chapter 8 reporting and interpreting property, plant, and equipment; natural resources; and...

Chapter 8

Reporting and Interpreting Property, Plant, and Equipment; Natural Resources; andIntangibles

© 2004 The McGraw-Hill CompaniesMcGraw-Hill/Irwin

8-2

Understanding The Business

How much is enough?

Insufficient capacity results

in lost sales.

Costly excesscapacity reduces

profits.


8-3

Tangible

PhysicalSubstance

Intangible

No PhysicalSubstance

Expected to Benefit Future Periods

Actively Used in Operations

Classifying Long-Lived Assets


8-4

Tangible

PhysicalSubstance

Intangible




Land Assets subject to depreciation

Buildings and equipmentFurniture and fixtures

Natural resource assets subject to depletion

Mineral deposits and timber

Examples



8-5

Tangible

PhysicalSubstance

Intangible




Value represented by rights that produce benefits

PatentsCopyrightsTrademarksFranchisesGoodwill

Subject to amortization

Examples



8-6

Fixed Asset Turnover

FixedAsset

Turnover

Net Sales Revenue

Average Net Fixed Assets=

This ratio measures a company’s ability to generate sales given an

investment in fixed assets.

This ratio measures a company’s ability to generate sales given an

investment in fixed assets.

For the year 2000, Delta Airlines had $16,741 ofrevenue. End-of-year fixed assets were $14,840and beginning-of-year fixed assets were $12,450.

(All numbers in millions.)

For the year 2000, Delta Airlines had $16,741 ofrevenue. End-of-year fixed assets were $14,840and beginning-of-year fixed assets were $12,450.

(All numbers in millions.)


8-7

Fixed Asset Turnover

FixedAsset

Turnover

$16,741

($14,840 + $12,450) ÷ 2= = 1.23

FixedAsset

Turnover

Net Sales Revenue

Average Net Fixed Assets=

Delta Southwest United1.23 1.04 1.47

2000 Fixed Asset Turnover Comparisons


8-8

Measuring and Recording Acquisition Cost

Acquisition cost includes the purchase price and all expenditures needed to prepare the asset for

its intended use.

Acquisition cost does not includefinancing charges and cash discounts.

Acquisition cost includes the purchase price and all expenditures needed to prepare the asset for

its intended use.

Acquisition cost does not includefinancing charges and cash discounts.


8-9

Purchase price

Architectural fees

Cost of permits

Excavation costs

Construction costs

Purchase price

Architectural fees

Cost of permits

Excavation costs

Construction costs

Acquisition CostBuildings


8-10

Purchase price Installation costs Modification to building

necessary to install equipment

Transportation costs

Purchase price Installation costs Modification to building

necessary to install equipment

Transportation costs

Acquisition CostEquipment


8-11

Purchase price Real estate commissions Title insurance premiums Delinquent taxes Surveying fees Title search and transfer fees

Purchase price Real estate commissions Title insurance premiums Delinquent taxes Surveying fees Title search and transfer fees

Land is not depreciable.Land is not depreciable.

Acquisition CostLand


8-12

Acquisition for Cash

On June 1, Delta Air Lines purchasedaircraft for $60,000,000 cash.

GENERAL JOURNAL Page 8

Date Description Debit Credit

June 1


8-13

Acquisition for Cash



June 1 Flight equipment 60,000,000

Cash 60,000,000

On June 1, Delta Air Lines purchasedaircraft for $60,000,000 cash.


8-14

Acquisition for Debt

On June 14, Delta Air Lines purchased aircraft for $1,000,000 cash and a

$59,000,000 note payable.



June 14


8-15



June 14 Flight equipment 60,000,000

Cash 1,000,000

Note payable 59,000,000

Acquisition for Debt

On June 14, Delta Air Lines purchased aircraft for $1,000,000 cash and a

$59,000,000 note payable.


8-16

Record at the current market value ofthe consideration given, or the current

market value of the asset acquired, whichever is more clearly evident.

Acquisition forNoncash Consideration


8-17


On July 7, Delta gave Boeing 400,000shares of $3 par value common stock with a

market value of $85 per share plus $26,000,000 in cash for aircraft.



July 7


8-18



July 7 Flight equipment 60,000,000

Cash 26,000,000

Common stock 1,200,000

Additional paid-in capital 32,800,000


On July 7, Delta gave Boeing 400,000shares of $3 par value common stock with a

market value of $85 per share plus $26,000,000 in cash for aircraft.


8-19

Acquisition by Construction

Asset cost includes:Asset cost includes:

All materials andlabor traceable tothe construction.

A reasonableamount ofoverhead.

Interest on debtincurred during

the construction.


8-20

Repairs, Maintenance,and Additions

Type of Capital orExpenditure Revenue Identifying Characteristics

Ordinary Revenue 1. Maintains normal operating conditionrepairs and 2. Does not increase productivity

maintenance 3. Does not extend life beyond original estimate

Extraordinary Capital 1. Major overhauls or partialrepairs replacements

2. Extends life beyond original estimate

Additions Capital 1. Increases productivity2. May extend useful life3. Improvements or expansions


8-21

Capital and Revenue Expenditures

Many companies have policies expensing all expenditures below a certain amount according to

the materiality constraint.

Financial Statement Effect

Current Current Treatment Statement Expense Income Taxes

Capital Balance sheetExpenditure account debited Deferred Higher Higher

Revenue Income statement CurrentlyExpenditure account debited recognized Lower Lower


8-22

Depreciation is a cost allocation process that systematically and rationally matches

acquisition costs of operational assets with periods benefited by their use.

Depreciation is a cost allocation process that systematically and rationally matches

acquisition costs of operational assets with periods benefited by their use.

Cost

Allocation

(Unused)

Balance Sheet

(Used)

Income Statement

Expense

Depreciation

AcquisitionCost


8-23

Depreciation

DepreciationExpense

Income

Statement

Balance

SheetAccumulatedDepreciation

Depreciation for

the current year

Total of depreciation

to date on an asset


8-24

Book Values

Depreciation on Delta’s2000 Balance Sheet

Property and Equipment: Flight equipment 17,565$ Less: Accumulated depreciation 5,173 12,392$

Ground property and equipment 4,371 Less: Accumulated depreciation 2,313$ 2,058

Advance payments for equipment 390 Total property and equipment 14,840$

Book value = Market valueBook value = Market value/


8-25

The calculation of depreciation requires three amounts for each asset:

Acquisition cost.

Estimated useful life.

Estimated residual value.

The calculation of depreciation requires three amounts for each asset:

Acquisition cost.

Estimated useful life.

Estimated residual value.

Depreciation Concepts


8-26

Alternative Depreciation Methods

Straight-line

Units-of-production

Accelerated Method: Declining balance

Straight-line

Units-of-production

Accelerated Method: Declining balance


8-27

At the beginning of the year, Delta purchased equipment for $62,500 cash. The equipment has

an estimated useful life of 3 years and an estimated residual value of $2,500.

Cost - Residual Value

Life in Years

Depreciation

Expense per Year=

Straight-Line Method

SL


8-28

Depreciation

Expense per Year=

Depreciation

Expense per Year= $20,000

$62,500 - $2,500

3 years


Cost - Residual Value

Life in Years

Depreciation

Expense per Year=

SL


8-29

Depreciation Accumulated Accumulated UndepreciatedExpense Depreciation Depreciation Balance

Year (debit) (credit) Balance (book value)62,500$

1 20,000$ 20,000$ 20,000$ 42,500 2 20,000 20,000 40,000 22,500 3 20,000 20,000 60,000 2,500

60,000$ 60,000$

Residual Value


SL More than 95 percent of companies use the

straight-line method for some or all of theirassets disclosed in financial reports.


8-30

Units-of-Production Method

Depreciation Rate

= Cost - Residual Value Life in Units of Production

Step 1:

Step 2:

Depreciation Expense =

Depreciation Rate

×Number of

Units Producedfor the Year


8-31


At the beginning of the year, Delta purchased ground equipment for $62,500 cash. The

equipment has a 100,000 mile useful life and an estimated residual value of $2,500.

If the equipment is used 30,000 miles in the first year, what is the amount of depreciation

expense?

At the beginning of the year, Delta purchased ground equipment for $62,500 cash. The

equipment has a 100,000 mile useful life and an estimated residual value of $2,500.

If the equipment is used 30,000 miles in the first year, what is the amount of depreciation

expense?


8-32


$62,500 - $2,500 100,000 miles

= $.60 per mileDepreciation Rate

=

Step 1:

Step 2:

$.60 per mile × 30,000 miles = $18,000

Depreciation Expense =


8-33

Units-of-Production MethodAccumulated Undepreciated

Depreciation Depreciation BalanceYear Miles Expense Balance (book value)

62,500$ 1 30,000 18,000$ 18,000$ 44,500 2 50,000 3 20,000

100,000


8-34

Accumulated UndepreciatedDepreciation Depreciation Balance

Year Miles Expense Balance (book value)62,500$

1 30,000 18,000$ 18,000$ 44,500 2 50,000 30,000 48,000 14,500 3 20,000 12,000 60,000 2,500

100,000 60,000$

Residual Value



8-35

Accelerated Depreciation

Depreciation RepairExpense Expense

Early Years High Low

Later Years Low High

Accelerated depreciation matches higher depreciation expense with higher revenuesin the early years of an asset’s useful life

when the asset is more efficient.


8-36Double-Declining-Balance Method

AnnualDepreciation

expense

NetBookValue

( )Useful Life in Years 2

= ×

Cost – Accumulated Depreciation

Declining balance rate of 2 isdouble-declining-balance (DDB) rate.

Annual computation ignores residual value.Annual computation ignores residual value.


8-37

At the beginning of the year, Delta purchased equipment for $62,500 cash. The equipment has an estimated useful life of 3 years and an estimated residual

value of $2,500.

Calculate the depreciation expense for the first two years.

Double-Declining-Balance Method


8-38

AnnualDepreciation

expense

NetBookValue

( )Useful Life in Years 2

= ×

( ) $62,500 × 3 years 2

= $41,667

( ) ($62,500 – $41,667) × 3 years 2

= $13,889


Year 1 Depreciation:

Year 2 Depreciation:


8-39

Depreciation Accumulated UndepreciatedExpense Depreciation Balance

Year (debit) Balance (book value)62,500$

1 41,667$ 41,667$ 20,833 2 13,889 55,556 6,944 3 4,629 60,185 2,315

60,185$

( ) ($62,500 – $55,556) × 3 years 2

= $4,629

Below residual value



8-40

Depreciation expense is limited to the amount thatreduces book value to the estimated residual value.

Depreciation Accumulated UndepreciatedExpense Depreciation Balance

Year (debit) Balance (book value)62,500$

1 41,667$ 41,667$ 20,833 2 13,889 55,556 6,944 3 4,444 60,000 2,500

60,000$



8-41

For tax purposes, most corporations use the Modified Accelerated Cost Recovery

System (MACRS).

MACRS depreciation provides for rapid write-off of an asset’s cost in order to

stimulate new investment.

For tax purposes, most corporations use the Modified Accelerated Cost Recovery

System (MACRS).

MACRS depreciation provides for rapid write-off of an asset’s cost in order to

stimulate new investment.

Depreciation andFederal Income Tax


8-42

Depreciation Methodsin Other Countries

Many countries, including Australia, Brazil, England, and Mexico, use other methods such as depreciation basedon the current fair value of assets.


8-43

Asset Impairment

Impairment is the loss of a significant portionof the utility of an asset through . . .

Casualty.Obsolescence.Lack of demand for the asset’s services.

A loss should be recognized when anasset suffers a permanent impairment.


8-44

Voluntary disposals: Sale

Trade-in

Retirement

Involuntary disposals:Fire Accident

Disposal of Property, Plant,and Equipment


8-45


Update depreciation to the date of disposal.

Journalize disposal by:

Writing off accumulateddepreciation (debit).

Writing off the asset cost (credit).

Recording cashreceived (debit)or paid (credit).

Recording again (credit)

or loss (debit).


8-46

If Cash > BV, record a gain (credit).

If Cash < BV, record a loss (debit).

If Cash = BV, no gain or loss.



8-47

Delta Airlines sold flight equipmentfor $5,000,000 cash at the end of its

17th year of use. The flight equipment originally cost $20,000,000, and was depreciated using the straight-line

method with zero salvage valueand a useful life of 20 years.

Delta Airlines sold flight equipmentfor $5,000,000 cash at the end of its

17th year of use. The flight equipment originally cost $20,000,000, and was depreciated using the straight-line

method with zero salvage valueand a useful life of 20 years.



8-48

The amount of depreciation recorded at the end of the 17th year to bring depreciation up to date is:

a. $0.

b. $1,000,000.

c. $2,000,000.

d. $4,000,000.


a. $0.

b. $1,000,000.

c. $2,000,000.

d. $4,000,000.



8-49


a. $0.

b. $1,000,000.

c. $2,000,000.

d. $4,000,000.


a. $0.

b. $1,000,000.

c. $2,000,000.

d. $4,000,000.

Annual Depreciation: ($20,000,000 - $0) ÷ 20 Years. = $1,000,000



8-50

After updating the depreciation,the equipment’s book value at the

end of the 17th year is:

a. $3,000,000.

b. $16,000,000.

c. $17,000,000.

d. $4,000,000.



a. $3,000,000.

b. $16,000,000.

c. $17,000,000.

d. $4,000,000.



8-51



a. $3,000,000.

b. $16,000,000.

c. $17,000,000.

d. $4,000,000.



a. $3,000,000.

b. $16,000,000.

c. $17,000,000.

d. $4,000,000.

Accumulated Depreciation =

(17yrs. × $1,000,000) = $17,000,000

BV = Cost - Accumulated Depreciation

BV = $20,000,000 - $17,000,000 = $3,000,000



8-52

The equipment’s sale resulted in:

a. a gain of $2,000,000.

b. a gain of $3,000,000.

c. a gain of $4,000,000.

d. a loss of $2,000,000.


a. a gain of $2,000,000.

b. a gain of $3,000,000.

c. a gain of $4,000,000.

d. a loss of $2,000,000.



8-53


a. a gain of $2,000,000.

b. a gain of $3,000,000.

c. a gain of $4,000,000.

d. a loss of $2,000,000.


a. a gain of $2,000,000.

b. a gain of $3,000,000.

c. a gain of $4,000,000.

d. a loss of $2,000,000.

Gain = Cash Received - Book ValueGain = $5,000,000 - $3,000,000 = $2,000,000



8-54



Prepare the journal entry to record Delta’s sale of the equipment at the end of the 17th year.



8-55



Cash 5,000,000

Accumulated Depreciation 17,000,000

Gain on Sale 2,000,000

Flight Equipment 20,000,000


Prepare the journal entry to record Delta’s sale of the equipment at the end of the 17th year.


8-56

Natural Resources

Depletion is like depreciation.

Total cost of asset is the cost

of acquisition, exploration,

and development.

Total cost isallocated over

periods benefitedby means of

depletion.


8-57

Intangible Assets

Noncurrent assetswithout physical

substance.

Noncurrent assetswithout physical

substance.

Useful life isoften difficultto determine.

Useful life isoften difficultto determine.

Usually acquired for operational

use.

Usually acquired for operational

use.

Often provideexclusive rights

or privileges.

Often provideexclusive rights

or privileges.

IntangibleAssets


8-58

Goodwill Trademarks Patents Copyrights Franchises Leaseholds

Record at current cash equivalent cost, including purchase price, legal fees, and

filing fees.

Intangible Assets


8-59

Amortize over shorter of economic life or legal life, subject to rules specified by GAAP.

Use straight-line method.

Research and development costs are normally expensed as incurred.

Amortize over shorter of economic life or legal life, subject to rules specified by GAAP.

Use straight-line method.

Research and development costs are normally expensed as incurred.

Intangible Assets


8-60

Occurs when onecompany buys

another company.

The amount by which thepurchase price exceeds the fair

market value of net assets acquired.

Only purchased goodwill is an

intangible asset.

Intangible AssetsGoodwill

Goodwill


8-61

Not amortized.Not amortized.Subject to assessment

for impairmentvalue and may be

written down.

Subject to assessment for impairment

value and may bewritten down.

Goodwill

Intangible AssetsGoodwill


8-62

Intangible Assets Goodwill

Eddy Company paid $1,000,000 to purchaseall of James Company’s assets and assumed liabilities of $200,000. The acquired assets were appraised at a fair value of $900,000.


8-63

What amount of goodwill should be recorded on Eddy Company books?

a. $100,000

b. $200,000

c. $300,000

d. $400,000


a. $100,000

b. $200,000

c. $300,000

d. $400,000



8-64


a. $100,000

b. $200,000

c. $300,000

d. $400,000


a. $100,000

b. $200,000

c. $300,000

d. $400,000

FMV of Assets 900,000$ Debt Assumed 200,000

FMV of Net Assets 700,000$ Purchase Price 1,000,000

Goodwill 300,000$



8-65

A symbol, design, or logo associated with a business.

A symbol, design, or logo associated with a business.

Purchasedtrademarks

are recordedat cost.

Internallydevelopedtrademarks

have norecorded

asset cost.

Intangible AssetsTrademarks


8-66

Intangible AssetsPatents

Exclusive right grantedby federal government to sell or

manufacture an invention.

Exclusive right grantedby federal government to sell or

manufacture an invention.

Cost is purchaseprice plus legalcost to defend.

Cost is purchaseprice plus legalcost to defend.

Amortize costover the shorter of

useful life or 20 years.

Amortize costover the shorter of

useful life or 20 years.


8-67

Intangible AssetsCopyrights

Exclusive right granted by the federal government to protect artistic or

intellectual properties.

Exclusive right granted by the federal government to protect artistic or

intellectual properties.

Amortize costover the period

benefited.

Amortize costover the period

benefited.

Legal life islife of creatorplus 70 years.

Legal life islife of creatorplus 70 years.


8-68

Legally protected right to sell products or provide services purchased by franchisee from

franchisor.

Legally protected right to sell products or provide services purchased by franchisee from

franchisor.

Purchase price is an intangibleasset that is amortized.

Purchase price is an intangibleasset that is amortized.

Intangible AssetsFranchises


8-69

Intangible Assets Leaseholds

A lease is a contract touse property grantedby lessor to lessee andrights granted under thelease are called a leasehold.

A leasehold is recorded onlyif advance payment is involved. Otherwise periodic payments are rent expense.

A lease is a contract touse property grantedby lessor to lessee andrights granted under thelease are called a leasehold.

A leasehold is recorded onlyif advance payment is involved. Otherwise periodic payments are rent expense.


8-70

Long-lived alterations made by lessee to leased property.

Intangible AssetsLeasehold Improvements

Leasehold improvements are recorded at cost and amortized over their useful life.


8-71

This computer is about to become

fully depreciated!

End ofChapter 8

chapter 8 reporting and interpreting property, plant, and equipment; natural resources; and...

Documents

longlived assets slide

year fixed assets

operations land assets

transfer fees land

equipment furniture

future periods

equipment natural resources

lost sales