Plant Assets, Intangible Assets, and Related Expenses Chapter 7

Learning Objective 1 Determine the cost of a plant asset.

Types of Assets Long-lived assets used in operations Plant Assets Intangible Assets

Plant Assets Terminology Plant Assets - Depreciation Natural Resources - Depletion Intangibles - Amortization

Determining the Cost of Land A business signs a $300,000 note payable to purchase land for a new store site. It pays: $10,000 in back property tax $8,000 in transfer taxes $5,000 for removal of an old building $1,000 survey fee $260,000 to pave the parking lot. What is the cost of the land?

Determining the Cost of Land Purchase price of land $300,000 Add related costs: Back property taxes $10,000 Transfer taxes 8,000 Removal of buildings 5,000 Survey fees 1,000 24,000 Total cost of land $324,000

Determining the Cost of Buildings: Construction Architectural fees Building permits Contractor’s charges Materials Labor Overhead Cost of interest

Determining the Cost of Buildings: Purchase Purchase price Brokerage commissions Sales and other taxes Repairing or renovating building for its intended purpose

Determining the Cost of Machinery and Equipment Purchase price less discounts Transportation charges Insurance in transit Sales and other taxes Purchase commission Installation costs Expenditures to test the asset Special platforms

Determining the Cost of Land and Leasehold Improvements Land improvements Paving Fences Sprinkler systems Lights in parking lot

Determining the Cost of Land and Leasehold Improvements Leasehold Improvement: Cost of improvements to leased assets Depreciate (amortize) over term of the lease.

Lump-Sum (or Basket) Purchases of Assets Xerox Corporation paid $2,800,000 for a combined purchase of land and a building. The land is appraised at $300,000 and the building at $2,700,000. How much of the purchase price is allocated to land and how much to the building?

Lump-Sum (or Basket) Purchases of Assets Total appraised value = $3,000,000 Land: $300,000 ÷ $3,000,000 = 10% $2,800,000 × 10% = $280,000 Building: $2,700,000 ÷ $3,000,000 = 90% $2,800,000 × 90% = $2,520,000

Capital Expenditure versus an Immediate Expense NO NO

Learning Objective 2 Account for depreciation.

Depreciation Methods Straight-line (SL) Units-of-production (UOP) Double-declining balance (DDB)

Depreciation Methods Data Items Amount Cost of truck $41,000 Estimated residual value ( 1,000) Depreciable cost $40,000 Estimated useful life 5 years Units of production 100,000 miles

(Cost – Residual value) ÷ Years of useful life Straight-Line Method (Cost – Residual value) ÷ Years of useful life ($41,000 – $1,000) ÷ 5 = $8,000 Year 1 depreciation: $ 8,000 Year 2 depreciation: 8,000 Year 3 depreciation: 8,000 Year 4 depreciation: 8,000 Year 5 depreciation: 8,000 Total depreciation: $40,000

Units-of-Production Method ($41,000 – $1,000) ÷ 100,000 = $.40/mile Year 1: 20,000 miles × $.40 = $ 8,000 Year 2: 30,000 miles × $.40 = 12,000 Year 3: 25,000 miles × $.40 = 10,000 Year 4: 15,000 miles × $.40 = 6,000 Year 5: 10,000 miles × $.40 = 4,000 $40,000

Double-Declining-Balance Method Straight-line rate per year: 100% ÷ 5 = 20% Double-declining balance: 2 times the straight-line rate = 40% Book value of truck at the end of the first year: $41,000 × 40% = $16,400 $41,000 – $16,400 = $24,600

Comparing Depreciation Methods Amount of Depreciation per Year Year 1 2 3 4 5 Total SL $ 8,000 8,000 $40,000 UOP $ 8,000 12,000 10,000 6,000 4,000 $40,000 DDB $16,400 9,840 5,904 3,542 4,314 $40,000

Depreciation Methods Used by 600 Companies 1% Other 5% Units-of-production 10% Accelerated 84% Straight-line

Learning Objective 3 Select the best depreciation method.

Relationship Between Depreciation and Taxes Cash revenues $400,000 $400,000 Cash operating expenses 300,000 300,000 Cash provided by operations before tax $100,000 $100,000 Depreciation expense 8,000 16,400 Income before income tax $ 92,000 $ 83,600 Income tax expense (30%) 27,600 25,080 Net income $ 64,400 $ 58,520 Straight-line Accelerated ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

Relationship Between Depreciation and Taxes Straight-line Accelerated Cash-flow analysis $100,000 $100,000 Income tax expense 27,600 25,080 Cash provided by operations before taxes $ 72,400 $ 74,920 Extra cash available for investment if DDB is used ($74,920 – $72,400) $ 2,520 ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

Depreciation for Partial Years Suppose a calendar-year business purchases a building on April 1 for $500,000 with an estimated life of 20 years and an estimated residual value of $80,000. What is the current year’s depreciation using the straight-line method?

Depreciation for Partial Years Full-year depreciation: ($500,000 – $80,000) ÷ 20 = $21,000 Partial-year depreciation: $21,000 × 9/12 = $15,750

Changing the Useful Life of a Depreciable Asset Assume an asset cost of $50,000, a ten-year useful life with no residual value, and the straight-line method. $50,000 ÷ 10 = $5,000 depreciation per year What is the book value after four years? $50,000 – $20,000 = $30,000

Changing the Useful Life of a Depreciable Asset Management determines that the asset will be useful for an additional ten years. How much depreciation expense would be recognized each year starting in year five? $30,000 / 10 years = $3,000

Learning Objective 4 Analyze the effect of a plant asset disposal.

Accounting for Disposal of Plant Assets: Example Fixtures cost: $4,000 Accumulated depreciation: $3,000 Book value $1,000 Accumulated Depreciation 3,000 Loss on Disposal of Asset 1,000 Store Fixtures 4,000 To dispose of store fixtures Accumulated Depreciation 3,000 Loss of Disposal of Asset 1,000 Store Fixtures 4,000 To dispose of store fixtures ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

Selling a Plant Asset: Example Equipment which cost $10,000 on 1/1/2002 is sold on 9/30/2005 for $5,000. It has been depreciated on a straight-line basis over its 10 years’ estimated useful life. There is no residual value.

Selling a Plant Asset: Example What is the accumulated depreciation on September 30, 2005? $10,000 ÷ 10 = $1,000/year $1,000 × 3 years = $3,000 $1,000 × 9/12 = $750 $3,000 + $750 = $3,750

Selling a Plant Asset: Example Sep 30 Cash 5,000 Accumulated Depreciation 3,750 Loss of Sale of Equipment 1,250 Equipment 10,000 To record sale of equipment. ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

Exchanging Plant Assets Assume than an old delivery car with a cost of $9,000 and a book value of $1,000 is exchanged for a new car. Cash payment is $10,000. What is the cost of the new car? $10,000 + $1,000 = $11,000

Exchanging Plant Assets Delivery Auto (new) 11,000 Accumulated Depreciation (old) 8,000 Delivery Auto (old) 9,000 Cash 10,000 To record exchange of auto. ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

Learning Objective 5 Account for natural resources and depletion.

Accounting for Natural Resources and Depletion Natural gas and oil Precious metals and gems Timber, coal, and iron ore (Cost – Residual value) ÷ Estimated units of natural resource = Depletion per unit

Accounting for Natural Resources and Depletion Assume an oil lease cost $100,000 and contains an estimated 10,000 barrels of oil. Depletion rate: $100,000 ÷ 10,000 = $10 per barrel. If 3,000 barrels are extracted during the year,depletion expense is $30,000. Accumulated Depletion is a contra account similar to Accumulated Depreciation

Learning Objective 6 Account for intangible assets and amortization

Intangible Assets Have no physical form Patents Copyrights Trademarks Franchises Leaseholds Goodwill

Intangible Assets Amortization expense - can be written off directly against asset account Assets with an indefinite useful life are not amortized. All intangible assets are subject to impairment

Intangible Assets: Patents Federal government grants giving holder the right to produce and sell an invention. Suppose a company pays $170,000 to acquire a patent on January 1. The company believes that its expected useful life is 5 years.

Intangible Assets: Patets Jan 1 Patents 170,000 Cash 170,000 To record acquisition of patent. Dec 31 Amortization Expense 34,000 Patents 34,000 To amortize cost of patent ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

Intangible Assets: Copyrights Literary compositions (novels) Musical compositions Films (movies) Software Other works of art Extend 50 years beyond author’s life.

Intangible Assets: Trademarks Trademarks, Trade Names, or Brand Names - assets that represent distinctive identifications of a product or service

Intangible Assets: Franchises Privileges granted by private business or government to sell a product or service

Intangible Assets: Goodwill Purchase price paid for Mexana Company $10 million Assets at market value $9 million Less: Mexana’s liabilities $1 million Market value of Mexana’s net assets 8 million Goodwill $ 2 million

Research and Development Expensed as it is incurred

Learning Objective 7 Report plant asset transactions on the statement of cash flows.

Reporting Plant Asset Transactions: Statement of Cash Flows Acquisitions (an investing activity) Sales Depreciation (including amortization and depletion)

End of Chapter 7