Financial Accounting, Seventh Edition Chapter 9 Plant Assets, Natural Resources, and Intangible Assets

Section 1 – Plant Assets Plant assets include land, land improvements, buildings, and equipment (machinery, furniture, tools). Major characteristics include: “Used in operations” and not for resale. Possess physical substance. Long-term in nature and usually depreciated. Referred to as property, plant, and equipment; plant and equipment; and fixed assets.

Depreciation Depreciation is the process of allocating the cost of a plant asset to expense in the accounting periods in a systematic and rational manner benefiting from its use. Acquisition Cost (Unused) Balance Sheet (Used) Income Statement Expense Cost Allocation Cost (of an asset) Less Accumulated Depreciation = BOOK VALUE  BOOK VALUE MARKET VALUE

Estimated Salvage Value Depreciation Factors in Computing Depreciation Actual Cost Estimated Useful Life Estimated Salvage Value

Depreciation Depreciation Methods Objective is to select the method that best measures an asset’s contribution to revenue over its useful life. Examples include: Straight-line method. Units-of-Activity method. Declining-balance method.

Straight Line Depreciation Method Cost - Salvage Value Useful life in periods Depreciation Expense for Period = On January 1, 2012, an equipment was purchased for $50,000 cash. The equipment has an estimated useful life of 5 years and an estimated salvage value of $5,000. Record the journal entry for Depreciation on December 31, 2012.

Straight Line Depreciation Method Cost - Salvage Value Useful life in periods Depreciation Expense for Period = December 31, 2010: Depreciation expense . . . . . . . . . . . . . . . . . 9,000 Accumulated Depreciation . . . . . . . . . . . . . . 9,000

Straight Line Depreciation Method

Units-of-Activity Depreciation Method Per Unit = Cost - Salvage Value Total Units of Production Step 1: Depreciation Expense = Per Unit × Number of Units Produced in the Period Step 2:

Units-of-Activity Depreciation Method On January 1, 2012, an equipment was purchased for $50,000 cash. The equipment is expected to produce 100,000 units during its useful life and has an estimated salvage value of $5,000. If 22,000 units were produced in 2012, what is the amount of depreciation expense?

Units-of-Activity Depreciation Method

Units-of-Activity Depreciation Method

Declining Balance Depreciation Method Repair Expense Early Years High Low Later Years Early years’ total expense approximates later years’ total expense.

Double Declining Balance Depreciation Method On January 1, 2012, equipment was purchased for $50,000 cash. The equipment has an estimated useful life of 5 years, and a salvage value of $5,000.

Double Declining Balance Depreciation Method

Double Declining Balance Depreciation Method

Double Declining Balance Depreciation Method What would happen if Salvage Value is $15,000?

Knowledge Check: A company purchased a cash register on January 1 for $5,400. This register has a useful life of 10 years and a salvage value of $400. What would be the depreciation expense for the second-year of its useful life using the double-declining-balance method? $ 800. $ 864. $1,000. $1,080.

Comparing Depreciation Methods Life in Years Annual SL Depreciation Annual Production Depreciation Life in Years P2 Annual DDB Depreciation Life in Years

Which method of Depreciation should a company choose?

Knowledge Check: The straight-line depreciation method and the double-declining-balance depreciation method: Yield the same depreciation expense each year. Yield the same book value each year Yield the same total depreciation over an asset's useful life. Are the only acceptable methods of depreciation for financial reporting.

Depreciation and Income Taxes IRS does not require taxpayer to use the same depreciation method on the tax return that is used in preparing financial statements. IRS requires the straight-line method or a special accelerated-depreciation method called the Modified Accelerated Cost Recovery System (MACRS). MACRS is NOT acceptable under GAAP.

Change in Estimates for Depreciation Predicted salvage value Predicted useful life So depreciation is an estimate. Over the life of an asset, new information may come to light that indicates the original estimates were inaccurate.

Change in Estimates for Depreciation On January 1, 2009, equipment was purchased that cost $30,000, has a useful life of 10 years and no salvage value. On January 1, 2012, the useful life was revised to 8 years total (5 years remaining). Calculate depreciation expense for the year ended December 31, 2012, using the straight-line method. Book value at date of change Salvage value at date of change Remaining useful life at date of change –

Change in Estimates for Depreciation

Knowledge Check Question: When originally purchased, a vehicle had an estimated useful life of 8 years. The vehicle cost $23,000 and its estimated salvage value was $1,500. After 4 years of straight-line depreciation, the asset's total estimated useful life was revised from 8 years to 6 years and there was no change in the estimated salvage value. The depreciation expense in year 5 equals: $ 5,375.00. $ 2,687.50. $ 5,543.75. $10,750.00.

Let us analyze Financial Statements! Compare the partial balance sheets of the following 3 companies and rank them in order of their asset’s average age? (All amounts are in millions of dollars) Company A Company B Company C Total Property, Plant and Equipment 19,231 8,130 3,273 Less: Accumulated Depreciation (10,962) (3,285) (882) Net Prop. Plant & Equipment $8,269 $4,845 $2,391

Disposal of Plant Assets Companies dispose of plant assets in three ways —Retirement, Sale, or Exchange (appendix). Record depreciation up to the date of disposal. Eliminate asset by (1) debiting Accumulated Depreciation, and (2) crediting the asset account.

Disposal of Plant Assets Update depreciation to the date of disposal. Journalize disposal by: Recording cash received (debit) or paid (credit). Recording a gain (credit) or loss (debit). Removing accumulated depreciation (debit). Removing the asset cost (credit).

Disposal of Plant Assets If Cash > BV, record a gain (credit). If Cash < BV, record a loss (debit). If Cash = BV, no gain or loss. Update depreciation to the date of disposal. Journalize disposal by: Recording a gain (credit) or loss (debit). Recording cash received (debit) or paid (credit). Removing accumulated depreciation (debit). Removing the asset cost (credit).

Disposal of Plant Assets Evans Company placed a machine in service on January 1, 2008. The machine cost $100,000, and was depreciated using the straight-line method with an estimated salvage value of $20,000 and a useful life of 10 years. The company’s accounting period ends on December 31. On September 30, 2012, the machine was sold for $60,000 cash.

Update Depreciation to the Date of Disposal

Determine Book Value of Asset

Determine Gain or Loss on Disposal If Cash > BV, record a gain (credit). If Cash < BV, record a loss (debit). If Cash = BV, no gain or loss.

Determine Gain or Loss on Disposal

Disposal of Plant Assets Evans Company placed a machine in service on January 1, 2008. The machine cost $100,000, and was depreciated using the straight-line method with an estimated salvage value of $20,000 and a useful life of 10 years. The company’s accounting period ends on December 31. On September 30, 2012, the machine was sold for $65,000 cash.

Knowledge Check Question: Bronco Company sold an equipment for cash of $40,500. Accumulated depreciation on the sale date was $34,000 and a loss of $1,800 was recognized on the sale. What was the original cost of the asset? $72,700 $75,900 $76,300 $42,300

Section 2 – Natural Resources Natural resources consist of standing timber and underground deposits of oil, gas, and minerals. Distinguishing characteristics: Physically extracted in operations. Replaceable only by an act of nature.

Section 2 – Natural Resources Cost - price needed to acquire the resource and prepare it for its intended use. Depletion - allocation of the cost to expense in a rational and systematic manner over the resource’s useful life. Depletion is to natural resources as depreciation is to plant assets. Companies generally use units-of-activity method. Depletion generally is a function of the units extracted.

Examples: oil, coal, gold Natural Resources Total cost, including exploration and development, is charged to depletion expense over periods benefited. Extracted from the natural environment and reported at cost less accumulated depletion. Examples: oil, coal, gold

Cost of Depletion of Natural Resources Per Unit = Cost - Salvage Value Total Units of Capacity Step 1: Depletion Expense = Per Unit × Units Extracted and Sold in Period Step 2:

Cost of Depletion of Natural Resources Chevy Oil and Gas Company acquired a tract of land containing crude oil deposits. Total costs of acquisition and development were $100,000,000. The company estimates the land contains 800,000 barrels of oil, and that the land will have a salvage value of $20,000,000 when the mine is stripped . During the first year of operations, they extracted and sold 13,000 barrels of crude.

Cost of Depletion of Natural Resources

Section 3 – Intangible Assets Intangible assets are rights, privileges, and competitive advantages that do not possess physical substance. Intangible assets are categorized as having either a limited life or an indefinite life. Common types of intangibles: Patents Copyrights Franchises or licenses Trademarks and trade names Goodwill

Accounting for Intangible Assets Valuation Purchased Intangibles: Recorded at cost. Includes all costs necessary to make the intangible asset ready for its intended use. Internally Created Intangibles: Generally expensed. Only capitalize direct costs incurred in perfecting title to the intangible, such as legal costs.

Accounting for Intangible Assets Illustration: Assume that National Labs purchases a patent at a cost of $60,000. National estimates the useful life of the patent to be eight years. National records the annual amortization as follows.

Accounting for Intangible Assets Goodwill Includes exceptional management, desirable location, good customer relations, skilled employees, high-quality products, etc. Only recorded when an entire business is purchased. Goodwill is recorded as the excess of ... purchase price over the FMV of the identifiable net assets acquired. Internally created goodwill should not be capitalized. Goodwill is NOT amortized, but tested for impairment at the end of every year.

Goodwill Example NOTE 9 — BUSINESS COMBINATIONS Excerpted from Form 10-K for MICROSOFT, Inc. For the Fiscal Year Ended June 30, 2012 NOTE 9 — BUSINESS COMBINATIONS On October 13, 2011, we acquired all of the issued and outstanding shares of Skype Global S.á r.l. (“Skype”), a leading global provider of software applications and related Internet communications products based in Luxembourg, for $8.6 billion, primarily in cash. The major classes of assets and liabilities to which we allocated the purchase price were goodwill of $7.1 billion, identifiable intangible assets of $1.6 billion, and unearned revenue of $222 million. The goodwill recognized in connection with the acquisition is primarily attributable to our expectation of extending Skype’s brand and the reach of its networked platform, while enhancing Microsoft’s existing portfolio of real-time communications products and services.

Knowledge Check Question: In 2006, YOUTUBE Company’s Net Assets had a market value of $60 million, but Google Inc paid $1,200 million to purchase YOUTUBE. At the end of 2012, Google makes assessment of the market value of YOUTUBE to be $3,000 million. In 2012, Google must record an impairment expense of: $2,940 million $1,800 million $1,140 million $0

Statement Presentation and Analysis Illustration: In its 2012 Balance Sheet, Microsoft Corporation reported a beginning balance of total assets of $108,704 million, and ending balance of $121,271 million. Microsoft’s net sales revenue for the year was $73,723 million. Determine the Asset Turnover Ratio for Microsoft Corporation. Average Total Assets Asset Turnover Ratio Net Sales ÷ =

The following data was reported by MICROSOFT, APPLE and WALMART. Sales Revenue $ 73,723 $108,249 $446,950 Total Assets, Ending Balance $108,704 $75,183 $180,702 Total Assets, Beg. Balance $121,271 $116,371 $193,406 Asset Turnover Ratio 0.64 1.13 2.39

The following data was reported by MICROSOFT, APPLE and WALMART. Sales Revenue $ 73,723 $108,249 $446,950 Property, Plant and Equipment, Ending Balance $8,269 $7,777 $112,324 Property, Plant and Equipment, Beg. Balance $8,162 $4,768 $107,878 PPE Turnover Ratio 8.97 17.26 4.06

You Can't Talk Yourself Out of End of Chapter 9 You Can't Talk Yourself Out of A Problem You Behaved Yourself Into. Dr. Stephen Covey