Long-Lived Tangible and Intangible Assets

Long-Lived Tangible and Intangible Assets
Chapter 9 Long-Lived Tangible and Intangible Assets PowerPoint Author: Brandy Mackintosh, CA Chapter 9: Long-Lived Tangible and Intangible Assets.

Define, classify, and explain the nature of long-lived assets.
Learning Objective 9-1 Define, classify, and explain the nature of long-lived assets. Learning objective number 9-1 is to define, classify, and explain the nature of long-lived assets.

Definition and Classification
Actively Used in Operations 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. Will not be used up within the next year Tangible Physical Substance Intangible No Physical Substance Land Assets subject to depreciation Buildings and equipment Furniture and fixtures Examples Part I Long-lived assets are assets that are used actively in the operations of the business, and that are expected to benefit the operations into the future. Part II There are two major categories of long-lived assets. Tangible plant assets are long-term assets that have physical substance. Intangible assets are long-lived assets without physical substance. Part III Land, buildings, equipment, furniture, and fixtures are examples of long-lived tangible assets. Land is not depreciated. Buildings, equipment, furniture, and fixtures are depreciated. Depreciation allocates the cost of a long-lived asset over the periods benefited by its use. We will study depreciation in detail later in the chapter. Part IV Intangible assets have value represented by rights that produce benefits. Trademarks, copyrights, patents, licensing rights, technology, franchises, and goodwill are examples of intangible assets. We will take a look at each of these later in the chapter. 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. Amortization is a process of allocating cost over the useful life, similar to depreciation.

Apply the cost principle to the acquisition of long-lived assets.
Learning Objective 9-2 Apply the cost principle to the acquisition of long-lived assets. Learning objective number 9-2 is to apply the cost principle to the acquisition of long-lived assets.

Acquisition of Tangible Assets
Acquisition cost includes: purchase price, and all expenditures needed to prepare the asset for its intended use. The cost of a tangible asset includes the purchase price as well as all costs necessary to get the asset in place and ready for its intended use. We record the purchase price net of any cash discounts taken. Generally finance charges are not included in the cost of an asset. If we elect to finance the purchase over a period of time, the interest cost is charged as an expense when incurred. Recording acquisition costs as assets is referred to as capitalizing the costs. Recording costs as assets is called capitalizing the costs.

Purchase cost Legal fees Survey fees Title search fees Land Purchase/construction cost Legal fees Appraisal fees Architect fees Buildings Part I When purchasing land, the cost includes the purchase price, legal fees, survey fees, title search fees, and other costs generally incurred in connection with the purchase such as taxes and recording fees. As noted earlier, land is not a depreciable asset. Part II Whether we purchase or construct a building, the cost should include the purchase price plus any legal fees, appraisal fees, and architect fees as well as any other costs required to prepare the asset for use. Part III Equipment is recorded at its purchase price less any available cash discounts. In addition to the purchase price, the cost of equipment includes sales taxes, delivery charges, and installation costs as well as any other costs required to prepare the asset for use. Purchase/construction cost Sales taxes Transportation costs Installation costs Equipment

Acquisition of Tangible Assets Basket Purchase
The total cost of a combined purchase of land and building is allocated in proportion to their relative market values. 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 assigned to the building and land accounts? Part I It is not uncommon to have a basket purchase of assets. The most common example may be when purchasing a building and land. Remember, the land is not depreciable but the building is. We must assign a portion of the purchase price separately to the building and to the land. When faced with this type of problem, accountants normally divide the cost between the assets on the basis of relative fair market values. Let’s see how this works. Part II On January 1, Jones purchased land and building for $400,000 cash. The appraised value of the building is $325,000, and the appraised value of the land is $175,000. We must determine how to divide the $400,000 purchase price between the land and building. Part III We begin by calculating the relative fair value of each asset as a percent of the total fair value. The total fair value is $500,000. The land has an appraised value of $175,000. So, land is valued at 35 percent of the total fair value. We get the percent by dividing $175,000 by the total fair value of $500,000. We do a similar calculation for the building. Next, we multiply the percentages we just calculated times the purchase price of $400,000 to determine the amount assigned to each asset. In the case of land, we multiply 35 percent times $400,000 and assign $140,000 to the land account. The remainder or $260,000 is assigned to the building account.

Acquisition of Tangible Assets Component Allocation
IFRS takes the idea of a basket purchase one step further. The cost of an individual asset’s components is allocated among each significant component and then depreciated separately over that component’s useful life. Component Allocation IFRS takes the idea of a basket purchase one step further. The cost of an individual asset’s components is allocated among each significant component and then depreciated separately over that component’s useful life. For example, British Airways (now merged into International Airlines Group) separates the cost of an aircraft between its body and engines and interior cabin space, and then depreciates the body and engines over 18 to 25 years, and the cabin interior over 5 years.

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 signed a note payable for the new roller coaster and paid cash for the transportation and installation costs. 1 Analyze Liabilities Assets = Stockholders’ Equity + Cash ,000 Equipment ,750,000 Note Payable +25,000,000 Part I Let’s see how to record the purchase of an asset. Cedar Fair purchased a new roller coaster and assume the list price for the roller coaster (including sales tax) was $26 million but that Cedar Fair received a $1 million discount. In other words, the roller coaster’s net purchase price to Cedar Fair was $25 million. Assume too that Cedar Fair paid $125,000 to have the roller coaster delivered and another $625,000 to have it assembled and prepared for use. We will record the purchase assuming that Cedar Fair signed a note payable for the new roller coaster and paid cash for the transportation and installation. Part II Cedar Fair’s cost is $25,750,000, the purchase price less the discount ($1,000,000) plus the transportation ($125,000) and installation ($625,000) costs. Part III The company will decrease the asset account, Cash, by $750,000, increase the Equipment account for $25,750,000 and increase the liability, Notes Payable, for $25,000,000. Part IV The entry to record the purchase includes a debit to the asset account Equipment for $25,750,000, credit the asset Cash for $750,000, and credit the liability Notes Payable for $25,000,000. 2 Record Equipment Cash Note Payable 750,000 25,000,000 25,750,000

Maintenance Costs Incurred during Use
After a tangible long-lived asset is purchased, a company may incur additional expenditures over the course of asset’s life to maintain or enhance it’s operation. These expenditures are broadly classified as either (1) ordinary repairs and maintenance or (2) extraordinary repairs and maintenance. Ordinary repairs and maintenance are expenditures for the routine maintenance and upkeep of long-lived assets. They are recurring, relatively small expenditures that do not directly increase an asset’s usefulness. In contrast to ordinary repairs and maintenance, extraordinary repairs and maintenance occur infrequently, involve large expenditures, and increase an asset’s economic usefulness through enhanced efficiency, capacity, or lifespan. Examples include additions, major overhauls, complete reconditioning, and major replacements and improvements. Generally, subsequent expenditures for ordinary repairs and maintenance are expensed in the period incurred. However, subsequent expenditures that are for extraordinary repairs and maintenance are capitalized instead of expensed.

Accumulated Depreciation
Depreciation Expense Depreciation is a cost allocation process that matches costs of operational assets with periods benefited by their use. Acquisition Cost Expense Cost Allocation Balance Sheet Income Statement Depreciation Expense Income Statement Depreciation for the current year Part I Depreciation is a process of cost allocation. We allocate the cost of the asset to expense over its useful life in some rational and systematic manner. We do not want to confuse asset valuation, an economic concept, with allocation. The unused portion of the asset’s cost appears on the balance sheet. We allocate a portion of the cost to expense on the income statement each accounting period. Part II The current year’s depreciation is an expense on the income statement. Accumulated Depreciation represents the depreciation taken on the asset since its purchase, and is deducted from the asset’s cost on the balance sheet. Balance Sheet Accumulated Depreciation Total of depreciation to date for an asset

Depreciation calculations require three amounts for each asset:
Depreciation Expense The effects of $130 of depreciation on the accounting equation and the journal entry to record them follow: 1 Analyze Liabilities Assets = Stockholders’ Equity + Accumulated Depreciation (+xA) Depreciation Expense (+E) 2 Record Depreciation Expense Accumulated Depreciation (+xA) 130 Part I The effects of $130 of depreciation on the accounting equation and the journal entry to record them follow: Part II Depreciation expense increases the contra asset account Accumulated Depreciation and increases the expense account Depreciation Expense. Part III We debit the expense account Depreciation Expense and credit the contra asset account Accumulated Depreciation. Part IV Regardless of the method used to calculate depreciation expense, we must know three amounts for the asset: (1) the asset’s acquisition cost; (2) the estimated useful life of the asset, and (3) the estimated residual (salvage) value we expect to receive at the end of its useful life. Once these three amounts are known, we select the depreciation method that we will use to calculate depreciation expense. Depreciation calculations require three amounts for each asset: Acquisition cost. Estimated useful life. Estimated residual value.

Depreciation Expense 2013 Depreciation Includes $125 for 2013
Part I Cedar Fair’s partial income statement in the upper left shows $125 million of Depreciation Expense in 2013. Part II The partial balance sheet in the lower right shows that this $125 million, when combined with depreciation of prior years, brought the total Accumulated Depreciation to $1,250 million at December 31, 2013. Part III The $1,500 difference between the Property and Equipment’s $2,750 cost and $1,250 of Accumulated Depreciation is called the book (or carrying) value. Most companies report a breakdown of these totals by class of asset (e.g., buildings, equipment) in their financial statement notes. Includes $125 for 2013 Book value 2013

Learning Objective 9-3 Apply various depreciation methods as economic benefits are used up over time. Learning objective number 9-3 is to apply various depreciation methods as economic benefits are used up over time.

Depreciation Methods Units-of-production Declining balance
Straight-line Units-of-production Declining balance We will use the following information to illustrate the three methods of depreciation: At the beginning of the year, Cedar Fair purchased a new go-kart Ride for $62,500. The ride has an estimated useful life of 3 years or 100,000 miles and an estimated residual value of $2,500. Part I There are three popular methods of calculating depreciation expense. The easiest and most widely used method is called straight-line depreciation. In special circumstances, we may wish to use the units-of-productions method. We would elect this method if the life of the asset is generally measured in terms of units of production. For example, airplanes keep highly detailed records of engine operating hours. The unit of production may be the operating hours of an aircraft engine. The third method is called the declining-balance method. Under this method, we take more depreciation expense in the early years of the asset’s life and lower amounts of depreciation in later years. Several income tax depreciation calculations are based on the declining balance method. Part II At the beginning of the year, Cedar Fair purchased a new go-kart Ride for $62,500. The ride has an estimated useful life of 3 years or 100,000 miles and an estimated residual value of $2,500. We will use this information to illustration the three depreciation methods.

Straight-Line Method = $20,000 per year ($62,500 - $2,500) × 1 3
($62,500 - $2,500) × 1 3 Part I Managers choose the straight-line depreciation method when an asset is expected to be used up in equal amounts each period of the asset’s estimated useful life.Depreciation expense for each year is determined by taking the asset’s cost less its estimated residual value and multiplying this amount by the fraction of 1 over the asset’s estimated useful life in years. Part II The annual depreciation is $20,000. Cost minus residual value ($62,500 - $2,500 = $60,000) is multiplied by one third. Part III. Notice that depreciation expense is the same amount in each of the three years. If we plot this amount on a graph, it would be a straight-line. That is how we got the name straight-line for this method. Accumulated depreciation increases by $20,000 each year. The cost of the asset ($62,500) less accumulated depreciation at the end of any year is called book value. Book value decreases by $20,000 each year. The book value is equal to the estimated salvage value at the end of the asset’s useful life. We want this to be true regardless of the method we use.

Units-of-Production Method
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? Part I Managers choose the units-of-production depreciation method if the amount of asset production varies significantly from period to period. Depreciation expense for a year is determined by taking the asset’s cost less its estimated residual value and multiplying this amount by the fraction of actual production for the period divided by the estimated total production over the asset’s useful life. Part II Cedar Fair’s new go-kart ride has a 100,000 mile useful life. If the ride is used 30,000 miles in the first year, what is the amount of depreciation expense for the year? Part III The depreciation expense for the first year is $18,000. Cost minus residual value ($62,500 - $2,500 = $60,000) is multiplied by the fraction of 30,000 over 100,000. Let’s look at a table of depreciation expense for this equipment over its life. Remember that we need to know the units produced in each year. = $18,000 ($62,500 - $2,500) × 30, ,000

Units-of-Production Method
Part I In the second column we see the miles for each of the three years within the depreciation calculation. The $18,000 is the depreciation expense from our previous computation. Book value of $44,500 is the acquisition cost of $62,500 less the accumulated depreciation of $18,000. Take time to complete this table before advancing. Part II The depreciation expense amounts for each year are determined by multiplying the asset’s cost less its estimated residual value ($62,500 - $2,500 = $60,000) by the fraction of actual production for the period divided by the estimated total production over the asset’s useful life. Finally, notice that the book value at the end of the third year is equal to the estimated residual value of $2,500.

Declining-Balance Method
What is the amount of amount of depreciation for each of the first two years? = $41,667 ($62,500 - $0) × 2 3 First Year Part I The declining-balance depreciation method is used to report more depreciation expense in the early years of an asset’s life when the asset is more efficient and less in later years as the asset becomes less efficient. Depreciation expense for a year is determined by taking the asset’s cost less its accumulated depreciation and multiplying this amount by the fraction of 2 over the asset’s estimated useful life in years. Part II What is the amount of amount of depreciation for each of the first two years? Part III At the start of the first year the book value of the asset is its acquisition cost of $62,500. For the first year, to determine depreciation expense, we multiply the book value of $62,500 times the double-declining-balance rate of 2/3 and find the depreciation expense of $41,667. Part IV At the start of the second year the book value of the asset is its acquisition cost of $62,500 minus the first year’s depreciation of $41,667. To determine depreciation expense, we multiply the book value times the double-declining-balance rate of 2/3 and find the depreciation expense of $13,889. Part V The double-declining-balance method ignores estimated residual value in the computation of depreciation expense except in the last year when it is subtracted from book value to arrive at that year’s depreciation expense. Second Year = $13,889 ($62,500 - $41,667) × 2 3 Cost – Accumulated Depreciation Annual computation ignores residual value.

Double-Declining-Balance Method
Depreciation expense is limited to the amount that reduces book value to the estimated residual value. Third Year = $4,629 ($62,500 - $55,556) × 2 3 Part I The third year depreciation is calculated to be $4,629. While we always want the book value to be equal to estimated residual value at the end of the asset’s useful life, it just will not work properly using the double-declining- balance method. Part II As you can see, the book value of the asset at the end of the third year is $2,315. It should be $2,500. The only way we can make this work is to force depreciation expense in the last year to be the amount needed to bring book value down to the $2,500 estimated residual value. Part III In the third year, depreciation expense is limited to the amount that will reduce the book value to the estimated residual value of $2,500. For the third year, we will record depreciation expense of $4,444. We determine this amount by subtracting the residual value of $2,500 from the book value at the end of the second year, $6,944.

Summary of Depreciation Methods
Notice that the amount of depreciation expense recorded in each year of an asset’s life depends on the method that is used. That means that the amount of net income that is reported can vary, depending on the depreciation method used. At the end of an asset’s life, after it has been fully depreciated, the total amount of depreciation will equal the asset’s depreciable cost regardless of the depreciation method used. Different depreciation methods can be used for different classes of assets provided they are used consistently over time so that financial statement users can compare results across periods.

Partial Year Depreciation Calculations
When a plant asset is acquired during the year, depreciation is calculated for the fraction of the year the asset is owned. To this point we have discussed depreciation of an asset that was purchased on January first of a particular year. When a plant asset is acquired during the year, depreciation is calculated for the fraction of the year the asset is owned. June 30

Tax Depreciation Most companies use one method of depreciation for reporting to stockholders and a different method for determining income taxes. Keeping two sets of accounting records like this is both ethical and legal because the primary objective of financial reporting differs from that of income tax reporting as you can see in the chart. One of the behaviors the government wants to encourage is economic renewal and growth. Thus, the IRS allows companies to deduct larger amounts of tax depreciation in the early years of an asset’s life than what GAAP allows. The larger tax deduction reduces the company’s income taxes significantly in the years immediately following the purchase of a long-lived asset. Although the IRS allows super-sized deductions in the early years of an asset’s life, it doesn’t allow a company to depreciate more than an asset’s depreciable cost over its life.

Explain the effect of asset impairment on the financial statements.
Learning Objective 9-4 Explain the effect of asset impairment on the financial statements. Learning objective number 9-4 is to explain the effect of asset impairment on the financial statements.

Asset Impairment Losses
Cedar Fair recorded a write-down of $25,000,000 on equipment. 1 Analyze Liabilities Assets = Stockholders’ Equity + Equipment -25,000,000 Loss on Impairment (+E) -25,000,000 Part I If an asset’s value decreases and cannot be recovered through future use or sale, the asset is considered to be impaired and it should be written down to its net realizable value. A loss is recognized when the asset is written down because of an impairment. An impairment can be the result of a casualty, obsolescence, or the lack of demand for the asset’s services. Part II Cedar Fair recorded a write-down of $25 million on equipment from a book value of $30 million to estimated fair value of $5 million. Part III The write down for the impairment loss reduces the asset account Equipment and increases the Loss on Impairment account by $25 million. Part IV We debit Loss on Impairment for $25 million and credit the asset account Equipment for $25 million. 2 Record Loss on Impairment Equipment 25,000,000

Analyze the disposal of long-lived tangible assets.
Learning Objective 9-5 Analyze the disposal of long-lived tangible assets. Learning objective number 9-5 is to analyze the disposal of long-lived tangible assets.

Disposal of Tangible Assets
 Update depreciation to date of disposal.  Record the disposal. dr Cash (+A) Part I Whenever we dispose of a plant asset, the first thing we do is update depreciation to the date of disposal. After completing the update we can record the disposal with a journal entry. Part II We start the journal entry by recording a debit to the Cash account for the amount of the sale price. Part III Next, we remove the plant asset’s cost from our books with a credit, and remove the related Accumulated Depreciation with a debit. Part IV We complete the journal entry by recording any gain or loss on the disposal. If the amount of cash received is greater than the asset’s book value, a gain is associated with the disposal. A gain is recorded with a credit just like revenue and appears on the income statement of the company. dr Accumulated Depreciation (-xA) cr Equipment (-A) Book value cr Gain on Disposal (+R, +SE) Gain if cash received is greater than asset’s book value

 Update depreciation to date of disposal.  Record the disposal. dr Cash (+A) dr Loss on Disposal (+E, -SE) Loss if cash received is less than asset’s book value Part I The procedure is the same when a disposal results in a loss. We first update depreciation to the date of disposal and then record the disposal with a journal entry by recording a debit to the cash account for the amount of the sale price, removing the plant asset’s cost from our books with a credit, and removing the related accumulated depreciation with a debit. Part II A loss results when the cash received is less than the asset’s book value. A loss is recorded with a debit just like an expense and appears on the company’s income statement. Note that when the amount of cash is exactly equal to the book value of the asset, there will be no gain or loss in connection with the disposal. dr Accumulated Depreciation (-xA) cr Equipment (-A) Book value

Cedar Fair sold one of its junior roller coasters for $50,000 cash at the end of its 6th year of use. The equipment originally cost $100,000, and was depreciated using the straight-line method with zero residual value and a useful life of 10 years. The amount of depreciation per year is: a. $0. b. $5,000. c. $10,000. d. $20,000. Annual Depreciation: ($100,000 - $0) ÷ 10 Years = $10,000 per year The amount of depreciation per year is: a. $0. b. $5,000. c. $10,000. d. $20,000. Part I Cedar Fair sold one of its junior roller coasters for $50,000 cash at the end of its 6th year of use. The equipment originally cost $100,000, and was depreciated using the straight-line method with zero residual value and a useful life of 10 years. We will use this information with a series of multiple choice questions to give you some practice accounting for the disposal of a long-lived asset. Try to answer each question before advancing to the next slide. What is the amount of depreciation that should be recorded for each year of the equipment's use up to the date of sale? Part II Annual depreciation is $10,000.

The equipment’s book value at date of sale is:
Disposal of Tangible Assets Cedar Fair sold one of its junior roller coasters for $50,000 cash at the end of its 6th year of use. The equipment originally cost $100,000, and was depreciated using the straight-line method with zero residual value and a useful life of 10 years. The equipment’s book value at date of sale is: a. $40,000. b. $30,000. c. $17,000. d. $16,500. Accumulated Depreciation = (6 yrs. × $10,000) = $60,000 BV = Cost - Accumulated Depreciation BV = $100,000 - $60,000 = $40,000 The equipment’s book value at date of sale is: a. $40,000. b. $30,000. c. $17,000. d. $16,500. Part II After updating the depreciation, what is the equipment’s book value on the date of sale? Book value is calculated by subtracting the Accumulated Depreciation at the date of sale from the equipment’s acquisition cost. The balance in the Accumulated Depreciation account is $60,000, calculated by multiplying the depreciation of $10,000 per year times the 6 years the equipment was owned before the sale. Book value is the $100,000 acquisition cost minus the $60,000 of Accumulated Depreciation. Once we determine the book value of the asset, we can calculate any gain or loss involved with the disposal.

The equipment’s sale resulted in:
Disposal of Tangible Assets Cedar Fair sold one of its junior roller coasters for $50,000 cash at the end of its 6th year of use. The equipment originally cost $100,000, and was depreciated using the straight-line method with zero residual value and a useful life of 10 years. The equipment’s sale resulted in: a. a gain of $10,000. b. a loss of $30,000. c. a loss of $10,000. d. a gain of $50,000. Gain = Cash Received - Book Value Gain = $50, $40,000 = $10,000 The equipment’s sale resulted in: a. a gain of $10,000. b. a loss of $30,000. c. a loss of $10,000. d. a gain of $50,000. Part I Did the sale of the equipment result in a gain or a loss? Part II To determine a gain or loss, compare the cash received of $50,000 with the book value of $40,000. Since the cash proceeds received was greater than the book value, Cedar Fair incurred a gain of $10,000.

Analyze and prepare the journal entry to record Cedar Fair’s sale of the equipment. 1 Analyze Liabilities Assets = Stockholders’ Equity + Equipment ,000 Accumulated Depreciation (-xA) +60,000 Cash ,000 Gain on Disposal (+R) +10,000 Part I Before preparing the journal entry, let’s look at the analysis of the transaction. Part II The asset account, Equipment, will be decreased by $100,000. The contra asset account, Accumulated Depreciation, will be decreased by $60,000. The asset account, Cash, will be increased by $50,000,. As a result of the sale, the Gain on Disposal of $10,000 will be recognized as an increase in Stockholders’ Equity. Part III We record the disposal with debits to the Cash account for $50,000, and to the Accumulated Depreciation account for $60,000. The debit to Accumulated Depreciation on the equipment eliminates the account balance. Next we credit the Equipment account for $100,000, the equipment’s original acquisition cost, and credit the Gain on Disposal for $10,000. 2 Record Cash Accumulated Deprecation (-xA) Equipment Gain on Disposal 100,000 10,000 50,000 60,000

Learning Objective 9-6 Analyze the acquisition, use, and disposal of long-lived intangible assets. Learning objective number 9-6 is to analyze the acquisition, use, and disposal of long-lived intangible assets.

Intangible Assets Intangible Assets
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 Intangible assets lack physical substance and that makes it difficult to determine the asset’s useful life or any residual value. Many intangible assets involve exclusive rights or privileges. We will review the major types of intangible assets and the related accounting procedures on the remaining screens.

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. Intangible assets are normally recorded at the purchase price plus any legal or related fees. Trademarks, copyrights, patents, licensing rights, technology, franchises, and goodwill are examples of intangible assets. We will briefly discuss each of these intangible assets. Amortization is the systematic write-off of the cost of an intangible asset over its useful or legal life, whichever is shorter. Amortization is the same concept as depreciation only we call it a different name because it refers to intangible assets. Goodwill and trademarks have unlimited (or indefinite) lives and are not amortized. According to Generally Accepted Accounting Principles, research and development costs should be expensed as incurred.

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. Part I A trademark or trade name is any symbol, name, phrase, or jingle that is identified with a company, product or service like the name Kleenex or image of McDonald’s golden arches. No other party may use the trademark or trade name without the permission of the holder. Many trademarks are extremely valuable. Internally developed trademarks have no recorded asset cost. Purchased trademarks are recorded at cost. Part II. A copyright grants to the holder the exclusive right to publish and sell musical, literary, or artistic work for the life of the creator plus 70 years. Most copyrights are amortized over a short period of time using the straight-line method.

Patents and Licensing Rights
A patent is an exclusive right granted by the federal government to sell or manufacture an invention. Cost is purchase price plus legal cost to defend. Amortize cost over the shorter of useful life or 20 years. 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. Part I A patent gives the holder the exclusive right to manufacture and sell an item or process for twenty years. A patent is amortized using the straight-line method over its useful life, but never more than 20 years. Most companies amortize patents over a very short period of time. Part II Licensing rights grant limited permission to use a product or service according to specific terms and conditions. For example, you may be using computer software that is made available to you through a campus licensing agreement.

Technology Assets Technology assets include software and Web development work. Technology assets include software and Web development work. Google, Inc., reported $915 million of these assets at the end of Most companies use up intangible technology assets over a relatively short time (three to seven years). Usually used up over a relatively short time (3 – 7 years)

Franchises A franchise provides legally protected rights to sell products or provide services purchased by a franchisee from the franchisor. The holder of a franchise has the right to deliver a product or service under conditions granted by the franchisor. You probably can’t drive down any major street without finding a number of fast-food franchise operations. For example, a business can buy franchise rights that allow it to use the Krispy Kreme name, store format, recipes, and ingredients by paying an up-front fee ranging from $10,000 to $50,000 per store plus ongoing fees of 6.0 percent of store sales.

Goodwill Occurs when one company buys another company.
Purchase Price > Fair Market Value of Net Assets Acquired Only purchased goodwill is an intangible asset. An intangible asset called goodwill can be created when one company buys another company. If the purchase price of the company is greater than the fair value of the net assets and liabilities acquired, we have goodwill associated with the transaction. Goodwill is not amortized. Each year we must test to see if there has been any impairment in the carrying value of the goodwill. If an impairment is determined to exist, we will reduce the goodwill account and recognize the loss in value. Is not amortized. Is impairment tested and may be written down.

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). 1 Analyze Liabilities Assets = Stockholders’ Equity + Accumulated Amortization (+xA) -40,000 Amortization Expense (+E) ,000 Part I 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 divided by 20 years). Part II In analyzing this event we see that the contra asset account, Accumulated Amortization, increases by $40,000 ($800,000 divided by 20 years), and the expense account, Amortization Expense, increases by $40,000. Part III The proper journal entry to record the event is to debit, or increase, Amortization Expense for $40,000, and credit, or increase, the contra asset account, Accumulated Amortization for the same amount. 2 Record Amortization Expense Accumulated Amortization (+xA) 40,000

Summary of Accounting Rules for Long-Lived Assets
Here you see a summary of the accounting procedures for both tangible and intangible assets, from acquisition to disposal. You should find this information useful when you are reviewing the material in this chapter.

Interpret the fixed asset turnover ratio.
Learning Objective 9-7 Interpret the fixed asset turnover ratio. Learning objective number 9-7 is to interpret the fixed asset turnover ratio.

Net Sales Revenue Average Net Fixed Assets
Turnover Analysis Fixed Asset Turnover Net Sales Revenue Average Net Fixed Assets = This ratio measures the sales dollars generated by each dollar invested in fixed assets. Part I The fixed asset turnover ratio is equal to the net sales revenue for a period divided by the average fixed assets. Average fixed assets is computed by dividing the sum of beginning and ending fixed assets by two. Part II Fixed asset turnover provides us with information about how efficiently a company uses its fixed assets to generate sales revenue. Part III Calculate the fixed asset turnover for Cedar Fair using the following information: For the year 2013, Cedar Fair had $1,135 of revenue. End-of-year fixed assets were $1,500 and beginning-of-year fixed assets were $1,540. (All numbers in millions.) For the year 2013, Cedar Fair had $1,135 of revenue. End-of-year fixed assets were $1,500 and beginning-of-year fixed assets were $1,540. (All numbers in millions.)

Turnover Analysis Part I
Cedar Fair’s fixed asset turnover is 0.75, meaning that Cedar Fair generates 75 cents of revenue for each dollar invested in fixed assets. Part II Compared to Cedar Fair and Six Flags, a company such as Facebook needs fewer fixed assets to generate revenue, so it has a higher turnover ratio. Cedar Fair generated about 75 cents of revenue for every dollar invested in net fixed assets, whereas Six Flags generated about 90 cents per dollar. Look closely at the ratios and you can see the reason for the difference. Cedar Fair has invested more in long-lived tangible assets than Six Flags.

Learning Objective 9-8 Describe factors to consider when comparing companies’ long-lived assets. Learning objective number 9-8 is to describe factors to consider when comparing companies’ long-lived assets.

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. Part I. 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. Part II. 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.

Supplement 9A Natural Resources Supplement 9A: Natural Resources

Analyze and report depletion of natural resources
Learning Objective 9-S1 Analyze and report depletion of natural resources Learning objective number 9-S1 is to analyze and report depletion of natural resources.

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. Unsold Inventory Cost of goods sold Depletion is the process of allocating a natural resource’s cost over the period of its extraction. Depletion is similar in concept to depreciation. The units-of-production method is the most common of computing depletion. Depletion that is computed for a period is first added to inventory and then expensed when the inventory is sold. Total depletion cost Inventory for sale

Changes in Depreciation
Supplement 9B Changes in Depreciation Supplement 9B: Changes in Depreciation

Learning Objective 9-S2 Calculate changes in depreciation arising from changes in estimates or capitalized cost. Learning objective number 9-S2 is to calculate changes in depreciation arising from changes in estimates or capitalized cost.

Changes in Depreciation Estimates
Predicted residual value Predicted useful life So depreciation is an estimate. Residual value and useful life of a plant asset are both estimates. Like all estimates, new information may come to light that will warrant a revision of a previous estimate. Let’s see how accountants handle the revision of previous estimates. Over the life of an asset, new information may come to light that indicates the original estimates need to be revised.

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. Shortly after the start of year 5, Cedar Fair changed the initial 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. Shortly after the start of year 5, Cedar Fair changed the estimated useful life to 25 years and lowered the estimated salvage value to $2,400,000. Cedar Fair uses the straight-line method for all equipment. Let’s calculate the proper depreciation expense for year 5 and all years thereafter.

When our estimates change, the new depreciation is: Book value at date of change Residual value at date of change Remaining useful life at date of change – Part I To compute the depreciation expense due to the changes, we use the formula for straight-line depreciation, substituting book value for the original cost, and using the new salvage value and the new estimated useful life. Part II Using the original cost of $60,000,000, an estimated salvage value of $3,000,000, and an estimated useful life of 20 years, we find the annual depreciation to be $2,850,000. After four years the accumulated depreciation is $11,400,000, and the book value is $48,600,000. The revised annual depreciation for year 5 and all years thereafter is $48,600,000 minus $2,400,000 divided by 21 years. The result is $2,200,000 per year.

Chapter 9 Solved Exercises
M9-4, M9-5, M9-6, E9-6, E9-7, E9-9 Chapter 9 Solved Exercises: M9-4, M9-5, M9-6, E9-6, E9-7, E9-9

M9-4 Computing Book Value (Straight-Line Depreciation)
A machine that cost $400,000 has an estimated residual value of $40,000 and an estimated useful life of four years. The company uses straight-line depreciation. Calculate its book value at the end of year 3. = $90,000 per year ($400,000 - $40,000) × 1 4 Year 1 2 3 Depreciation Expense (debit) $ ,000 90,000 Undepreciated Balance (book value) $ ,000 310,000 220,000 130,000 Accumulated (credit balance) $ ,000 180,000 270,000 Part I M9-4 Computing Book Value (Straight-Line Depreciation) A machine that cost $400,000 has an estimated residual value of $40,000 and an estimated useful life of four years. The company uses straight-line depreciation. Calculate its book value at the end of year 3. Part II Depreciation expense for each year is determined by taking the asset’s cost less its estimated residual value and multiplying this amount by the fraction of 1 over the asset’s estimated useful life in years. Part III The annual depreciation is $90,000. Cost minus residual value ($400,000 - $40,000 = $360,000) is multiplied by one fourth. Part IV After three years, the book value is $130,000 ($400,000 cost less $270,000 of accumulated depreciation).

= $54,000 ($400,000 - $40,000) × 3,000 20,000 1st Year Depreciation
M9-5 Computing Book Value (Units-of-Production Depreciation) A machine that cost $400,000 has an estimated residual value of $40,000 and 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, 8,000 hours in year 2, and 6,000 hours in year 3. Calculate its book value at the end of year 3. = $54,000 ($400,000 - $40,000) × 3,000 20,000 1st Year Depreciation Part I M9-5 Computing Book Value (Units-of-Production Depreciation) A machine that cost $400,000 has an estimated residual value of $40,000 and 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, 8,000 hours in year 2, and 6,000 hours in year 3. Calculate its book value at the end of year 3. Part II Depreciation expense for a year is determined by taking the asset’s cost less its estimated residual value and multiplying this amount by the fraction of actual production for the period divided by the estimated total production over the asset’s useful life. Part III The depreciation expense for the first year is $54,000. Cost minus residual value ($400,000 - $40,000 = $360,000) is multiplied by the fraction of 3,000 over 20,000. Part IV The depreciation expense for the second year is $144,000. Cost minus residual value ($400,000 - $40,000 = $360,000) is multiplied by the fraction of 8,000 over 20,000. Part V The depreciation expense for the third year is $108,000. Cost minus residual value ($400,000 - $40,000 = $360,000) is multiplied by the fraction of 6,000 over 20,000. = $144,000 ($400,000 - $40,000) × 8,000 20,000 2nd Year Depreciation = $108,000 ($400,000 - $40,000) × 6,000 20,000 3rd Year Depreciation

M9-5 Computing Book Value (Units-of-Production Depreciation)
A machine that cost $400,000 has an estimated residual value of $40,000 and 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, 8,000 hours in year 2, and 6,000 hours in year 3. Calculate its book value at the end of year 3. Year 1 2 3 Hours 3,000 8,000 6,000 Depreciation Expense (debit) $ ,000 144,000 108,000 Undepreciated Balance (book value) $ ,000 346,000 202,000 94,000 Accumulated (credit balance) $ ,000 198,000 306,000 After three years, the book value is $94,000 ($400,000 cost less $306,000 of accumulated depreciation).

1st Year Depreciation 2 4 ($400,000 - $0) × $200,000 =
M9-6 Computing Book Value (Double-Declining-Balance Depreciation) A machine that cost $400,000 has an estimated residual value of $40,000 and an estimated useful life of four years. The company uses double-declining-balance depreciation. Calculate its book value at the end of year 3. Round to the nearest dollar. = $200,000 ($400,000 - $0) × 2 4 1st Year Depreciation 2nd Year Depreciation = $100,000 ($400,000 - $200,000) × 2 4 Part I M9-6 Computing Book Value (Double-Declining-Balance Depreciation) A machine that cost $400,000 has an estimated residual value of $40,000 and an estimated useful life of four years. The company uses double-declining-balance depreciation. Calculate its book value at the end of year 3. Round to the nearest dollar. Part II Depreciation expense for a year is determined by taking the asset’s cost less its accumulated depreciation and multiplying this amount by the fraction of 2 over the asset’s estimated useful life in years. Recall that the double-declining-balance method ignores estimated residual value in the computation of depreciation expense except in the last year when it is subtracted from book value to arrive at that year’s depreciation expense. Part III At the start of the first year the book value of the asset is its acquisition cost of $400,000. For the first year, to determine depreciation expense, we multiply the book value of $400,000 times the double-declining-balance rate of 2/4 and find the depreciation expense is $200,000. Part IV At the start of the second year the book value of the asset is its acquisition cost of $400,000 minus the first year’s depreciation of $200,000. To determine depreciation expense, we multiply the book value times the double-declining-balance rate of 2/4 and find the depreciation expense is $100,000. Part V As the start of the third year the book value of the asset is its acquisition cost of $400,000 minus the accumulated depreciation for both years one and two which equals $300,000. To determine depreciation expense, we multiply the book value times the double-declining balance rate of 2/4 and find the depreciation expense of $50,000. 3rd Year Depreciation = $50,000 ($400,000 – ($200,000 + $100,000) × 2 4

M9-6 Computing Book Value (Double-Declining-Balance Depreciation)
A machine that cost $400,000 has an estimated residual value of $40,000 and an estimated useful life of four years. The company uses double-declining-balance depreciation. Calculate its book value at the end of year 3. Round to the nearest dollar. Year 1 2 3 Depreciation Expense (debit) $ ,000 100,000 50,000 Undepreciated Balance (book value) $ ,000 200,000 Accumulated (credit balance) $ ,000 300,000 350,000 At three years, the book value is $50,000 ($400,000 cost less $350,000 of accumulated depreciation).

E9-6 Computing Depreciation under Alternative Methods
Solar Innovations Corporation bought a machine at the beginning of the year at a cost of $22,000. 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, 2,000 units; year 2, 3,000 units; year 3, 2,000 units; year 4, 2,000 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 Year 1 2 3 4 5 Depreciation Expense (debit) ($22,000 - $2,000) x 1/5 = $4,000 Book Value $ ,000 18,000 14,000 10,000 6,000 2,000 Accumulated (credit balance) $ ,000 8,000 12,000 16,000 20,000 Part I E9-6 Computing Depreciation under Alternative Methods Solar Innovations Corporation bought a machine at the beginning of the year at a cost of $22,000. 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, 2,000 units; year 2, 3,000 units; year 3, 2,000 units; year 4, 2,000 units; and year 5, 1,000 units. Requirement 1. Complete a depreciation schedule for each of the alternative methods, straight-line, units-of-production, and double-declining-balance. Part II Case 1a. Straight-line. Depreciation expense for each year is determined by taking the asset’s cost less its estimated residual value and multiplying this amount by the fraction of 1 over the asset’s estimated useful life in years. Book value is equal to the cost of $22,000 less the Accumulated Depreciation.

1b. Units-of-production
E9-6 Computing Depreciation under Alternative Methods 1b. Units-of-production Year 1 2 3 4 5 Depreciation Expense (debit) ($22,000 - $2,000) x 2,000/10,000 = $4,000 ($22,000 - $2,000) x 3,000/10,000 = $6,000 ($22,000 - $2,000) x 1,000/10,000 = $2,000 Book Value $ ,000 18,000 12,000 8,000 4,000 2,000 Accumulated (credit balance) $ ,000 10,000 14,000 20,000 1c. Double-declining-balance Year 1 2 3 4 5 Depreciation Expense (debit) ($22,000 - $0) x 2/5 = $8,800 ($22,000 - $8,800) x 2/5 = $5,280 ($22,000 - $14,080) x 2/5 = $3,168 ($22,000 - $17,248) x 2/5 = $1,901 $2, $2,000 = $851 Book Value $ ,000 13,200 7,920 4,752 2,851 2,000 Accumulated (credit balance) $ ,800 14,080 17,248 19,149 20,000 Part I Case 1b. Units-of-production. Depreciation expense for a year is determined by taking the asset’s cost less its estimated residual value and multiplying this amount by the fraction of actual production for the period divided by the estimated total production over the asset’s useful life. Book value is equal to the cost of $22,000 less the Accumulated Depreciation. Part II Case 1c. Double-declining balance. Depreciation expense for a year is determined by taking the asset’s cost less its accumulated depreciation and multiplying this amount by the fraction of 2 over the asset’s estimated useful life in years. Recall that the double-declining-balance method ignores estimated residual value in the computation of depreciation expense except in the last year when it is subtracted from book value to arrive at that year’s depreciation expense. As you can see, the book value of the asset at the end of the fourth year is $2,851. The final book value should be $2,000. So we are limited to depreciation of $851 ($ $2,000) for the fifth year.

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? 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 ($4,000), 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 using straight-line depreciation. Part I Requirement 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? Part II The method that will result in the highest net income is the one that reports the lowest depreciation expense. In this example, the straight-line depreciation method results in the highest net income in year 2. This higher net income does not mean the equipment was used more efficiently under this method. It only means a smaller amount of the asset’s cost was allocated to depreciation expense in year 2.

1 3 ($27,000 - $1,500) × $8,500 per year = 1. Straight-line
E9-7 Computing Depreciation under Alternative Methods Sonic Corporation purchased and installed electronic payment equipment at its drive-in 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. 1. Straight-line Part I 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. Complete a depreciation schedule for each of the alternative methods. 1. Straight-line. 2. Units-of-production. 3. Double-declining-balance. Part II Requirement 1. Straight-line method. Depreciation expense for each year is determined by taking the asset’s cost less its estimated residual value and multiplying this amount by the fraction of 1 over the asset’s estimated useful life in years. Part III The annual depreciation is $8,500. Cost minus residual value ($27,000 - $1,500 = $25,500) is multiplied by one third. = $8,500 per year ($27,000 - $1,500) × 1 3

1. Straight-line E9-7 Computing Depreciation under Alternative Methods
Year 1 2 3 Depreciation Expense (debit) $ ,500 8,500 $ ,500 Undepreciated Balance (book value) $ ,000 18,500 10,000 1,500 Accumulated (credit balance) $ ,500 17,000 25,500 At the end of three years, the Accumulated Depreciation balance is $25,500 and the book value is $1,500.

1st Year Depreciation 61,200 255,000 ($27,000 - $1,500) × = $6,120
E9-7 Computing Depreciation under Alternative Methods 2. Units-of-production = $6,120 ($27,000 - $1,500) × 61, ,000 1st Year Depreciation = $14,025 ($27,000 - $1,500) × 140, ,000 2nd Year Depreciation Part I Requirement 2. Units-of-production method. Depreciation expense for a year is determined by taking the asset’s cost less its estimated residual value and multiplying this amount by the fraction of actual production for the period divided by the estimated total production over the asset’s useful life. Part II The depreciation expense for the first year is $6,120. Cost minus residual value ($27,000 - $1,500 = $25,500) is multiplied by the fraction of 61,200 over 255,000. Part III The depreciation expense for the second year is $14,025. Cost minus residual value ($27,000 - $1,500 = $25,500) is multiplied by the fraction of 140,250 over 255,000. Part IV The depreciation expense for the third year is $5,355. Cost minus residual value ($27,000 - $1,500 = $25,500) is multiplied by the fraction of 53,550 over 255,000. = $5,355 ($27,000 - $1,500) × 53, ,000 3rd Year Depreciation

2. Units-of-production Year 1 2 3 Depreciation Expense (Debit) 6,120 14,025 5,355 25,500 Undepreciated Balance (book value) $ ,000 20,880 6,855 1,500 Accumulated Depreciation (credit balance) $ ,120 20,145 At the end of three years, the Accumulated Depreciation balance is $25,500 and the book value is $1,500.

1st Year Depreciation 2 3 ($27,000 - $0) × $18,000 =
E9-7 Computing Depreciation under Alternative Methods 3. Double-declining-balance = $18,000 ($27,000 - $0) × 2 3 1st Year Depreciation 2nd Year Depreciation = $6,000 ($27,000 - $18,000) × 2 3 Part I Requirement 3. Double-declining-balance method. Depreciation expense for a year is determined by taking the asset’s cost less its accumulated depreciation and multiplying this amount by the fraction of 2 over the asset’s estimated useful life in years. Part II At the start of the first year the book value of the asset is its acquisition cost of $27,000. For the first year, to determine depreciation expense, we multiply the book value of $27,000 times the double-declining-balance rate of 2/3 and find the depreciation expense is $18,000. Part III At the start of the second year the book value of the asset is its acquisition cost of $27,000 minus the first year’s depreciation of $18,000. To determine depreciation expense, we multiply the book value times the double-declining-balance rate of 2/3 and find the depreciation expense is $6,000. Part IV At the start of the third year the book value of the asset is its acquisition cost of $27,000 minus the first two year’s depreciation of $24,000 ($18,000 +$6,000). To determine depreciation expense, we multiply the book value times the double-declining-balance rate of 2/3 and find the depreciation expense is $2,000. We will see that $2,000 is too much depreciation as we prepare the depreciation schedule. 3rd Year Depreciation = $2,000 [$27,000 – ($18,000 + $6,000)] × 2 3

3. Double-declining-balance Year 1 2 3 Depreciation Expense (debit) $ ,000 6,000 2,000 $ ,000 Undepreciated Balance (book value) $ ,000 9,000 3,000 1,000 Accumulated $ ,000 24,000 26,000 Year 1 2 3 Depreciation Expense (debit) $ ,000 6,000 1,500 $ ,500 Undepreciated Balance (book value) $ ,000 9,000 3,000 Accumulated $ ,000 24,000 25,500 Below residual value Depreciation expense is limited to the amount that reduces book value to the estimated residual value. Part I We always want the book value to be equal to estimated residual value at the end of the asset’s useful life, but it just will not work properly using the double-declining-balance method. As you can see, the book value of the asset at the end of the third year is $1,000. It should be $1,500. The only way we can make this work is to force depreciation expense in the last year to be the amount needed to bring book value down to the $1,500 estimated residual value. Let’s look at a corrected schedule. Part II In the third year, depreciation expense is limited to the amount that will reduce the book value to the estimated residual value of $1,500. For the third year, we will record depreciation expense of $1,500. We determine this amount by subtracting the residual value of $1,500 from the book value at the end of the second year, $3,000.

Less: Accumulated Depreciation Book Value Gain (Loss) c $ 16,000
E9-9 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 54,000 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. Sale price Cost Less: Accumulated Depreciation Book Value Gain (Loss) c $ 16,000 28,000 15,000 13,000 $ 3,000 Case b 10,000 18,000 $ (2,000) a 12,000 16,000 $ Part I. E9-9 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 54,000 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. Requirement 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. Part II We determine the gain or loss by comparing the sale price with the book value. In case (a), the sale price of $16,000 is the same as the book value so there is no gain or loss. In case (b), the sale price of $16,000 is less than the book value of $18,000, resulting in a $2,000 loss. In case (c), the sale price of $16,000 is greater than the book value of $13,000, resulting in a $3,000 gain.

E9-9 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 Assets Cash Equipment Accumulated Depreciation (-xA) + 16,000 28,000 + 12,000 Liabilities Stockholders’ Equity = + Part I Requirement 2. Indicate the effects (accounts, amounts, and + or -) for the disposal of the truck in each of the three preceding situations. Part II Case (a) Book Value = $16,000. The asset account, Cash, will be increased by $16,000. The asset account, Equipment will be decreased by $28,000. The contra asset account, Accumulated Depreciation, will be decreased by $12,000. There is no gain or loss on the disposal so there is no change in Stockholders’ Equity (no change in net assets).

Case (b) Book Value = $18,000 Case (c) Book Value = $13,000
E9-9 Demonstrating the Effect of Book Value on Reporting an Asset Disposal Case (b) Book Value = $18,000 Assets Cash Equipment Accumulated Depreciation (-xA) + 16,000 28,000 + 10,000 Liabilities Stockholders’ Equity Loss of Disposal (+E) - 2,000 = + Case (c) Book Value = $13,000 Assets Cash Equipment Accumulated Depreciation (-xA) + 16,000 28,000 + 15,000 Liabilities Stockholders’ Equity Gain on Disposal (+R) + 3,000 = + Part I Case (b) Book Value = $18,000. The asset account, Cash, will be increased by $16,000. The asset account, Delivery Trucks will be decreased by $28,000. The contra asset account, Accumulated Depreciation, will be decreased by $10,000. The Loss on Disposal will increase resulting in a decrease to Stockholders’ Equity of $2,000 (a decrease in net assets of $2,000). Part II Case (c) Book Value = $13,000. The asset account, Cash, will be increased by $16,000. The asset account, Delivery Trucks will be decreased by $28,000. The contra asset account, Accumulated Depreciation, will be decreased by $15,000. The Gain on Disposal will increase resulting in an increase in Stockholders’ Equity of $3,000 (an increase in net assets of $3,000).

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). Part I Requirement 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. Part II 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. All else equal, the larger the amount of depreciation recorded before a disposal, the more likely the asset will generate a gain on disposal (see 1c above) or, at least, the less likely it will generate a loss. Conversely, the smaller the amount of depreciation recorded before a disposal, the more likely the asset will generate a loss on disposal (see 1b above) or, at least, the less likely it will generate a gain.

Case (a) Book value = $16,000 Case (b) Book value = $18,000
E9-9 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 Cash Accumulated Depreciation-Equipment(-xA) Equipment 28,000 16,000 12,000 Case (b) Book value = $18,000 Part I Requirement 4. Prepare the journal entry to record the disposal of the truck for each situation in requirement 1. Part II Case (a). Book value = $16,000. We debit the asset account Cash for $16,000 and the contra asset account Accumulated Depreciation-Equipment for $12,000. We credit the asset account Equipment for $28,000. Part III Case (b) Book value = $18,000. We debit the asset account Cash for $16,000, the contra asset account Accumulated Depreciation-Equipment for $10,000, and Loss on Disposal for $2,000. We credit the asset account Equipment for $28,000. Cash Accumulated Depreciation -Equipment(-xA) Loss on Disposal Equipment 28,000 16,000 10,000 2,000

Required: 4. Prepare the journal entry to record the disposal of the truck for each situation in requirement 1. Case (c) Book value = $13,000 Cash Accumulated Depreciation-Equipment (-xA) Gain on Disposal Equipment 3,000 28,000 16,000 15,000 Case (c). Book value = $13,000. We debit the asset account Cash for $16,000, the contra asset account Accumulated Depreciation-Equipment for $15,000. We credit Gain on Disposal for $3,000 and the asset account Equipment for $28,000.

End of Chapter 9 End of Chapter 9.

Long-Lived Tangible and Intangible Assets

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Long-Lived Tangible and Intangible Assets

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