchange Plant Assets On December 31, Smart Touch Learning exchanges used equipment and $2,000 cash for new equipment. The old equipment has a cost of $10,000 and accumulated depreciation of $9,000. The new equipment has a market value of $8,000. If an exchange has commercial substance, the new asset is recorded at its market value on the date of the exchange. Gains or losses may have to be recorded. However, if there IS commercial substance then the new asset is recorded at its market value, regardless of the book value of the asset traded in. In such cases, gains or losses may need to be recorded. Assume that on December 31, Smart Touch Learning exchanges used equipment plus $2,000 cash for new equipment. The old equipment has a cost of $10,000 and accumulated depreciation of $9,000, or a book value of $1,000. Smart Touch Learning acquires new equipment having a market value of $8,000. How should we record the transaction? Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

Exchange Plant Assets Take the old equipment off the books. Record the cash payment. Record the new asset. Record any gain or loss. The steps are quite simple: Take the old equipment off the books. Record the cash payment. Record the new asset. Record any gain or loss. Prepare the journal entry. Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

Exchange Plant Assets Take the old equipment off the books. Record the cash payment. Record the new asset. Record any gain or loss. Step 1: Credit the old equipment for $10,000 and debit Accumulated Depreciation for $9,000. Step 2: Credit Cash for $2,000 to recognize the cash payment. Step 3: Debit the new Equipment for its market value of $8,000. Step 4: Record a Gain on Exchange of $5,000 to balance the journal entry. Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

>TRY IT! Area Salvage Company purchased equipment for $10,000. Over the asset’s life, they recorded accumulated depreciation of $8,000. They exchange the old equipment and $4,000 for new equipment with a market value of $5,000. In this Try It exercise, Area Salvage Company purchased equipment for $10,000. Over the asset’s life, Area Salvage Company records Accumulated Depreciation of $8,000 on the equipment. Later they exchange this old equipment plus $4,000 for new equipment with a fair market value of $5,000. Prepare the journal entry. Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

>TRY IT! Area Salvage Company purchased equipment for $10,000. Over the asset’s life, they recorded accumulated depreciation of $8,000. They exchange the old equipment and $4,000 for new equipment with a market value of $5,000. Step 1: Debit Accumulated Depreciation for $8,000 and credit Equipment (old) for $10,000. Step 2: Credit Cash for $4,000. Step 3: Debit Equipment (new) for $5,000. Step 4: A Loss on Exchange for $1,000 must also be recorded in order for the entry to balance. Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

Plant Assets, Natural Resources, and Intangibles

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Plant Assets, Natural Resources, and Intangibles

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