Long-term Assets

Types of Long-Term Assets n Property, plant, and equipment –Long-term assets acquired for use in operations n Natural resources –Long-term assets with a value that decreases through use or sale

Types of Long-Term Assets n Intangible assets –Long-term assets that do not have physical substance

Plant Asset Cost Purchase price (less cash discount)

Plant Asset Cost Purchase price (less cash discount) plus all other reasonable and necessary expenditures

Plant Asset Cost Purchase price (less cash discount) plus all other reasonable and necessary expenditures to prepare the asset for use

Examples of Items Included n Purchase price less any cash discount n Shipping costs n Installation costs n Cost of modifications n Interest cost during construction

Depreciation n Allocation of the cost of an asset to the periods the asset benefits n Not a valuation process

Factors in Estimating Depreciation n Initial cost n Estimated residual value n Estimated Useful Life

Depreciation Methods n Straight-line –allocate an equal amount to each period n Production unit –depreciation based on volume of output

Accelerated Depreciation Methods n Double Declining-balance –apply a uniform rate to a declining amount (book value) n Sum-of-the-Years’-Digits –annual amount the decreases by a constant amount

Example Data n Depreciable Asset - Truck n Invoice price$20,000 n Cash discount2% n Modifications $3,400 n Estimated residual value$2,000 n Useful life - 4 years or 200,000 miles n Acquisition date - January 8, 19X1

Cost of Truck n Invoice price$20,000 n Less: Cash discount400 n subtotal$19,600 n Modification3,400 n Cost$23,000

Straight-Line Method Cost - Est. Residual Value Est. Useful Life = Depreciation Expense

Straight-Line Method ExpenseAccum 19X1: ($23,000 - $2,000) / 4$5,250$5,250 19X2: ($23,000 - $2,000) / 4$5,250$10,500 19X3: ($23,000 - $2,000) / 4$5,250$15,750 19X4: ($23,000 - $2,000) / 4$5,250$21,000

Production Units Method Cost - Est. Residual Value Est. Useful Life in Units = Depreciation Expense per Unit Depreciation Expense per Unit X Units Produced = Depreciation Expense

Production Units Method Exp Accum ($23,000 - $2,000) / 200,000 = $0.105 per mile 19X1: 50,000 miles X $0.105$5,250$5,250 19X2: 40,000 miles x $0.105$4,200$9,450 19X3: 60,000 miles x $0.105$6,300$15,750 19X4: 10,000 miles x $0.105$1,050$16,800 19X5: 20,000 miles x $0.105$2,100$18,900 19X6: 20,000 miles x $0.105$2,100$21,000

Double-Declining Balance n Calculate a straight-line rate ›1 divided by estimated useful life n Multiply straight-line rate by 2 n Multiply previous asset book value by doubled rate

Double-Declining Balance Exp Accum 19X1: ($23,000 - $0) x (2)(1/4)$11,500$11,500 19X2: ($23,000 - $11,500) x.5$5,750$17,250 19X3: ($23,000 - $17,250) x.5$2,875$20,125 19X4: ($23,000 - $20,125) x.5$1,438$21,623 overdepreciated

Double-Declining Balance Exp Accum 19X1: ($23,000 - $0) x (2)(1/4)$11,500$11,500 19X2: ($23,000 - $11,500) x.5$5,750$17,250 19X3: ($23,000 - $17,250) x.5$2,875$20,125 19X4: ($23,000 - $20,125) x.5$1,438$21,623 overdepreciated 19X4: ($23,000 - $2,000) - $20,125 $875$21,000

Double-Declining Balance Exp Accum 19X1: ($23,000 - $0) x (2)(1/4)$11,500$11,500 19X2: ($23,000 - $11,500) x.5$5,750$17,250 19X3: ($23,000 - $17,250) x.5$2,875$20,125 19X4: ($23,000 - $2,000) - $20,125 $875$21,000

Sum-of-the-Years’-Digits (Cost - Est. Residual Value)x Individual Year (reverse order) Sum of Years’ Digits

Sum-of-the-Years’-Digits n Calculating sum of years’ digits n Add the numeric digits in useful life n Example › = 10

Sum-of-the-Years’-Digits Exp Accum 19X1: ($23,000 - $2,000) x 4/10$8,400$ 8,400 19X2: ($23,000 - $2,000) x 3/10$6,300$14,700 19X3: ($23,000 - $2,000) x 2/10$4,200$18,900 19X4: ($23,000 - $2,000) x 1/10$2,100$21,000

Pattern of depreciation expense n Straight-line –Amount is constant and equal n Production –Amount varies depending on usage

Pattern of depreciation expense n Double declining –Amount is decreasing by decreasing amounts n Sum-of-the-Year’s-Digits –Amount is decreasing by constant amount

Comparison of Depreciation Straight-lineProduction

Double-declining balance Sum-of-the-Years’ Digits

Modified Accelerated Cost Recovery System - MACRS n Income tax reporting method n Applies to tangible property placed in service after 1986 n Eight cost recovery classes with rates for each year n Tax deduction equals cost times appropriate rate for each year

Revenue and Capital Expenditures n Revenue expenditure –Benefits only the current accounting period n Capital expenditure –Significant costs that benefit two more accounting periods

Capital Expenditures n Additions –Enhance usefulness by enlarging asset –Debited to asset n Betterments –Increase or improve services –Debited to asset

Capital Expenditures n Extraordinary repairs –Significant expenditures that extend useful life or change residual value –Debited to accumulated depreciation n In all capital expenditures –Depreciate increased book value over remaining useful life

Disposal of Plant Assets n Sale n Retirement n Exchange

Accounting for Disposal n Remove asset cost and related accumulated depreciation from the records n Book value is cost - accum deprec n Determine gain or loss on disposal n Gain –Received more than book value n Loss –Received less than book value

Sales or Retirements n Always recognize any gain or loss

Exchanges n Always recognize loss n Recognize gain only if exchange of dissimilar assets n If gain on exchange of similar assets –Reduce cost of new asset by gain

Natural Resources n Mineral deposits, oil reserves, timber tracts n Consumption has a cost –Recognize depletion by production method

Intangible Assets n Long-term rights that have future value n Patents, R&D, Goodwill n Consumption has a cost –Recognize amortization by straight- line method

Analyzing Information n Are methods, asset lives, and residual values used reasonable? n If methods, lives, or residual values are changed during year, what is impact on net income? n If some interest cost was capitalized, what is total interest cost for period? –How would this change ratio “Times Interest Earned”?

Times Interest Earned n Net income + Income Tax Expense + Total Interest Cost n divided by n Total Interest Cost