1. Operating Assets: Property, Plant, and Equipment, and Intangibles
Chapter 8
Operating Assets: Property, Plant, and Equipment, and Intangibles

2. Operating Assets
Two categories of operating assets presented on the balance sheet:
Property, Plant and Equipment
Intangible Assets
Presented at their acquisition cost (historical cost)
Essential to a company’s long-term future
Used to produce the goods or services the company sells to customers
Constitute the major productive assets of many companies
LO 1

3. Balance Sheet Presentation of Property, Plant, and Equipment
Balance sheet uses one line item for property, plant, and equipment and presents the details in the notes

4. Acquisition of Property, Plant, and Equipment
Initially recorded at acquisition cost or original cost
Includes all cost normally necessary to acquire an asset and prepare it for its intended use
Purchase price
Taxes paid at time of purchase (for example, sales tax)
Transportation charges
Installation costs
LO 2

5. Group Purchase
Firm purchases several assets as a group and pays a lump-sum amount
Acquisition cost of each asset is separately measured on the basis of the proportion of the fair market value of each
LO 3

6. Example 8.1—Determining Cost When a Group of Assets Is Purchased
Assume that on January 1, ExerCo purchased a building and the land on which it is situated for $100,000. The accountant established the assets’ fair market value on January 1 as follows:
Based on the estimated market values, purchase price should be allocated as follows:
To land $100,000 × $30,000/$120,000 = $25,000
To building $100,000 × $90,000/$120,000 = $75,000

7. Example 8.1—Determining Cost When a Group of Assets Is Purchased (continued)
The effect of the transaction can be identified and analyzed as follows:

8. Capitalization of Interest
The interest on borrowed money should be treated as an expense of the period
If a company constructs an asset over a period of time and borrows money to finance the construction
The interest incurred during the construction period is not treated as interest expense
The interest must be included as part of the acquisition cost of the asset
LO 4

9. Land Improvements
The acquisition cost of land should be kept in a separate account because land has an unlimited life and is not subject to depreciation
Costs associated with land should be recorded in an account such as Land Improvements
Example: Costs of paving a parking lot and landscaping costs
Have a limited life
Should be depreciated over their useful lives

10. Use and Depreciation of Property, Plant, and Equipment
Depreciation: allocation of the original cost of an asset to the periods benefited by its use
An asset’s decline in usefulness is related to:
Physical deterioration from usage or from the passage of time
Obsolescence factors such as changes in technology
The company’s repair and maintenance policies
LO 5

11. Use and Depreciation of Property, Plant, and Equipment
Methods of depreciation:
Straight-line
Units-of-production
Accelerated depreciation
The method chosen should be one that best matches the expense to the revenue generated by the asset

12. Straight-Line Method
Allocates the cost of the asset evenly over time

13. Example 8.2—Computing Depreciation Using the Straight-Line Method
Assume that on January 1, 2014, ExerCo, a manufacturer of exercise equipment, purchased a machine for $20,000. The machine’s estimated life would be five years, and its residual value at the end of 2018 would be $2,000. The annual depreciation should be calculated as follows:
The book value at the end of 2014

14. Example 8.2—Computing Depreciation Using the Straight-Line Method (continued)
The book value at the end of 2014

15. Units-of-Production Method
Depreciation is determined as a function of the number of units the asset produces

16. Example 8.3—Computing Depreciation Using the Units-of-Production
ExerCo has estimated that the total number of units that will be produced during the asset’s five-year life is 18,000. During 2014, ExerCo produced 4,000 units. The depreciation per unit for ExerCo’s machine can be calculated as follows:
The book value at the end of 2014

17. Accelerated Depreciation Method
Higher amount of depreciation is recorded in the early years than in later years
Double-declining-balance method: recorded at twice the straight-line rate, but the balance is reduced each period

18. Example 8.4—Computing Depreciation Using the Double-Declining-Balance Method
Assume that ExerCo wants to depreciate its asset using the double-declining-balance method. The first step is to calculate the straight-line rate as a percentage. The straight-line rate for the ExerCo asset with a five-year life is as follows:
The second step is to double the straight-line rate, as follows:
The amount of depreciation for 2014
The amount of depreciation for 2015

19. Example 8.4—Computing Depreciation Using the Units-of-Production (continued)
The complete depreciation schedule for ExerCo for all five years of the machine’s life would be as follows:

20. Exhibit 8.1—Comparison of Depreciation and Book Values of Straight-Line and Double-Declining-Balance Methods

21. Exhibit 8.2—Management’s Choice of Depreciation Method

22. Changes in Depreciation Estimate
Change in the life of the asset or in its residual value
Recorded prospectively
The depreciation recorded in prior years is not corrected or restated
The new estimate should affect the current and future years
LO 6

23. Example 8.5—Calculating a Change in Depreciation Estimate
$20,000 machine originally expected to be depreciated over 5 years. After 2 years, useful life is increased to 7 years
$3,600
$3,600
2012
2013
2014
2015
2016
revise
estimate
Depreciation
From 5 years to 7 years

24. Example 8.5—Calculating a Change in Depreciation Estimate (continued)
$3,600
$3,600
$2,160
$2,160
$2,160
$2,160
$2,160
2012
2013
2014
2015
2016
2017
2018
revise
estimate
Depreciation

25. Example 8.5—Calculating a Change in Depreciation Estimate (continued)
In Example 8-5, the effect of the transaction can be identified and analyzed as follows:

26. Capital vs. Revenue Expenditures
Capital Expenditure
Increases the life of the asset or its productivity
Treated as an asset (Balance sheet)
Revenue Expenditure
Maintains an asset in its normal operating condition
Treated as an expense (Income statement)
LO 7

27. Capital vs. Revenue Expenditures

28. Example 8.6—Capitalizing Costs of a Major Repair
At the beginning of 2016, ExerCo made a $3,000 overhaul to the machine, extending its life by three years. Because the expenditure qualifies as a capital expenditure, the cost of overhauling the machine should be added to the asset account.
Beginning in 2016, the company should record depreciation of $2,300 per year, computed as follows:

29. Example 8.6—Capitalizing Costs of a Major Repair (continued)
The effect of the transaction for the overhaul is as follows:

30. Example 8.6—Capitalizing Costs of a Major Repair (continued)
The effect of the transaction to record depreciation for 2016 can be identified and analyzed as follows:

31. Disposal of Property, Plant, and Equipment
Occurs when the asset is sold, traded, or discarded
Update depreciation to the date of disposal and calculate gain or loss
A gain occurs when the selling price of the asset exceeds its book value
A loss occurs when the selling price of the asset is less than its book value
Gain or loss is reported in the Other Income or Expense category of the income statement
LO 8

32. Gain on Sale of an Asset
On January 1,2014, ExerCo purchased a machine 2014, for $20,000, estimating its life to be five years and the residual value to be $2,000. ExerCo used the straight-line method of depreciation. ExerCo sold the machine on July 1, Depreciation for the six-month period from January 1 to July 1, 2016, is $1,800 ($3,600 per year × 1/2 year = 1,800). The effect of the transaction for depreciation can be identified and analyzed as follows:

33. Example 8.7—Calculating the Gain on Sale of an Asset
Assume that ExerCo purchased a machine on January 1, 2014, for $20,000, estimating its life to be five years and the residual value to be $2,000. ExerCo used the straight-line method of depreciation. ExerCo sold the machine on July 1, 2016,for $12,400. The gain can be calculated as follows:

34. Example 8.7—Calculating the Gain on Sale of an Asset (continued)
After the July 1 entry, the balance of the Accumulated Depreciation—Machine account is $9,000, which reflects depreciation for the 2½ years from the date of purchase to the date of sale. The effect of the transaction for the sale can be identified and analyzed as follows:

35. Example 8.8—Calculating the Loss on Sale of an Asset
Assume that ExerCo purchased a machine on January 1, 2014, for $20,000, estimating its life to be five years and the residual value to be $2,000. ExerCo used the straight-line method of depreciation. ExerCo sold the machine on July 1, 2016,for $10,000. The loss is calculated as follows:

36. Example 8.8—Calculating the Loss on Sale of an asset (continued)
The effect of the transaction for the sale can be identified and analyzed as follows:

37. IFRS and Property, Plant, and Equipment
IFRS requires estimates of residual value and the life of the asset be reviewed at least annually
FASB standards does not require the annual review
The international standards also indicate that companies should determine the components of an asset and depreciate each component separately
International Standards allow companies to revalue the assets to reflect their fair market values
FASB does not allow the revaluing to fair market value

38. Operating Assets: Intangible Assets
Assets with no physical properties
Long-term assets and should be shown separately from property, plant, and equipment
LO 9

39. Operating Assets: Intangible Assets
Most common intangible assets:
Patent: right to use, manufacture, or sell a product
Copyright: right to reproduce or sell a published work
Trademark: symbol or name that allows a product or service to be identified
Goodwill: excess purchase price to acquire a business over the value of net assets acquired

40. Acquisition Cost of Intangible Assets
Includes cost to acquire and prepare it for its intended use
Acquisition Cost (i.e., legal fees, registration fees, etc.)
Purchase Price +

41. Exhibit 8.4—The Nike, Inc., Consolidated Assets Section and Intangibles Notes

42. Research and Development Costs
Costs incurred in the discovery of new knowledge
According to FASB, all such expenditures must be treated as expenses in the period incurred
Patent account should not include the costs of research and development of a new product

43. Amortization of Intangibles
Intangibles with finite life must be amortized
Recorded over the legal life or the useful life, whichever is shorter
Mostly recorded using the straight-line method
Intangibles with indefinite life are not amortized
Example: trademark, goodwill, and broadcast license
LO 10

44. Example 8.9—Calculating the Amortization of Intangibles
Assume that Nike developed a patent for a new shoe product on January 1, The costs involved with patent approval were $10,000, and the company wants to record amortization on the straight-line basis over a five-year life with no residual value. In this case, the useful life of the patent is less than the legal life. Nike should record amortization over the useful life as $10,000/5 years = $2,000. The effect of the amortization for 2014 is as follows:

45. Example 8.9—Calculating the Amortization of Intangibles
Some companies decrease (credit) the intangible asset account directly. In that case, the preceding transaction is recorded as follows:

46. Intangibles with Indefinite Life
If an intangible asset has an indefinite life, amortization should not be recognized

47. Goodwill and Impairments
As per the FASB, goodwill should be treated as an intangible asset with an indefinite life and that companies should not record amortization expense related to goodwill
Each year, Assets with indefinite life should be checked for impairment
If an impairment has occurred, a loss should be recognized

48. Goodwill and Impairments
Assume that Nike learns on January 1, 2015, when accumulated amortization is $2,000 (or the book value of the patent is $8,000), that a competing company has developed a new product that renders Nike’s patent worthless. Nike has a loss of $8,000 and should record an entry to write off the asset as follows:

49. IFRS and Intangible Assets
International standards are more flexible than the FASB standards in allowing the use of fair market values for intangible assets
Active market must exist
Fair value must be possible to determine
Research and development costs
FASB: all such costs should be treated as an expense
IFRS: Research costs be treated as an expense and development costs can be capitalized as an asset

50. Exhibit 8.5—Long-Term Assets and the Statement of Cash Flows

51. Analyzing Long-term Assets—Average Life
Ratios are used to determine the age, composition, and quality of the operating assets
What is the average depreciable period (or life) of the company’s assets?
Property, Plant, and Equipment
Depreciation Expense
Average Life =
LO 12

52. Analyzing Long-term Assets—Average Age
Are assets old or new?
Accumulated Depreciation
Depreciation Expense
Average Age =

53. Analyzing Long-term Assets—Asset Turnover
How productive are the company’s assets?
Net Sales
Average Total Assets
Asset Turnover =

54. The Ratio Analysis Model
What is the average life of the assets? What is the average age of the assets? How productive are the assets in producing revenue for the company?
Gather the information about net sales and cost of goods sold
Calculate the average life and average age
Compare the ratio with prior years and with competitors
Interpret the ratios

55. The Business Decision Model
If you were a lender, would you be willing to lend money to Nike, Inc., and use the operating assets as collateral for the loan?
Gather information from the financial statements and other sources
Compare the ratios with industry averages and look at trends
Lend money or find an alternative use for the money
Monitor the investment periodically

56. End of Chapter 8