1 Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall.

Plant Assets, Natural Resources & Intangibles Chapter 7 2 Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall.

Plant Asset Terminology Asset Account (Balance Sheet) Related Expense Account (Income Statement) Plant assets Land Buildings, Machinery & Equipment Furniture & Fixtures Land Improvements Natural Resources Intangibles 3 Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall.

Measure and account for the cost of plant assets 4 Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall.

Measuring the Cost of a Plant Asset 5 Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 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 6 Copyright © 2012 Pearson Education Inc. Publishing as Prentice Hall.

Buildings Constructed ▫Architectural fees and contractors’ charges, ▫Materials, labor, and overhead ▫Interest on funds borrowed Purchased ▫Purchase price, ▫Broker’s commission, ▫Taxes paid ▫Costs to repair and renovate 7 Copyright © 2012 Pearson Education Inc. Publishing as Prentice Hall.

Equipment Purchase price Transportation, Insurance in transit Sales tax Installation and testing 8 Copyright © 2012 Pearson Education Inc. Publishing as Prentice Hall.

Land Improvements Leasehold Improvements Parking lots Driveways Signs Fences Sprinkler systems Improvements to lease property Depreciated or amortized over lease term 9 Copyright © 2012 Pearson Education Inc. Publishing as Prentice Hall.

Lump-Sum (Basket) Purchases Several assets purchased in a group at one price Total cost is allocated based on their market values 10 Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. Asset Market value Total market value % of total market valueTotal cost Cost of each asset Land$100,000$500,00020%$450,000$90,000 Building$400,000$500,00080%$450,000$360,000 $500,000100%$450,000 = =

Distinguish a capital expenditure from an immediate expense 11 Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall.

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 12 Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. Distinction between the two requires judgment

Measure and record depreciation on plan assets 13 Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall.

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 14 Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall.

Depreciation is NOT: 15 Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. A fund to replace assets Valuation process

Amounts Needed for Depreciation ?? ? 16 Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall.

Depreciation Methods Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 17 Straight-lineUnits-of-production Double-declining- balance

Straight-Line (SL) Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 18 Cost – Residual value Useful life, in years Results in equal amount of expense each year

Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 19 Accumulated depreciation increases Book value decreases Asset’s final book value = Residual value

Units-of-Production (UOP) Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 20 Cost – Residual value Useful life in units Depreciation per unit Activity for period (units, miles)

Double-Declining-Balance (DDB) Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 21 DDB rate Book value Straight-line rate x 2 (or 2/life in years) Straight-line rate x 2 (or 2/life in years) Cost minus accumulated depreciation

Residual Value: DDB 22 Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. Ignored until final year Final year depreciation Book value at the beginning final year Residual value

DDB differences 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 23 Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall.

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 24 Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall.

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Depreciation Methods Used 26 Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall.

Exercise 7-19A Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 27 Straight-line Useful life, in years $ $ Cost – Residual value

Exercise 7-19A Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 28 Useful life in units Depreciation per unit Units-of-production Cost – Residual value

Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 29 Depreciation per unit Activity for period (units, miles) Exercise 7-19A Units-of-production Miles Depreciation expense 13,500 12,000 3,500 6,000

Exercise 7-19A Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 30 DDB rate 2/Life in years YearBook valueDepr. Exp.Accum. Depr. Book value Double-declining-balance

Plant Asset Issues Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 31 Long lives Income taxes affected by depreciation Gains and losses incurred when sold Future impact on adoption of International Standards

Depreciation for Tax Purposes Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 32 Tax savings can be reinvested in business Tax deductions decrease tax payments Accelerated deprecation provides fastest tax deductions

Partial Year Depreciation Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 33 Annual depreciation Months from date of purchase to end of year 12

Changing Useful Life Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 34 Remaining depreciable book value (New) Estimated remaining useful life

Analyze the effect of a plant asset disposal 35 Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall.

Disposal of Plant assets Bring depreciation up-to-date to: ▫Measure asset’s final book value ▫Record expense up to date of disposal Remove asset and related accumulated depreciation account from books 36 Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall.

Disposing of Asset for No Proceeds 37 Copyright © 2012 Pearson Education Inc. Publishing as Prentice Hall. JOURNAL DateAccounts and explanationDebitCredit Accumulated depreciation Equipment Disposed of fully depreciated asset

Selling a Plant Asset Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 38 If cash received is greater than book value ? ? If cash received is less than book value ? ?

Exercise 7-22A Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 39 YearBook valueDepr. Exp.Accum. Depr. Book value /5-year life = 40% DDB Rate $5,220 x 40% x 9/12 Cash received:Book value: < Loss =

Exercise 7-22A Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 40 JOURNAL DateAccounts and explanationDebitCredit Aug 31

Exchanging Plant Assets Old assets traded in for new assets ▫Nonmonetary exchange Cost of plant asset received is equal 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 41 Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall.

Apply GAAP for natural resources and intangible assets 42 Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall.

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 43 Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall.

Accounting for Depletion Copyright © 2012 Pearson Education Inc. Publishing as Prentice Hall. 44 JOURNAL Accounts and explanationDebitCredit Oil reserve Cash Oil inventory Oil reserve Cost of oil sold Oil inventory

Intangible Assets No physical form ▫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) 45 Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall.

Accounting for Specific Intangibles 46 Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. PatentsCopyrights Trademarks and trade names Franchises & licenses Goodwill

Patents Granted by federal government Give holder exclusive right to produce and sell an invention Last 20 years 47 Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall.

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 48 Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. ©

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 ® 49 Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall.

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 50 Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall.

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 51 Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall.

Explain the effect of an asset impairment on the financial statements 52 Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall.

Asset Impairment Both tangible and intangible asset musts be test yearly for impairment Expected future cash flows less than asset’s book value Carrying value adjusted to fair value 53 Copyright © 2012 Pearson Education Inc. Publishing as Prentice Hall.

Impairment Steps Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall Impairment loss > Estimated future cash flows 2. If yes, asset is impaired and proceed to step 2 Net book value Fair value Net book value

Recording Impairment Loss Copyright © 2012 Pearson Education Inc. Publishing as Prentice Hall. 55 JOURNAL DateAccounts and explanationDebitCredit Impairment loss on long-term asset Long-term asset

Analyze rate of return on assets 56 Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall.

Return on Assets (ROA) Copyright © 2012 Pearson Education Inc. Publishing as Prentice Hall. 57 ? ? (Beginning total assets + Ending total assets)/2

DuPont Analysis Copyright © 2012 Pearson Education Inc. Publishing as Prentice Hall. 58 Net profit margin Net sales Net income Total asset turnover Net sales Average total assets

ROA using DuPont Analysis Copyright © 2012 Pearson Education Inc. Publishing as Prentice Hall. 59 ? ? ? ? Return on assets

Analyze the cash flow impact of long-lived asset transactions 60 Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall.

Plant Asset Transactions on the Cash Flow Statement ItemSectionDescription DepreciationOperatingAdded to net income as a reconciling item Sales of plant assetsInvestingCash proceeds from sales of plant assets - inflow Purchase of plant assets InvestingCash purchases - outflow 61 Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall.

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