1. 8-1 ©2006 Prentice Hall, Inc.

2. 8-2 ©2006 Prentice Hall, Inc. REPORTING & INTERPRETING L-T OPERATIONAL ASSETS (1 of 2)  Learning objectives Learning objectives  Acquiring plant assets Acquiring plant assets  Using long-term tangible assets— depreciation and depletion Using long-term tangible assets— depreciation and depletion  Using intangible assets—amortization Using intangible assets—amortization  Changes after the purchase of an asset Changes after the purchase of an asset

3. 8-3 ©2006 Prentice Hall, Inc. REPORTING & INTERPRETING L-T OPERATIONAL ASSETS (2 of 2)  Selling long-term assets Selling long-term assets  Long-term asset presentation on financial statements Long-term asset presentation on financial statements  Financial statement analysis Financial statement analysis  Business risk, control, and ethics Business risk, control, and ethics

4. 8-4 ©2006 Prentice Hall, Inc. Learning Objectives (1 of 3)  Explain how long-term assets are classified, how their cost is computed, and how they are reported  Explain and compute how tangible assets are written off over their useful lives and reported on the financial statements

5. 8-5 ©2006 Prentice Hall, Inc. Learning Objectives (2 of 3)  Explain how decreases in value, repairs, changes in productive capacity, and changes in estimates of useful life and salvage value of assets are reported on the financial statements  Describe how long-term assets are reported on the financial statements

6. 8-6 ©2006 Prentice Hall, Inc. Learning Objectives (3 of 3)  Describe how long-term assets are reported on the financial statements  Use return-on-assets (ROA) and the asset turnover ratio to help evaluate the firm’s performance  Recognize the risks associated with long-term assets and the controls that can minimize those risks

7. 8-7 ©2006 Prentice Hall, Inc. Acquiring Plant Assets (1 of 2)  Long-term operational assets  Assets that last for more than one accounting period  Used to help a business generate revenue  Does purchase of a plant asset affect the income statement?

8. 8-8 ©2006 Prentice Hall, Inc. Acquiring Plant Assets (2 of 2)  Types of long-lived assets  Tangible assets  Property, plant, and equipment  Intangible assets  Trademarks, patents, copyrights, etc.  Acquisition costs Acquisition costs  Basket purchase allocation Basket purchase allocation

9. 8-9 ©2006 Prentice Hall, Inc. Acquisition Costs (1 of 2)  Historical cost principle requires assets to be recorded at their cost  Plus cost of getting asset in place and ready for use  Why aren’t most long-term assets reported at their current market value?  Why aren’t long-term assets immediately expensed when purchased?

10. 8-10 ©2006 Prentice Hall, Inc. Acquisition Costs (2 of 2)  Which of the following are acquisition costs for a building and why?  Real estate commissions  Cost of tearing down an existing building  Consultant’s fee to decide whether to lease or purchase the building  Installation fees  Cost of land where building will be built

11. 8-11 ©2006 Prentice Hall, Inc. Basket Purchase Allocation  Purchase of two or more assets for one price  Cost allocated to each asset based on their relative fair market values  Percent of total FMV of the assets  How do firm’s determine an asset’s current fair market value?  Basket purchase example Basket purchase example

12. 8-12 ©2006 Prentice Hall, Inc. Basket Purchase Example (1 of 2)  On July 1, Valdez Environmental purchased a tug boat and oil cleaning equipment for $7M  FMV of tug boat is $4M  FMV of oil cleaning equipment is $6M  How much of the $7M will be allocated to the tug boat and to the oil cleaning equipment?

13. 8-13 ©2006 Prentice Hall, Inc. Basket Purchase Example (2 of 2) Relative FMVFMV Tug Boat Cleaning Equip _ _ Total Allocation Tug BoatX $7M = Cleaning EquipX $7M =

14. 8-14 ©2006 Prentice Hall, Inc. Using L-T Tangible Assets: Depreciation and Depletion (1 of 3)  Purchase of long-term tangible assets are capitalized (recorded as assets)  L-T tangible assets expensed by depreciating (or depleting) them  Depreciation allocates the COST of an asset to the periods that benefit from the use of the asset  What accounting principle requires this (ch 2)?

15. 8-15 ©2006 Prentice Hall, Inc. Using L-T Tangible Assets: Depreciation and Depletion (2 of 3)  Depreciation terminology  Acquisition cost (cost)  Estimated useful life Estimated useful life  Salvage value (residual value)  Estimated value of an asset at the end of its useful life  Depreciable base = cost - salvage value  Book value (carrying value) Book value (carrying value)

16. 8-16 ©2006 Prentice Hall, Inc. Using L-T Tangible Assets: Depreciation and Depletion (3 of 3)  Depreciation methods  Straight-line Straight-line  Activity (units of production) Activity (units of production)  Declining balance Declining balance  Depreciation example Depreciation example  Depletion Depletion

17. 8-17 ©2006 Prentice Hall, Inc. Estimated Useful Life  How long a company expects an asset to be productive  May be expressed in years or units of activity (e.g., miles, hours, # of units produced)

18. 8-18 ©2006 Prentice Hall, Inc. Book Value  Book value equals cost less accumulated depreciation  The unexpensed portion of an asset  Book value bears NO relationship to FMV

19. 8-19 ©2006 Prentice Hall, Inc. Straight line Depreciation  Equal amount of an asset are expensed each year  Depreciable base is constant (cost-SV)  Depreciation rate is constant (1/UL) Depreciable cost (cost - SV) Useful life (in years)

20. 8-20 ©2006 Prentice Hall, Inc. Activity (Units of Production) Depreciation  Amount of asset expensed each year depends on asset’s usage  Depreciable base is constant (cost-SV)  Depreciation rate is constant (1/UL) Depreciable cost (cost - SV) Useful life in units  Annual depreciation expense  depr rate x actual level of activity for year Depr Rate =

21. 8-21 ©2006 Prentice Hall, Inc. Declining Balance Depreciation (1 of 2)  Accelerated depreciation method  Annual depreciation expense declines over asset’s useful life  Depreciable base changes (beg book value)  Depreciation rate is constant (X/UL)  X = Depreciation rate  Most common rate is 200% Also called double-declining balance (DDB)  Never depreciate below salvage value

22. 8-22 ©2006 Prentice Hall, Inc. Declining Balance Depreciation (2 of 2) 2 _ UL DDB Exp = x Book value (cost – A/D)

23. 8-23 ©2006 Prentice Hall, Inc. Depreciation Example (1 of 5)  Photocopier purchased on 1/1/08  Acquisition cost $14,000  Useful life  5 years or  300,000 copies  Estimated salvage value $2,000

24. 8-24 ©2006 Prentice Hall, Inc. Depreciation Example (2 of 5)  Straight-line method $14,000 - $2,000 5 years  Activity method  Assume 40,000 copies were made $14,000 - $2,000 300,000 copies =$2,400/year x 40,000 =$1,600

25. 8-25 ©2006 Prentice Hall, Inc. Depreciation Example (3 of 5)  Double-declining balance method  Year 1  Year 2 2 _ 5 yrs x $14,000 = $5,600 2 _ 5 yrs x ($14,000 - $5,600) = $3,360

26. 8-26 ©2006 Prentice Hall, Inc. Depreciation Example (4 of 5) SL DDB YrExpA/D ExpA/D 1 2,400 5,600 2 2,4004,800 3,3608,960 3 2,4007,200 2,01610,976 4 2,4009,600 1,02412,000 5 2,40012,000 -

27. 8-27 ©2006 Prentice Hall, Inc. Depreciation Example (5 of 5)  Which method (SL or DDB) produces the highest income in the earliest years?  Which method has the highest book value throughout the asset’s life?  Which method is best for income smoothing?  Which method produces the best asset turnover ratio over the asset’s life?

28. 8-28 ©2006 Prentice Hall, Inc. Depletion  Used to expense natural resources as they are used up  Same computation to activity depreciation with zero salvage value Cost _ Useful life in units  Annual depletion expense  depl rate x actual level of activity for year Depl rate =

29. 8-29 ©2006 Prentice Hall, Inc. Using Intangible Assets: Amortization (1 of 3)  Rights, privileges, or benefits that have long-term value to the firm  Recorded at cost  Amortization  Same method of expensing as straight- line depreciation with zero salvage value  Accumulated amortization calculated for each intangible asset

30. 8-30 ©2006 Prentice Hall, Inc. Using Intangible Assets: Amortization (2 of 3)  Copyright  Provides U.S. legal protection for authors of original work  Amortized over shorter of legal or useful life  Patent  A property right on inventions  Amortized over shorter of legal life (20 years) or useful life (often around 10 years)

31. 8-31 ©2006 Prentice Hall, Inc. Using Intangible Assets: Amortization (3 of 3)  Trademarks  10 years of protection; renewable  Franchise  Agreement that authorizes someone to sell or distribute a company’s goods or services in a certain area  Goodwill  Research and development costs  Immediately expensed. Why?

32. 8-32 ©2006 Prentice Hall, Inc. Goodwill  Excess of cost over FMV of net assets when one company purchases another company  Why would a company pay more than the FMV of the net assets for a company?  Goodwill is not amortized  Loss recorded for decrease in value  Reported in the notes to the financial statements

33. 8-33 ©2006 Prentice Hall, Inc. Changes After an Asset Purchase (1 of 2)  Asset impairment  Permanent reduction in market value below book value  Similar to LCM method for inventory  Capital expenditures to improve or extend an asset’s useful life  Capitalize and depreciate

34. 8-34 ©2006 Prentice Hall, Inc. Changes After an Asset Purchase (2 of 2)  At what point does a roof repair become a capital expenditure?  Revising estimates of useful life and salvage value  Depreciate remaining depreciable cost over remaining useful life  Revising estimate example Revising estimate example

35. 8-35 ©2006 Prentice Hall, Inc. Revising an Estimate Example (1 of 2)  Facts  Asset cost: $30,000  Original useful life: 5 years  Original salvage value: $8,000  In the beginning of year 3, the asset is determined to have 4 years of useful life remaining and a salvage value of $6,000

36. 8-36 ©2006 Prentice Hall, Inc. Revising an Estimate Example (2 of 2)  Depreciation expense for yr 1 & 2  ($30,000 - $8,000)/5 = $4,400/yr  Book value at beginning of year 3  ($30,000 - $8,800) = $21,200  Depreciation expense yr 3-6  ($21,200 - $6000)/4 = $3,800/yr  4 =remaining years of useful life

37. 8-37 ©2006 Prentice Hall, Inc. Selling Long-term Assets (1 of 2)  Cash proceeds > BV = gain  Cash proceeds < BV = loss  Cash proceeds = BV = no gain/loss  Journal entry  Increase cash (debit)  Remove asset (credit)  Remove A/D (debit)  Record gain (credit) or loss (debit)

38. 8-38 ©2006 Prentice Hall, Inc. Selling Long-term Assets (2 of 2)  Sold asset for $20,000 cash  Cost $35,000; A/D $18,000 DateTransactionDebitCredit Assets = Liab. + Cont. Cap. + R/E

39. 8-39 ©2006 Prentice Hall, Inc. Long-term Asset Presentation on Financial Statements  PP&E may be reported on the financial statements at book value or showing cost and A/D  How can you calculate the average age of depreciable assets when all you have is cost, A/D and depr exp?  Could you do this if you did not know A/D?

40. 8-40 ©2006 Prentice Hall, Inc. Financial Statement Analysis (1 of 3)  Return on assets (ROA)  Measures how well a company is using its assets to generate revenue  Answers the following  Did the company invest wisely in its assets? Net Income + Interest Expense Average Total Assets  Avg total assets = (Beg TA + End TA)/2

41. 8-41 ©2006 Prentice Hall, Inc. Financial Statement Analysis (2 of 3)  Interest expense results from financing with debt instead of equity  Why is interest expense added back to net income to compute ROA?  How can a company increase its ROA without increasing its net income?  Compare the ROA of a CPA firm to the ROA of an auto manufacturer

42. 8-42 ©2006 Prentice Hall, Inc. Financial Statement Analysis (3 of 3)  Asset Turnover Ratio  Measures how efficiently a company uses its assets to generate sales Net Sales _ Average Total Assets  Explain how a company can have a high asset turnover and a low ROA

43. 8-43 ©2006 Prentice Hall, Inc. Business Risk, Control, and Ethics (1 of 2)  Risks associated with long-term assets  Theft, vandalism, natural disasters, terrorist attacks, etc.  Controls used to safeguard assets  Physical controls  Complete and reliable record keeping

44. 8-44 ©2006 Prentice Hall, Inc. Business Risk, Control, and Ethics (2 of 2)  Controls used to safeguard assets (continued)  Monitoring  Make sure that physical controls, separation of duties, and other policies and procedures related to protecting assets are operating properly  Who is responsible for monitoring function?

45. Comments or questions about PowerPoint Slides? Contact Dr. Richard Newmark at University of Northern Colorado’s Kenneth W. Monfort College of Business richard.newmark@PhDuh.com 8-45 ©2006 Prentice Hall, Inc.