Plant Assets, Natural Resources, & Intangibles Chapter 7

Plant Asset Terminology Asset Account (Balance Sheet) Related Expense Account (Income Statement) Plant assets Land None Buildings, Machinery, & Equipment Depreciation Furniture & Fixtures Land Improvements Natural Resources Depletion Intangibles Amortization

Learning Objective One Measure and account for the cost of plant assets

Measuring the Cost of a Plant Asset Sum of all costs incurred to bring the asset to its intended use

Land Purchase price Commissions Survey & legal fees Back property taxes paid Grading and removing unwanted buildings

Buildings Constructed Purchased Architectural fees, building permits, and contractors’ charges Materials, labor, and overhead Interest on funds borrowed Purchased Purchase price Broker’s commission Taxes paid Costs to repair and renovate

Equipment Purchase price (after discounts) Transportation Insurance in transit Sales and other taxes Purchase commission Installation and testing

Leasehold Improvements Land Improvements Leasehold Improvements Parking lots Driveways Signs Fences Sprinkler systems Improvements to lease property Depreciated or amortized over lease term

Lump-Sum (Basket) Purchases Several assets purchased in a group at one price Total cost is allocated based on their market values Asset Market value Total market value % of total market value Total cost Cost of each asset Land $100,000 $500,000 20% $450,000 $90,000 Building $400,000 80% $360,000 100% = =

Learning Objective Two Distinguish a capital expenditure from an immediate expense

Distinction between the two requires judgment CAPITAL EXPENDITURES EXPENSES Increase capacity or extend useful life Cost is added to an asset account Do not extend capacity or useful life Maintain or restore working order Cost is recorded as an expense Distinction between the two requires judgment

Learning Objective Three Measure and record depreciation on plant assets

Depreciation Allocation of plant asset’s cost to expense over its life Supports matching principle Causes: Physical wear and tear Obsolescence Land is NOT depreciated Unlimited useful life

A fund to replace assets Depreciation is NOT: Valuation process A fund to replace assets

Amounts Needed for Depreciation Cost Useful life Residual value

Depreciation Methods Straight-line Units-of-production Double-declining-balance

Annual Depreciation expense Straight-Line (SL) Cost – Residual value Annual Depreciation expense Useful life, in years

Accumulated depreciation increases Book value decreases Asset’s final book value = Residual value

Units-of-Production (UOP) Cost – Residual value Depreciation per unit Useful life in units Depreciation per unit Activity for period (units) Depreciation Expense

Double-Declining-Balance (DDB) DDB rate Book value Straight-line rate x 2 (or 2/life in years) Cost minus accumulated depreciation

Residual Value: DDB Ignored until final year Final year depreciation Book value at the beginning final year Residual value

DDB Differences with other methods First-year depreciation is based on asset’s full cost Final year depreciation is a “plug” amount needed to reduce book value to residual value

Comparing Depreciation Methods Straight-line Best for assets that generate revenue evenly Best meets matching principle Units-of-production Best for assets that wear out because of use Double-declining-balance Best for assets that generate revenue early in useful life

Depreciation Methods Used

$4,025 depreciation expense per year Exercise 7-19A Straight-line Cost – Residual value Useful life, in years $4,025 depreciation expense per year $18,600 - $2,500 4 years

Exercise 7-19A Units-of-production $18,600 - $2,500 35,000 miles Cost – Residual value Depreciation per unit Useful life in units $18,600 - $2,500 $0.46 per mile 35,000 miles

Activity for period (units, miles) Exercise 7-19A Units-of-production Depreciation per unit Activity for period (units, miles) Miles Depreciation expense 13,500 $6,210 12,000 $5,520 3,500 $1,610 6,000 $2,760 $0.46 per mile

Exercise 7-19A DDB rate 50% Double-declining-balance 2/Life in years Beginning Book value Depr. Exp. Accum. Depr. Ending 1 18,600 9,300 2 4,650 13,950 3 4,650 2,150 2,325 16,100 16,275 2,500 2,325 Less than residual value

Plant Asset Issues Income taxes affected by depreciation Long lives Gains and losses incurred when sold Future impact on adoption of international standards

Depreciation for Tax Purposes Tax savings can be reinvested in business Tax deductions decrease tax payments Accelerated deprecation provides fastest tax deductions

Partial Year Depreciation Months from date of purchase to end of year Annual depreciation 12

Changing Useful Life Remaining depreciable book value (New) Annual Depreciation (New) Estimated remaining useful life

Learning Objective Four Analyze the effect of a plant asset disposal

Disposal of Plant Assets Bring depreciation up to date to: Measure asset’s final book value Record expense up to date of sale Remove asset and related accumulated depreciation account from books

Disposing of Asset for No Proceeds JOURNAL Date Accounts and explanation Debit Credit Accumulated depreciation Equipment Disposed of fully depreciated asset

Selling a Plant Asset GAIN LOSS If cash received is greater than book value GAIN If cash received is less than book value LOSS

Exercise 7-22A < Loss = $1,054 Cash received: $2,600 2/5-year life = 40% DDB Rate Year Beginning Book value Depr. Exp. Accum. Depr. Ending 2012 8,700 3,480 5,220 2013 1,566 5,046 3,654 $5,220 x 40% x 9/12 Loss = $1,054 Cash received: $2,600 Book value: $3,654 <

Exercise 7-22A Depreciation expense 1,566 Accumulated depreciation JOURNAL Date Accounts Debit Credit Sep 30 Depreciation expense 1,566 Accumulated depreciation Cash 2,600 5,046 Loss on sale of plant assets 1,054 Fixtures 8,700

Exchanging Plant Assets Old assets traded in for new assets Nonmonetary exchange Cost of plant asset received is equal to the fair values of assets given up Old asset and any cash paid Difference between fair value of old asset and its book value is a gain or loss

Learning Objective Five Apply GAAP for natural resources and intangible assets

Natural Resources Include iron ore, oil, and timber Assets are physically used – depletion Distinct from depreciation Computed like units-of-production If all of extracted resource is sold Amount depleted is recorded as an expense If portion of extracted resource is not immediately sold Amount becomes inventory

Accounting for Depletion JOURNAL Accounts Debit Credit Oil Reserve X,XXX Cash Oil Inventory Cost of Oil Sold

Intangible Assets No physical form Two categories Carry special rights Include patents, copyrights, and franchises Two categories Finite lives Amortization recorded Straight-line method Intangible asset reduced directly Indefinite lives Tested for loss in value (impairment)

Accounting for Specific Intangibles Patents Copyrights Trademarks and trade names Franchises and licenses Goodwill

Patents Granted by federal government Give holder exclusive right to produce and sell an invention Last 20 years

© Copyrights Granted by the federal government Give holder exclusive rights to reproduce and sell a book, musical composition, film, or other work of art Extend 70 years after creator’s life Useful life is usually very short ©

Trademarks and Trade Names Distinctive identification of a product or service Also include advertising slogans Useful life may be set by contract Or indefinite life Indicated by TM or ®

Franchises and Licenses Granted by private business or government Give purchase right to sell a product or service with specified conditions Include restaurant chains and sports organizations Have indefinite life

Goodwill Only recorded when an entire company is purchased Defined as the excess of the purchase price of the company over the market value of its net assets Represents earning power of company purchased Not amortized

Learning Objective Six Explain the effect of an asset impairment on the financial statements

Asset Impairment Both tangible and intangible assets must be tested yearly for impairment Occurs when expected future cash flows less than asset’s book value Carrying value adjusted to fair value

Impairment Steps > Net book value Estimated future cash flows 1. Net book value Estimated future cash flows > If yes, asset is impaired and proceed to step 2 2. Net book value Fair value Impairment loss

Recording Impairment Loss JOURNAL Date Account Debit Credit Impairment Loss on Long-term asset X,XXX Long-term asset

Learning Objective Seven Analyze rate of return on assets

(Beginning total assets + Ending total assets)/2 Return on Assets (ROA) Net income Average total assets (Beginning total assets + Ending total assets)/2

DuPont Analysis Net income Net profit margin Net sales Net sales Total asset turnover Average total assets

ROA Using DuPont Analysis Net profit margin Total asset turnover Return on assets

Learning Objective Eight Analyze the cash flow impact of long-lived asset transactions

Long-Lived Asset Transactions on the Cash Flow Statement Item Section Description Depreciation Operating Added to net income as a reconciling item Sales of long-lived assets Investing Cash proceeds from sales of plant assets (inflow) Purchase of long-lived assets Cash purchases (outflow)

End of Chapter Seven