1 Financial Accounting: Tools for Business Decision Making, 4th Edition Kimmel ∙ Weygandt ∙ Kieso CHAPTER 9 Prepared by Ellen L. Sweatt Georgia Perimeter College and Barbara Muller Arizona State University West

2 Chapter 9 REPORTING AND ANALYZING LONG- LIVED ASSETS

3 Chapter 9 Reporting and Analyzing Long-Lived Assets After studying this chapter, you should be able to: 1.Describe how the cost principle applies to plant assets. 2.Explain the concept of depreciation. 3.Compute periodic depreciation using the straight-line method, and contrast its expense pattern with those of other methods. 4.Describe the procedure for revising periodic depreciation.

4 5.Explain how to account for the disposal of plant assets. 6.Describe methods for evaluating the use of plant assets. 7.Identify the basic issues related to reporting intangible assets. 8.Indicate how long-lived assets are reported on the balance sheet. Chapter 9 Reporting and Analyzing Long-Lived Assets

5 Cost of Plant Assets  Plant assets are resources that have physical substance are used in the operations of a business are not intended for sale to customers deliver service potential over their useful lives (except land)  Plant assets are recorded at cost cost consists of all expenditures necessary to acquire the asset and make it ready for its intended use 11 1

6 Types of Expenditures  Revenue Expenditure - immediately charged against revenue as an expense  Capital Expenditure - capitalized as an asset, not immediately expensed

7 Cost is measured by the cash paid in a cash transaction, or the cash equivalent price paid when noncash assets are used in payment. The cash equivalent price is equal to the fair market value of the asset given up, or the fair market value of the asset received, whichever is more clearly determinable. Plant Assets

8 Cost of land includes Cash price, closing costs, brokers’ commissions, accrued property taxes, etc. Can also include costs to raze a building, drain and fill the land Proceeds from sale of salvaged materials are deducted from the cost Plant Assets Land

9 Cost of Land Improvements  All expenditures necessary to make the improvements ready for their intended use Drive ways Parking lots Fences Underground sprinklers

10 Buildings  All necessary expenditures relating to the purchase or construction of a building.  When a building is purchased such costs include the purchase price closing costs (attorney's fees title insurance) real estate broker's commissions

11 Buildings  If a building is purchased, but needs to be readied for its intended use, cost includes expenditures for remodeling rooms or offices replacing or repairing oroof ofloors oelectrical wiring oplumbing

12 Buildings  When a building is constructed, its cost consists of the contract price architect's fees building permits excavation cost interest costs during construction

13 Equipment  Cost of equipment includes purchase price sales tax freight charges and insurance during transit paid by the purchaser expenditures required in assembling installing and testing the unit

14 Equipment  Two criteria apply in determining the cost of equipment the frequency of cost - one time or recurring the benefit period - the life of the asset or 1 year

15 Leasing Versus Purchasing an Asset  Advantages of leasing include Reduced risk of obsolescence Little or no down payment Shared tax advantages Assets and liabilities may not be recorded

16 Review Question Which of the following is/are properly classified as plant assets (property, plant, and equipment)? I.Inventory II.Machinery III.Office supplies a.I and II only. b.II and III only. c.II only. d.III only.

17 Review Question Which of the following is/are properly classified as plant assets (property, plant, and equipment)? I.Inventory II.Machinery III.Office supplies a.I and II only. b.II and III only. c.II only. d.III only.

18 Review Question Real estate fees incurred to purchase a building are treated on the financial statements as an? a.Expense in the period incurred. b.Expense in the period the fees are paid. c.Extraordinary expense, reported net of tax. d.Asset.

19 Review Question Real estate fees incurred to purchase a building are treated on the financial statements as an? a.Expense in the period incurred. b.Expense in the period the fees are paid. c.Extraordinary expense, reported net of tax. d.Asset.

20 Depreciation  The process of allocating to expense the cost of a plant asset over its useful life in a rational and systematic manner. Depreciation is not a process of asset valuation. 11 2

21 Depreciation  Three classes of plant assets are depreciated Land improvements Buildings Equipment  Land is NOT depreciated

22 The revenue-producing ability of an asset declines during its useful life because of wear and tear. Depreciable Assets A decline in revenue- producing ability may also occur because of obsolescence.

23 Land Does not depreciate since its usefulness and revenue producing ability generally remain intact, or increase.

24 CASH Accumulated Depreciation The balance in Accumulated Depreciation is The total amount of the asset’s cost charged to expense to date Not a cash fund

25 Factors in Computing Depreciation

26 Review Question Depreciation is a process of? a.Valuation. b.Cost allocation. c.Cash accumulation. d.Appraisal.

27 Review Question Depreciation is a process of? a.Valuation. b.Cost allocation. c.Cash accumulation. d.Appraisal.

28 Depreciation Methods  Straight-line  Declining-balance  Units-of-activity 11 3

29 Straight-line Method Depreciable Cost* ______________________________________________________________________________________ The asset's useful life measured in years *(cost of the asset less its salvage value)

30 Straight-Line Depreciation Formula

31 Straight-line Method  Is the most widely used method of depreciation.  Depreciation is the same for each year of the asset's useful life.

32 Partial Year Depreciation If an asset is purchased during the year rather than on January 1, the annual depreciation is prorated for the proportion of a year it is used.

33 Declining-Balance Method  Is an accelerated method.  Accelerated methods of depreciation result in more depreciation in the early years of an asset's life and less depreciation in the later years.

34 Units-of-Activity Method  The life of an asset is expressed in terms of the total units of production or the use expected from the asset.  The amount of depreciation is proportional to the activity that took place during the period.

35 Patterns of Depreciation

36 Depreciation and Income Taxes The IRS allows corporate taxpayers to deduct depreciation when computing taxable income. The IRS does not require the taxpayer to use the same depreciation method on the tax return that is used in preparing financial statements.

37 Depreciation and Income Taxes  Many large corporations use straight-line depreciation in their financial statements to maximize net income.  At the same time they use a special accelerated- depreciation method on their tax returns to minimize their income taxes.  The choice of depreciation method must be disclosed in the notes to financial statements.

38 Revising Periodic Depreciation  A change in estimate (estimated useful life, estimated salvage value, etc.) affects current and future years but not prior periods.  Significant changes in estimate must be disclosed in the financial statements.  Extending an asset's estimated life reduces depreciation expense and increases net income for the period. 11 4

39 Expenditures During Useful Life  Ordinary Repairs are expenditures to maintain the operating efficiency and expected productive life of the asset. are usually small in amount that occur frequently throughout the service life. examples include oil changes on vehicles and painting of buildings.

40 EXPENDITURES DURING USEFUL LIFE  Additions and Improvements are expenditures incurred to increase the operating efficiency, productive capacity, or expected useful life of the plant asset. are usually material in amount and occur infrequently during the period of ownership. are capital expenditures.

41 Impairments  A permanent decline in the market value of an asset.  The asset is written down to the new market value during the year in which the decline occurs.

42 Review Question The main reason companies record depreciation expense is? a.For tax purposes. b.To establish a fund for replacing depreciable assets. c.To systematically allocate the asset’s cost over its useful life. d.As an “earnings management” technique.

43 Review Question The main reason companies record depreciation expense is? a.For tax purposes. b.To establish a fund for replacing depreciable assets. c.To systematically allocate the asset’s cost over its useful life. d.As an “earnings management” technique.

44 Review Question True or False? The double-declining balance method of deprecation usually results in the least rapid decrease in an asset’s book value.

45 Review Question True or False? The double-declining balance method of deprecation usually results in the least rapid decrease in an asset’s book value. FALSE

46 Plant Asset Disposals 11 5

47 Sale of Plant Assets  In the sale of an asset, the book value of the asset is compared with the proceeds from the sale. If the proceeds exceed the book value a gain on disposal occurs. If proceeds from the sale are less than the book value a loss on disposal occurs.

48 Retirement of Plant Assets  A retirement is recorded by decreasing Accumulated Depreciation for the full amount of depreciation taken over the life of the asset, and decreasing the asset account for the original cost of the asset.  The loss is equal to the asset's book value at the time of retirement (a gain is not possible).

49 Analyzing Plant Assets  The two measures by which a company’s use of its plant assets is evaluated are Return on Assets Ratio Asset Turnover Ratio 11 6

50 Return on Assets Ratio  Indicates the amount of net income generated by each dollar invested in assets

51 Asset Turnover Ratio  Indicates (1) how efficiently a company uses its assets, and (2) how many dollars of sales are generated by each dollar invested in assets?

52 Analyzing Plant Assets  A company can increase its return on assets by (1) increasing profit per sale as measured by profit margin ratio, or (2) increasing its volume of sales as measured by the asset turnover ratio

53 Intangible Assets  Intangible assets are rights, privileges, or competitive advantages  Intangible assets result from ownership of long-lived assets that do not possess physical substance  Intangible assets are often a company’s most valuable assets 11 7

54 Types of Intangible Assets  Patents  Copyrights  Trademark or Trade Names  Franchises and Licenses  Goodwill PATENT

55 Intangible Assets  Intangible assets are recorded at cost  If the intangible has a limited useful life, its cost is allocated (amortized) over the useful life.  If the intangible has an indefinite life, it is not amortized.

56  Patents are an exclusive right that enables the recipient to manufacture, sell, or control a patent for 20 years from the date of grant.  The initial cost of a patent is cash or cash equivalent price paid to acquire the patent.  Legal costs of protecting a patent are added to the Patent account and amortized over the remaining life of the patent. Patents

57  R&D costs are expenditures that may lead to a patent, copyright, or other intangible asset  R&D costs are not intangible assets  R&D costs are usually expensed as incurred Research and Development Costs

58 Copyrights  Copyrights are granted by the federal government giving the owner the exclusive right to reproduce and sell artistic or published work.  Copyrights extend for the life of the creator plus 70 years.

59 Trademarks/ Trade Names  A word, phrase, jingle,or symbol that distinguishes or identifies a particular enterprise or product.

60 Franchises and Licenses  A franchise is a contractual agreement under which the franchiser grants the franchisee the right (within a designated geographic area) to sell certain products to render specific services, or to use certain trademarks or trade names  When costs can be identified with the acquisition of the franchise or license, an intangible asset should be recognized  Annual payments made under a franchise agreement should be recorded as operating expenses

61 Goodwill  Goodwill represents the value of all favorable attributes that relate to a business enterprise, including exceptional management desirable location good customer relations skilled employees  Goodwill cannot be sold individually, it is associated with the business as a whole  Goodwill is only recorded when an entire business is purchased

62 Presentation Of Long-lived Assets  Plant assets are shown in the financial statements under Property, Plant, and Equipment.  Intangibles are shown separately under Intangible Assets 11 8

63 Presentation Of Long-lived Assets  Contra accounts Plant assets make use of a contra account “Accumulated Depreciation” Amortization of intangible assets is generally recorded directly to the asset account, bypassing the use of a contra account  Disclosures include major classes of assets and methods of depreciation

64 Review Question Which of the following is not considered an intangible asset? a.Franchise. b.Natural gas. c.Patent. d.Goodwill.

65 Review Question Which of the following is not considered an intangible asset? a.Franchise. b.Natural gas. c.Patent. d.Goodwill.

66 Review Question Intangible assets? a.Have physical substance. b.Have no real economic value. c.Can often be bought and sold. d.Are not expensed (through amortization) over their useful life.

67 Review Question Intangible assets? a.Have physical substance. b.Have no real economic value. c.Can often be bought and sold. d.Are not expensed (through amortization) over their useful life.

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