Investments in Property, Plant, and Equipment and in Intangible Assets Investments in Property, Plant, and Equipment and in Intangible Assets C H A P T E R 9

Learning Objective 1 Identify the two major categories of long- term operating assets: property, plant, and equipment and intangible assets.

n Property, plant, and equipment n Intangible assets Long-term, or noncurrent, assets acquired for use in a business to facilitate operating activities rather than for resale. Examples include Define and Provide Examples of Operating Assets

Name and Define the Two Types of Operating Assets Property, Plant, and Equipment Tangible, long-lived assets acquired for business operations. Depreciation is the process of allocating the costs of these assets over their estimated lives. Intangible Assets: Long-lived assets without physical substance that are used in business. Amortization is the process of allocating the costs of these assets over their estimated useful lives.

Time Line of Business Issues EvaluateAcquire Estimate and Recognize MonitorDispose

Learning Objective 2 Understand the factors important in deciding whether to acquire a long-term operating asset.

Define Capital Budgeting Systematic planning for long-term investments in operating assets. Long-term operating assets have value because they are expected to help a company generate cash flows in the future. If events occur to change the expectation concerning those future cash flows, then the value of the asset changes.

What is the Time Value of Money? $ The concept that a dollar to be received now is worth more than a dollar to be received far in the future. $ Essential to properly evaluating whether to acquire any long-term asset. At 10% interest, receiving $1 today is the same as receiving $6.73 in 20 years.

Learning Objective 3 Record the acquisition of property, plant, and equipment through a simple purchase as well as through a lease, self- construction, and as part of the purchase of several assets at once.

Assets Acquired by Purchase Frank’s Fruit Farm purchased a fork lift for use in its wholesale business. Frank’s paid $12,000 cash for the fork lift. Make the necessary journal entry for this purchase. Fork Lift ,000 Cash ,000 Purchased a fork lift for $12,000.

Assets Acquired by Purchase Frank’s Fruit Farm purchased a fork lift for use in its wholesale business. Frank’s paid $12,000 for the fork lift. What entry is necessary if Frank paid $3,000 cash and borrowed the remaining $9,000? Make the appropriate entry. Fork Lift ,000 Cash ,000 Notes Payable ,000 Purchased a fork lift for $12,000; paid $3,000 cash and issued a note for $9,000 to Friendly Bank.

What is a Lease? Time period Payment amount Due dates A contract that specifies the terms under which the owner of an asset (the lessor) agrees to transfer the right to use the asset to another party (the lessee). What terms should be included in a lease?

Match Lease Terms to Definitions starting with #1. The party that is granted the right to use the property under the terms of a lease. The owner of property that is leased (rented) to another party. A simple rental agreement. A leasing transaction that is recorded as a purchase by the lessee. 4. Lessee2. Lessor 3. Operating Lease 1. Capital Lease

Operating Lease Frank’s Fruit Farm leases a building with monthly rental payments of $1,000. Make the appropriate entry if rent is paid in cash the first month. Rent (or Lease) Expense ,000 Cash ,000 To record monthly rent of storage building.

Capital Lease Frank’s Fruit Farm enters into a non-cancelable lease agreement that requires lease payments of $100,000 a year for 20 years. At the end of 20 years, Frank’s will own the property. Make the appropriate entries. Leased Property ,360 Lease Liability ,360 To record commercial building acquired under a 20-year non-cancelable lease. Lease Liability ,864 Interest Expense ,136 Cash ,000 To record annual payments under capital lease.

Classifying Leases Yes No Transfer of Ownership? Bargain Purchase Option? Term  75% of Useful Life? PV Payment  90% of FMV? Capital Lease Operating Lease Respond YES or NO. If the item below occurs, is the lease a capital lease? If the lease is non- cancelable and does not meet all four of the requirements, it is an operating lease.

Assets Acquired by Self Construction Self-constructed assets ò recorded at cost ò include all expenditures incurred to build the asset and make it ready for its intended use Costs include ò materials used to build the asset ò the construction labor ò capitalized interest ò some reasonable share of the general company overhead

Acquisition of Several Assets at Once— Define the Terms Below Basket Purchase The purchase of two or more assets acquired together at a single price. Relative Fair Market Value Method A way of allocating a basket purchase price to the individual assets acquired based on their respective market values.

3,000, $3,600,000 Example: Basket Purchase AssetFMV % of Total Value Cost Land$1,000,000 25%0.25 x $3,600,000 =$ 900,000 Building x $3,600,000 = 2,700,000 Total$4,000,000 % When two or more assets are acquired at a single price, the prices are allocated on a “relative fair market value” method. In this example, Frank’s Fruit Farm purchased land and a new sorting facility at a total cost of $3,600,000. Prepare the entry to record the purchase. Land ,000 Building ,700,000 Cash ,600,000 To record building and land acquired for $3,600,000.

Learning Objective 4 Compute straight-line and units-of-production depreciation expense for plant and equipment.

Define these Depreciation Terms Depreciation The process of cost allocation that assigns the original cost of plant and equipment to the periods benefited. Book Value For a long-term operating asset, book value is equal to the asset’s original cost less any accumulated depreciation. Salvage Value The amount expected to be received when an asset is sold at the end of its useful life.

Methods of Depreciation Straight-Line The cost of the asset is allocated equally over the periods of an asset’s estimated useful life. Units-of-Production The cost of an asset is allocated to each period on the basis of the productive output or use of the asset during the period.

Frank’s Fruit Farm purchased a fork lift on January 1 for transporting fresh produce to and from the warehouse. The following facts apply: Acquisition cost $24,000 Estimated salvage value.....$ 2,000 Estimated life: In years years In miles driven ,000 miles Compute Frank’s annual depreciation expense using both the straight-line and units-of-production methods and determine the appropriate journal entries. Example: Depreciation Methods

What is the Formula for the Straight-Line Method? Annual Depreciation Expense = Cost - Salvage value Estimated useful life (years) = $24,000 - $2,000 4 years = $5,500 Depreciation Expense ,500 Accumulated Depreciation, Fork Lift....5,500 To record annual depreciation for the fork lift. Do the calculation. Make the Journal Entry

What is the Formula for the Units-of-Production Method? Per Unit Depreciation = Cost - Salvage value Estimated life in units Depreciation Expense = Per unit depreciation x Units produced Depreciation Expense = ($24,000 - $2,000) 60,000 miles x 12,000 miles = $4,400 Depreciation Expense ,400 Accumulated Depreciation, Fork Lift....4,400 To record annual depreciation for the fork lift. Do the calculation. Make the Journal Entry

Comparison of Methods Year Straight-Line Units-of-Production Total $ 5,500 5,500 $22,000 $ 4,400 6,600 7,700 3,300 $22,000

Partial-Year Depreciation What are the two steps to compute depreciation expense for less than a full year? First, calculate depreciation expense for the year. Second, distribute it evenly over the number of months the asset is held during the year.

More Depreciation Terms Defined. Natural Resources Assets that are physically consumed or waste away, such as oil, minerals, gravel, and timber. Depletion The process of cost allocation that assigns the original cost of a natural resource to the periods benefited.

Example: Depletion Depletion Expense ,000 Accumulated Depreciation, Coal Mine.. 72,000 To record depletion for the year: $12,000 at $6 per ton. Hard Hat’s mine contains an estimated 200,000 tons of coal. The depletion expense for each ton of coal is $6. Determine the journal entry if 12,000 tons are mined.

Learning Objective 5 Account for repairs and improvements of property, plant, and equipment.

Expenditures on Existing Assets Ordinary expenditures è Typically benefit only the period in which they are made (repairs, maintenance, and minor improvements). Capitalized expenditures è Significant in amount. è Benefit the company over several periods, not just the current one. è Increase the productive life or capacity of the asset.

Learning Objective 6 Identify whether a long-term operating asset has suffered a decline in value and record the decline.

Impairment Test Sum of future cash flows (from asset) Book value (of asset) IMPAIRMENT Record asset at its fair value NO IMPAIRMENT Asset continues to be reported at book value YES Sum of future cash flows less than book value NO

Learning Objective 7 Record the discarding and selling of property, plant, and equipment.

Example: Discarding Property, Plant, and Equipment Accumulated Depreciation, Conveyor... 15,000 Conveyor ,000 Scrapped $15,000 conveyor. Frank’s Fruit Farm purchased a conveyor system for $15,000. It has a 5-year life, no salvage value, and is depreciated on a straight-line basis. If Frank’s scraps the conveyor after 5 full years, what is the appropriate entry?

Example: Discarding Property, Plant, and Equipment Accumulated Depreciation, Conveyor... 15,000 Loss on Disposal of Conveyor Conveyor ,000 Cash Scrapped $15,000 conveyor and paid $300 disposal costs. Frank’s Fruit Farm purchased a conveyor system for $15,000. It has a 5- year life, no salvage value, and is depreciated on a straight-line basis. If Frank pays $300 to have the conveyor dismantled and removed, what is the appropriate entry?

Example: Selling Property, Plant, and Equipment Accumulated Depreciation, Conveyor... 12,000 Loss on Disposal of Conveyor ,300 Conveyor ,000 Cash Scrapped $15,000 conveyor, recognized loss of $3,300, including disposal costs of $300. Frank’s Fruit Farm purchased a conveyor system for $15,000. It has a 5-year life, no salvage value, and is depreciated on a straight-line basis. If Frank scraps the conveyor after only 4 years of service, there will be a loss of $3,300. What is the appropriate journal entry?

Example: Selling Property, Plant, and Equipment Cash Accumulated Depreciation, Conveyor... 15,000 Conveyor ,000 Gain on Sale of Conveyor Sold $15,000 conveyor at a gain of $600. Frank’s Fruit Farm purchased a conveyor system for $15,000. It has a 5- year life, no salvage value, and is depreciated on a straight-line basis. If the conveyor is sold for $600 after 5 full years of service, what is the appropriate journal entry?

Example: Selling Property, Plant, and Equipment Cash Accumulated Depreciation, Conveyor... 12,000 Loss on Sale of Conveyor ,400 Conveyor ,000 Sold $15,000 conveyor at a loss of $2,400. Frank’s Fruit Farm purchased a conveyor system for $15,000. It has a 5- year life, no salvage value, and is depreciated on a straight-line basis. If the conveyor is sold for $600 after only four years of service, Frank’s will experience a loss of $2,400. Make the appropriate entry.

Learning Objective 8 Account for the acquisition and amortization of intangible assets and understand the special difficulties associated with accounting for intangibles.

What are Intangible Assets? Rights and privileges that are a.long-lived b.not held for resale c.have no physical substance d.usually provide owner with competitive advantage over other firms Amortization a.Periodic allocation to expense of an intangible asset’s cost. b.Conceptually, the same as depreciation. c.Intangible assets generally use straight-line amortization.

Define Each of These Intangible Assets. Patent An exclusive right granted for 17 years by the U.S. Federal Government to manufacture and sell an invention. Franchise An entity that has been licensed to sell the product of a manufacturer or to offer a particular service in a given area. License The right to perform certain activities, generally granted by a government agency.

Amortizing a Patent $200,000 Patent with useful life of 8 years: PATENT Calculate the amortization for each of the eight years. Benefit Year 1 — $25,000 Year 2 — $25,000 Year 3 — $25,000 Year 4 — $25,000 Year 5 — $25,000 Year 6 — $25,000 Year 7 — $25,000 Year 8 — $25,000

Goodwill l An intangible asset that exists when a business is valued at more than the fair market value of its net assets, usually due to: w strategic location w reputation w good customer relations w similar factors l Equal to the excess of the purchase price over the fair market value of the net assets purchased.

Inventory$750,000 Long-term operating assets220,000 Other assets25,000 Liabilities (18,000) Total Net Assets$977,000 Example: Goodwill Frank’s Fruit Farm purchased Farmers’ Market for $1,200,000. At the time of the purchase, Farmers’ recorded the following market values of its assets and liabilities:

Example: Goodwill Frank’s Fruit Farm purchased Farmers’ Market for $1,200,000. Make the journal entry in Frank’s books to appropriately recognize goodwill. Inventory ,000 Long-Term Operating Assets ,000 Other Assets ,000 Goodwill ,000 Liabilities ,000 Cash ,200,000 Purchased Farmers’ Market for $1,200,000.

Learning Objective 9 Use the fixed asset turnover ratio as a measure of how efficiently a company is using its property, plant, and equipment.

Fixed Asset Turnover The number of dollars in sales generated by each dollar of fixed assets. Sales Average property, plant, and equipment

Expanded Material Learning Objective 10 Compute declining- balance and sum-of- the-years’-digits depreciation expense for plant and equipment.

Accelerated Depreciation Define each term. Declining-Balance Method An asset’s book value is multiplied by a constant depreciation rate {such as double the straight-line percentage, in the case of double-declining balance (DDB)}. Sum-of-the-Years’-Digits Method (SYD) A constant balance (cost minus salvage value) is multiplied by a declining depreciation rate.

Accelerated Depreciation Methods Frank’s Fruit Farm purchased a fork lift for $12,000. The fork lift has a salvage value of $2,000 and a useful life of 4 years. Compute depreciation using both the DDB and SYD depreciation methods. X 2 = Double- Declining Balance Depreciation Expense Book Value Asset’s Life in Years Book Value = Cost – Accumulated Depreciation Sum of the years of the asset’s life Sum-of- the-Year’s- Digits (Cost – Salvage Value) Current Year / ( ) Year 1 ($12,000 – 0) 4 X 2 = $6,000 Year 2 ($12,000 – $6,000) 4 X 2 = $3,000 Year 3 ($12,000 – $9,000) 4 X 2 = $1,000 DDB Year 1 ($12,000 – $2,000) 4/( ) = $4,000 Year 2 ($12,000 – $2,000) 3/( ) = $3,000 Year 3 ($12,000 – $9,000) 2/( ) = $2,000 SYD Can’t Depreciate Below Salvage Value

Expanded Material Learning Objective 11 Account for changes in depreciation estimates.

Change in Estimates Frank’s purchased a fork lift for $12,000 with a $2,000 salvage value Fruit Farm a 4-year useful life. After 3 years, better information reveals the fork lift has a 6-year useful life and a $3,000 salvage value. Calculate a new depreciation expense for the next three years.