1. Chapter 07 Long-Term Assets McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc.

2. Participation Questions – Chapter 7  Nike was used as an example for the intangible asset of Trademarks. True or False  What company committed fraud by capitalizing $11 billion of costs instead of properly expensing them? Target, WorldCom, JC Penney, Albright Mobile Communications  Name a type of intangible asset. Equipment, Building, Land, Goodwill  Tangible property is depreciated each year in order to comply with the matching principle. True or False  The double declining balance method of calculating depreciation expense forces companies to pay higher income taxes in the earlier years of the assets life. True or False

3. Announcements  Handouts PPT pgs. 31, 38, 43, 50 or in Webcourses Class Materials  Assignments – Due 11/1/15 Chapter 7 Homework (Connect) – unlimited attempts Participation questions for Chapter 1 (Webcourses) – 1 attempt Learn Smart Extra Credit for Block 2 (All 4 chapters @ 100%)  Exam 2: 11/2 – 11/4 Study Sessions for Exam #2 - October 30th @ 12:00 PM – 2:00 PM with Louis  Upcoming Assignments SEC Financial Statement Assignment (Webcourses) - 1 attempt and Due on 11/15/15  College of Business Accounting Tutoring Lab - BA 1 – Room 355 Monday10:30 AM – 5:30 PM Tuesday10:00 AM – 5:45 PM Wednesday12:30 PM – 8:00 PM Thursday9:00 AM – 4:30 PM; 6:30 PM – 9:00 PM

4. Questions to be Answered Overall - What is financial reporting’s role in today’s American society? Chapter 7 – How does the purchase or sale of long-term assets impact period earnings?

5. Chapter 7 - LONG-TERM ASSETS

6. WorldCom http://www.accounting-degree.org/scandals/ 2002 – WorldCom did not record expenses for costs associated with lines and cabling; instead they ‘parked’ the cost on the balance sheet to be expensed at a later time. Found through a routine internal audit. If the amount = $11 Billion – what is the result to the financial statements? Led to $100 Billion in losses to shareholders

7. WorldCom – Capitalization of Lease Expenses – (not actual results, just for representation)

8. Chapter 7 – Long-term Assets (LTA) What is it? Calculate costs Purchase Cost allocation - Spread costs to the periods when revenue is earned Sell or retire asset Tangible Asset Intangible Asset

9. Categories of Long-Term Assets Tangible Assets- Property, Plant and Equipment Intangible Assets Land, land improvements, buildings, equipment, and natural resources Patents, trademarks, copyrights, franchises, and goodwill Physical substanceLacks physical substance 7-9

10. Part A Acquisition (Purchase) 7-10

11. Purchase of Long-term Assets - Measuring the Cost of a Plant Asset 11 Copyright ©2010 Pearson Education Inc. Publishing as Prentice Hall. Record a long-term asset at Cost + All expenditures necessary to get the asset ready for use

12. 12 AssetCosts included LandPurchase price, commissions, survey & legal fees, and back property taxes paid; grading and removing unwanted buildings Land ImprovementsFencing, paving, security systems & lighting Building – Constructed Architectural fees, contractors’ charges, materials, labor, and overhead; interest on funds borrowed Building – Purchased Purchase price, broker’s commission, taxes paid and all costs to repair and renovate building EquipmentPurchase price, transportation, insurance in transit, sales tax, installation and testing

13. Purchase of Land and Related costs 13

14. How do you allocate the purchase cost when you pay a lump sum for more than 1 asset? Purchase Land and Building for $450,000 and signed a promissory note.  Appraisal shows the land value at $100,000  Appraisal shows the buildings value at $350,000 Purchase Land and Building for $450,000 and signed a promissory note  Appraisal shows the land value at $100,000  Appraisal shows the buildings value at $400,000 14 Lump-sum (Basket) Purchases

15. Step 1.) Calculate the % each asset account is of the total Fair Market Value of the asset bundle purchased (appraisal). Step 2.) Multiply each asset accounts % by the Total Cost of the asset bundle. 15 AssetMarket 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 = = Lump-sum (Basket) Purchases (Cont.) Step 1 Step 2

16. Basket Purchase Example On 1/1/14, a used truck and fork lift are purchased for $50,000 cash. The Fair Market Value (FMV) on the truck is $30,000 and the FMV for the fork lift is $30,000. Journalize the purchases.

17. Part B Cost Allocation 7-17

18. Plant Asset Terminology – Cost Allocation Asset Account (Balance Sheet) Related Expense Account (Income Statement) Plant assets (aka fixed, capital) LandNone Buildings, Machinery & Equipment Depreciation Furniture & FixturesDepreciation Land ImprovementsDepreciation Natural ResourcesDepletion IntangiblesAmortization 18 Copyright ©2010 Pearson Education Inc. Publishing as Prentice Hall.

19. LO4 Calculate depreciation of property, plant, and equipment Dictionary definition = Decrease in value. Accounting definition = Allocation of an asset’s cost $Cost $Benefit Time Periods Depreciation = Allocation of a portion of the asset’s cost to an expense over all periods benefited. Cost incurred to purchase an asset (future benefit) 7-19

20. Matching Expense to Revenue 20 Copyright © 2010 Pearson Education Inc. Publishing as Prentice Hall.

21. Depreciation Terminology  Residual value (or salvage value) is the amount the company expects to receive from selling the asset at the end of its service life. (Residual value is never depreciated)  Depreciable cost – total purchase cost less residual value.  Service life (or useful life) is how long the company expects to receive benefits from the asset before disposing of it; can be measured in units of time or in units of activity.  Accumulated depreciation is a contra-asset account representing the total depreciation taken to date.  Book value is equal to the original cost of the asset minus the current balance in accumulated depreciation. 7-21 http://www.irs.gov/pub/irs-pdf/p946.pdf

22. 22 Southwest Airlines

23. Depreciation Methods Straight-lineDeclining-balanceActivity-based 7-23

24. Straight-Line Depreciation Allocates an equal amount of the depreciable cost to each year of the asset’s service life. Asset cost - Estimated residual value Straight-Line Depreciation = Asset’s service life 7-24

25. Truck purchase for $41,000; residual value = $1,000; useful life = 5 years. What is Annual Depreciation Expense? Journalize. 25

26. Straight-line Depreciation – Balance Sheet 26 Copyright © 2010 Pearson Education Inc. Publishing as Prentice Hall.

27. Activity-Based Depreciation Allocate an asset’s cost based on use rather than time Step 1 Compute the average depreciation rate per unit Depreciable Cost (Cost – Salvage Value) Total units expected to be produced/used Step 2Multiply the average depreciation rate per unit by the number of units consumed each period 7-27 Step 3 Journal entry recording a debit to depreciation expense and a credit to accumulated depreciation.

28. Activity Based Depreciation – Example Truck purchase $41,000, 5 year useful life, $1,000 residual value, 100,000 miles expected use. UseMiles Year 1 - 20,000 Year 2 - 30,000 Year 3 - 25,000 Year 4 - 15,000 Year 5 - 10,000 100,000 28

29. Activity Based Depreciation – Example Truck purchase $41,000, 5 year useful life, $1,000 residual value, 100,000 expected use. 29

30. Declining-Balance Depreciation  An accelerated depreciation method Depreciates a larger portion of the asset in the first years of the useful life.  Will be higher than straight-line depreciation in earlier years, but lower in later years  Double-declining-balance (DDB) depreciation computes annual depreciation by multiplying the asset’s declining book value by a constant percentage, which is two times the straight-line depreciation rate.  Does not consider residual value until last year. 7-30

31. Double Declining Balance - STEPS 1.Compute the rate of straight-line depreciation as a percentage. For example, 4 year useful life = 25% of the value each year (1 / useful life) 2.Multiply the straight-line percentage rate by 2 to compute the DDB percentage rate. 3.Multiply the DDB rate by the period’s beginning asset book value (cost less accumulated depreciation). ***Under the DDB method, ignore the residual value of the asset in computing depreciation, except during the last year. *** 4.Record and post the calculated depreciation expense (debit depreciation expense and credit accumulated depreciation) 5.Determine the final year’s depreciation amount—that is, the amount needed to reduce asset book value to its residual value. The residual value should not be depreciated but should remain on the books until the asset is disposed. 31

32. Double Declining Balance (DDB) Calculating depreciation per year to be applied to remaining depreciable value each period. 32

33. DDB - Example 33

34. DDB Example and Differences  First-year depreciation is based on asset’s full cost (NOT the depreciable cost)  Final year depreciation is a “plug” amount needed to reduce book value to residual value 34

35. Comparing Depreciation Methods  Straight line Best for assets that generate revenue evenly - TIME  Units of production Best for assets that wear out based on USAGE  Double declining balance Best for assets that generate most revenues early in their life Tax Advantage in the early years  Matching best achieved considering these scenarios

36. Depreciation for Tax Purposes 36 Tax savings increase cashflow and cash can be reinvested in business Tax deductions decrease tax payments Accelerated deprecation provides fastest tax deductions

37. Comparison of Dep. Methods 37

38. Exercise 38

39. Straight-line Depreciation – Bought van on 1-1-13 4 year useful life (36,000) miles Residual value = $2,800  What is book value at the end of year 2?

40. Straight Line – Journal Entry DateAccountDebitCredit 12/31/2013Depreciation Expense 4,050 Accumulated Depreciation 4,050 (Annual depreciation expense) 12/31/2014Depreciation Expense 4,050 Accumulated Depreciation 4,050 (Annual depreciation expense) 12/31/2015Depreciation Expense 4,050 Accumulated Depreciation 4,050 (Annual depreciation expense) 12/31/2016Depreciation Expense 4,050 Accumulated Depreciation 4,050 (Annual depreciation expense)

41. Activity Based Depreciation Bought van on 1-1-13; 4 year useful life (36,000) miles; Residual value = $2,800 Actual usage – Year 1 – 11,000 miles; Year 2 – 13,000 miles; Year 3 – 5,000 miles; Year 4 – 7,000 miles  What is book value at the end of year 2?

42. Activity Based – Journal Entries DateAccountDebitCredit 12/31/2013Depreciation Expense 4,950 Accumulated Depreciation 4,950 (Annual depreciation expense) 12/31/2014Depreciation Expense 5,850 Accumulated Depreciation 5,850 (Annual depreciation expense) 12/31/2015Depreciation Expense 2,250 Accumulated Depreciation 2,250 (Annual depreciation expense) 12/31/2016Depreciation Expense 3,150 Accumulated Depreciation 3,150 (Annual depreciation expense)

43. 43 Double-declining-balance Bought van on 1-1-13 4 year useful life (36,000) miles Residual value = $2,800 DepreciationAccumulatedEnding DateAsset CostDDB RateBook ValueExpenseDepreciationBook Value 1/1/2013 12/31/2013 12/31/2014 12/31/2015 12/31/2016  Step 1  Step 2

44. Exercise 44 DDB rate 1/Life in years * 2 1/4 *2 50% Double-declining- balance DepreciationAccumulatedEnding DateAsset CostDDB RateBook ValueExpenseDepreciationBook Value 1/1/2011 19,000 12/31/2011 0.50 19,000 9,500 12/31/2012 0.50 9,500 4,750 14,250 4,750 12/31/2013 0.50 4,750 1,950 16,200 2,800*** 12/31/2014 0.50 2,800 - 16,200 2,800

45. Double Declining Balance – JE’s DateAccountDebitCredit 12/31/2011Depreciation Expense 9,500 Accumulated Depreciation 9,500 (Annual depreciation expense) 12/31/2012Depreciation Expense 4,750 Accumulated Depreciation 4,750 (Annual depreciation expense) 12/31/2013Depreciation Expense 1,950 Accumulated Depreciation 1,950 (Annual depreciation expense) 12/31/2014Depreciation Expense - Accumulated Depreciation - (Annual depreciation expense)

46. Partial Year Depreciation 46 Annual depreciation Months from date of purchase to end of year 12

47. Partial Year Depreciation Example Cost = $500,000; Residual Value = $80,000; Useful Life = 20 years – bought April 1 st. 47 Copyright © 2010 Pearson Education Inc. Publishing as Prentice Hall.

48. Part C Asset Disposition THE FOOD STORE 7-48

49. LO6 Disposal of Long-Term Assets Disposal of Long-Term Assets Sale Retirement Can result in either a gain or a loss Occurs when a long- term asset is no longer useful but cannot be sold 7-49

50. Step 1: Bring accumulated depreciation up-to-date to: Record depreciation expense up to date of disposal Step 2: Calculate sale amount based on one of 2 scenarios Sale Price - Equals cash received (sale) Retirement, $0.00 is received. Step 3: Subtract current book value (Updated after Step 1). Step 4: If result is positive, record gain; if negative, record loss. Journal Entry – close out asset and accumulated depreciation Debit Cash if sale Debit accumulated depreciation Credit tangible asset account Record gain (credit) or loss (debit) on disposal Disposal of Long-Term Assets - STEPS

51. Selling a Plant Asset 51 If cash received is greater than book value GAIN (Credit) GAIN (Credit) If cash received is less than book value LOSS (Debit) LOSS (Debit)

52. Recording Long-Term Asset Disposals Little King Sandwiches purchased a new delivery truck. Here are the specific details: Cost of the new truck$40,000 Estimated residual value$5,000 Estimated service life5 years 7-52 Assume a sale after 3 years for 22,000.

53. Sale If we assume that Little King sells the delivery truck at the end of year 3 for $22,000, we can calculate the gain as $3,000. Note that both the delivery truck and the related accumulated depreciation account are removed. The entry to record the gain on sale is: Cash22,000 Accumulated Depreciation21,000 Delivery Truck40,000 Gain on sale3,000 (Record gain on sale) Sale amount$22,000 Less: Cost of the new truck$40,000 Less: Accumulated depreciation (3 years x $7,000/year)(21,000) Book value at the end of year 319,000 Gain on sale$3,000 7-53 STEP 2 STEP 3 STEP 4

54. Retirement If we assume that the delivery truck is totaled in an accident at the end of year 3, we have a $19,000 loss on retirement. 7-54

55. Retirement If we assume that the delivery truck is totaled in an accident at the end of year 3, we have a $19,000 loss on retirement. Sale amount$0 Less: Cost of the new truck$40,000 Less: Accumulated depreciation (3 years x $7,000/year)(21,000) Book value at the end of year 319,000 Loss on retirement($19,000) The entry to record the loss on retirement is: Accumulated Depreciation21,000 Loss on Retirement19,000 Delivery Truck40,000 (Record loss on retirement) 7-55 STEP 2 STEP 3 STEP 4

56. INTANGIBLE ASSETS – Purchase or Create oPurchase intangible assets like patents, copyrights, trademarks, or franchise rights from other entities. oRecord purchased intangible assets at their original cost plus all other costs, such as legal and filing fees, necessary to get the asset ready for use. o Create intangible assets internally through research and development or advertising. o Most of the costs for internally developed intangible assets are expensed to the income statement as they are incurred. 7-56

57. Research & Development Costs  R&D costs are generally not capitalized.  Generally, all R&D costs are expensed when incurred  What makes sense is not always GAAP Research & development may lead to revenue producing intangible assets  Drug formula, special recipes, processes 57 Copyright ©2010 Pearson Education Inc. Publishing as Prentice Hall.

58. LO5 Amortization of Intangible Assets Definition: Allocation of the cost of intangible assets to the periods it helped earn the revenue Intangible assets subject to amortization for useful life only Intangible assets not subject to amortization Assets having a FINITE useful life that we can estimate Assets having INDEFINITE useful lives Goodwill, Trademarks Patents, Copyrights, Franchises 7-58

59. Amortization of Intangible Assets (Cont.) Allocates an equal amount of the amortization cost to each year of the asset’s useful life. Asset cost Straight-Line Amortization = Lessor of Useful Life or Legal Life 7-59

60. Patents (example, patent with a useful life of 5 years is purchased for $100,000 cash).  Granted by federal government  Give holder exclusive right to produce & sell an invention  Granted for 20 years  Useful life may be less 60

61. Copyrights  Granted by the federal government  Give holder exclusive rights to reproduce & sell a book, musical composition, film or other work of art  Extend 70 years after creator’s life Useful life is usually very short 61 ©

62. Trademarks & Trade Names TM ®  Distinctive identification of a product or service Also include  Advertising slogans  Coloring/uniforms  Signage, mastheads, etc.  Useful life may be set by contract Or indefinite life 62

63. Franchises & Licenses  Granted by private business or government  Give purchaser right to sell a product or service with specified conditions  Include restaurant chains & sports organizations  May have indefinite life 63

64. Intangible with Finite life – Purchased Patent for $170,000 Legally Enforceable for 20 years Estimated Useful life – 5 years 64

65. Intangible with Finite life – Purchased Patent for $170,000 Legally Enforceable for 20 years Estimated Useful life – 5 years 65 Copyright © 2010 Pearson Education Inc. Publishing as Prentice Hall.

66. Goodwill  Only recorded when assets are acquired in a business combination Assets not individually identified  Reputation, corporate culture, market share  Defined as the excess of the purchase price of the company over the market value of its net assets  Represents future economic benefits (earning power of assets acquired in a business combination)  Not amortized – evaluate at least annually for impairment 66

67. Questions to be Answered How does the purchase or sale of long-term assets impact period earnings?

68. Participation Questions – Chapter 7  Nike was used as an example for the intangible asset of Trademarks. True or False  What company committed fraud by capitalizing $11 billion of costs instead of properly expensing them? Target, WorldCom, JC Penney, Albright Mobile Communications  Name a type of intangible asset. Equipment, Building, Land, Goodwill  Tangible property is depreciated each year in order to comply with the matching principle. True or False  The double declining balance method of calculating depreciation expense forces companies to pay higher income taxes in the earlier years of the assets life. True or False