2. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2015 9- 1 Chapter Eight Accounting for Long- Term Operational Assets

3. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2015 9- 2 Chapter 8 Long-Term Operational Assets

4. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2015 9- 3 Classification of Operational Assets l Operational assets are used by a business to generate revenue. l Tangible operational assets have physical substance. –Property, Plant, and Equipment –Property, Plant, and Equipment – Sometimes called plant assets or fixed assets. We depreciate these assets over their useful life.

5. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2015 9- 4 Classification of Operational Assets l Tangible operational assets have physical substance. –Land –Land – Has an infinite life and is not subject to depreciation.

6. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2015 9- 5 Classification of Operational Assets l Tangible operational assets have physical substance. –Natural Resources –Natural Resources – Mineral deposits, oil and gas reserves, timber stands, coal mines, and stone quarries are some examples of natural resources. We deplete these assets over their useful life.

7. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2015 8-6 Cost of Long-Term Assets Buildings Purchase pricePurchase price Sales taxesSales taxes Title search and transfer document costsTitle search and transfer document costs Realtor’s and attorney’s feesRealtor’s and attorney’s fees Remodeling costsRemodeling costsBuildings Purchase pricePurchase price Sales taxesSales taxes Title search and transfer document costsTitle search and transfer document costs Realtor’s and attorney’s feesRealtor’s and attorney’s fees Remodeling costsRemodeling costs Equipment Purchase price (less discounts)Purchase price (less discounts) Sales taxesSales taxes Delivery costsDelivery costs Installation costsInstallation costs Costs to adapt to intended useCosts to adapt to intended useEquipment Purchase price (less discounts)Purchase price (less discounts) Sales taxesSales taxes Delivery costsDelivery costs Installation costsInstallation costs Costs to adapt to intended useCosts to adapt to intended use Land Purchase pricePurchase price Sales taxesSales taxes Title search and transfer document costsTitle search and transfer document costs Realtor’s and attorney’s feesRealtor’s and attorney’s fees Costs of removal of old buildingsCosts of removal of old buildings Grading costsGrading costsLand Purchase pricePurchase price Sales taxesSales taxes Title search and transfer document costsTitle search and transfer document costs Realtor’s and attorney’s feesRealtor’s and attorney’s fees Costs of removal of old buildingsCosts of removal of old buildings Grading costsGrading costs

8. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2015 9- 7 Classification of Operational Assets l Intangible operational assets lack physical substance and confer specific use rights on the owner. p Patents p Copyrights p Franchises p Licenses p Trademarks Burger Queen Franchise

9. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2015 9- 8 Basket Purchases of Assets When land and building are purchased together, the land cost and the building cost are placed in separate accounts. The total cost of the purchase is separated on the basis of relative market values.

10. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2015 9- 9 Example: On March 1, Arco Co. purchased land and building for $100,000 cash. The appraised value of the building was $90,000 and the land was appraised at $30,000. How much of the $100,000 purchase price will be allocated to each account? Land = ? Building = ? Basket Purchases of Assets

11. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2015 9- 10 Basket Purchases of Assets Fair Market Values: Building$ 90,000 Land$ 30,000 Total market value$120,000 Allocation of cost: Building* $100,000 = Land* $100,000 = Appraised Values Total Cost

12. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2015 9- 11 Basket Purchases of Assets Fair Market Values: Percent Building$ 90,00075% Land$ 30,00025% Total market value$120,000 Allocation of cost: Building* $100,000 = Land* $100,000 = Total Cost Appraised Values

13. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2015 9- 12 Basket Purchases of Assets Fair Market Values: Percent Building$ 90,00075% Land$ 30,00025% Total market value$120,000 100% Allocation of cost: Building* $100,000 = Land* $100,000 = Total Cost Appraised Values

14. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2015 9- 13 Basket Purchases of Assets Fair Market Values: Percent Building$ 90,000 75% Land$ 30,000 25% Total market value$120,000 100% Allocation of cost: Building75%* $100,000 = Land25%* $100,000 = Total Cost Appraised Values

15. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2015 9- 14 Basket Purchases of Assets Fair Market Values: Building$ 90,000 Land$ 30,000 Total market value$120,000 Allocation of cost: Building75%* $100,000 = $75,000 Land25%* $100,000 = $25,000 Total Cost Appraised Values Allocated Cost

16. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2015 9- 15 Basket Purchases of Assets General Journal entry: Building$ 75,000 Land$ 25,000 Cash$100,000 Allocation of cost: Building75%* $100,000 = $75,000 Land25%* $100,000 = $25,000 Total Cost Allocated Cost

17. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2015 Depreciation 9- 16 You’ve purchased an asset that will be used to benefit more than one year of operations. When you buy the asset you do NOT “expense” it. You postpone (defer) the recognition of the expense until you have used the asset over a period of time. Recognizing an expenditure by spreading it over several years, allocating a part of the expense to each of several periods during which the asset is used, is called depreciation.

18. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2015 Depreciation l The portion of the cost of an asset allocated to any one accounting period is called-- DEPRECIATION EXPENSE l Depreciation of an asset is an allocation process-- spreading the cost of an asset that benefits more than one accounting period over the estimated useful life of the asset.

19. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2015 Example of Depreciation: l ABC Sports Bar Co. bought equipment for $55,000. The asset is expected to last five years and have a $10,000 salvage value at the end of its useful life. How will the purchase and use of the asset affect the financial statements?

20. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2015 Why? l We want to allocate the cost of the asset to the income statement as an expense during the time period we use the asset. Why? MATCHING To comply with the MATCHING principle. Expenses incurred must be “matched” to the same time period the revenues (from using this equipment) are recorded. l If we depreciate the asset using the STRAIGHT LINE method, we will divide the cost of the asset (minus any estimated salvage value) by the useful life: (55,000-10,000)/5 yrs. = $9,000 depreciation expense each year.

21. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2015 Effect on the financial statements: Purchase of asset: _Balance Sheet u Increases assets (eg. Equip); may decrease “cash” asset (thus, no effect on net assets) or may increase a liability _Income Statement _Statement of Changes in Stockholders’ Equity _Statement of Cash Flows

22. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2015 Effect on the financial statements: Purchase of asset: _Balance Sheet uIncreases assets; may decrease an asset (cash) or increase a liability (payable) if we haven’t paid yet. _Income Statement uNo effect _Statement of Changes in Stockholders’ Equity _Statement of Cash Flows

23. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2015 Effect on the financial statements: Purchase of asset: _Balance Sheet uIncreases assets; may decrease an asset (cash) or increase a liability (payable) if we haven’t paid yet. _Income Statement uNo effect _Statement of Changes in Stockholders’ Equity uNo effect _Statement of Cash Flows

24. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2015 Effect on the financial statements: Purchase of asset: _Balance Sheet uIncreases assets; may decrease an asset (cash) or increase a liability (payable) if we haven’t paid yet. _Income Statement uNo effect _Statement of Changes in Stockholders’ Equity uNo effect _Statement of Cash Flows  Depends on whether or not the asset was purchased for cash. If cash is paid it is an Investing Activity cash flow.

25. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2015 l Balance Sheet u Reduces the net value of the asset by increasing a contra-asset account called accumulated depreciation l Income Statement l Statement of Changes in Stockholders’ Equity l Statement of Cash Flows Use of the asset: Accumulated Depreciation is a Permanent (Asset) Account. It accumulates the depreciation expense each year of the asset’s useful life.

26. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2015 l Balance Sheet u Reduces the net value of the asset by increasing a contra-asset called accumulated depreciation l Income Statement u Increase in depreciation expense reduces Net Income l Statement of Changes in Stockholders’ Equity l Statement of Cash Flows Use of the asset:

27. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2015 l Balance Sheet u Reduces the net value of the asset by increasing a contra-asset called accumulated depreciation l Income Statement u Increase in depreciation expense reduces Net Income l Statement of Changes in Stockholders’ Equity u Since the Net Income decreased, the remaining Retained Earnings will decrease causing total Stockholders’ Equity to decrease. l Statement of Cash Flows Use of the asset:

28. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2015 l Balance Sheet u Reduces the net value of the asset by increasing a contra-asset called accumulated depreciation l Income Statement u Increase in depreciation expense reduces Net Income l Statement of Changes in Stockholders’ Equity u Since the Net Income decreased, the remaining Retained Earnings will decrease causing total Stockholders’ Equity to decrease. l Statement of Cash Flows u No cash involved. Depreciation is an adjusting entry. Use of the asset:

29. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2015 8-28 Depreciation Methods 1.Straight-line method - the same amount is depreciated each accounting period. 2.Units-of-Production – produces varying amounts of depreciation in different accounting periods depending upon the number of units produced. 3.Double-declining-balance – produces more depreciation expense in the early years of an asset’s life, with a declining amount of expense in later years. 1.Straight-line method - the same amount is depreciated each accounting period. 2.Units-of-Production – produces varying amounts of depreciation in different accounting periods depending upon the number of units produced. 3.Double-declining-balance – produces more depreciation expense in the early years of an asset’s life, with a declining amount of expense in later years.

30. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2015 Example of Balance Sheet Net Asset Balance

31. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2015 9- 30 Cost - Salvage Value Life in Years Straight-Line Method Depreciation Expense per Year =

32. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2015 9- 31 Straight-Line Method: Example On January 1, 2013, equipment was purchased for $55,000 cash. The equipment has an estimated useful life of 5 years and an estimated Salvage value of $10,000. What is the annual straight-line depreciation expense?

33. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2015 Straight-Line Method: Example On January 1, 2013, equipment was purchased for $55,000 cash. The equipment has an estimated useful life of 5 years and an estimated Salvage value of $10,000. 8-32

34. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2015 9- 33 Straight-Line Method: Example Depreciation Expense per Year = Depreciation Expense per Year = Cost - Salvage Value Life in Years Depreciation Expense per Year = 55,000 - 10,000 5 9,000

35. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2015 9- 34 Straight-Line Method: Example The company use the equipment to generate $30,000 revenue for the period

36. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2015 9- 35 Units-of-Production Method Step 1:Depreciation Rate Rate= Cost - Salvage Value Cost - Salvage Value Estimated units of useful life Depreciation Rate = Depreciation charge per each unit produced

37. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2015 9- 36 Units-of-Production Method Depreciation Rate Rate= Cost - Salvage Value Cost - Salvage Value Estimated units of useful life Step 1: Step 2: Depreciation Expense = Depreciation Rate × Number of Units Produced for the Year

38. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2015 9- 37 Given the same information [asset cost $55,000, has a salvage value of $10,000, has a useful life of five years] plus the fact that the asset is estimated to have a total productive capacity of 100,000 units during the useful life: If 22,000 units were produced this year, what is the amount of depreciation expense? Example of Units of Production Method

39. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2015 9- 38 Example of Production Method Step 1: Step 2: Depreciation Expense = $.45/unitx 22,000 = $9,900 Depreciation Rate Rate = = Cost - salvage value Productive output $45,000 100,000 Dep. rate x units produced =$.45 Per unit

40. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2015 9- 39 Example of Production Method l If 15,000 units are produced during the second year of the asset’s life, what is the amount of depreciation expense? $0.45 x 15,000 = $6,750 l What is the Accumulated Depreciation at the end of the second year? $9,900 + $6,750 = $16,650 l What is the 12/31/05 Equip. Book Value? $55,000 cost - $16,650 Accum. Dep. = $38,350

41. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2015 9- 40 l Accelerated depreciation methods result in more depreciation expense in the early years of an asset’s useful life and less depreciation expense in later years of the an asset’s useful life. Accelerated Depreciation

42. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2015 9- 41 Double-Declining Balance Method l Declining-balance depreciation is based on the straight-line rate multiplied by an acceleration factor. –For example, when the acceleration factor is 200 percent, the method is referred to as double-declining balance depreciation. l Declining-balance depreciation computations ignore salvage value.

43. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2015 9- 42 Double-Declining Balance Method Annual Depreciation is calculated with the following formula: Book Value × (2 × Straight-Line Rate) $55,000 – 10,000x 1 5 yrs Straight-Line: 1515 x 2 = 2 or 5 40%

44. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2015 9- 43 Using the same information from our earlier example [asset cost $55,000, Salvage value is $10,000, and useful life is 5 years]: Calculate the depreciation expense for the asset’s life. Double-Declining-Balance Example

45. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2015 9- 44 Double-Declining-Balance Example

46. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2015 9- 45 Double-Declining-Balance Example

47. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2015 9- 46 Double-Declining-Balance Example

48. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2015 9- 47 Comparison of Depreciation Methods Straight-line Production* Double-Declining Bal. Dep. Accum. Dep. Accum. Dep. Accum. Year Exp. Dep. Exp. Dep. Exp. Dep. 1 9000 9000 9900 9900 22,000 22,000 2 9000 18000 6750 16650 13,200 35,200 3 9000 27000 11250 27900 7,920 43,120 4 9000 36000 11250 39150 1,880 1 45,000 5 9000 45000 5850 45000 0 1 45,000 *Units produced were Yr 1= 22,000; Yr 2=15,000; Yrs 3&4=25,000 each; Yr. 5=13,000. [ 1 In yr. 4, didn’t use DDB formula. Wrote-off last 1,880.]

49. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2015 9- 48 Comparison of Depreciation Methods l The total amount of depreciation recorded over the useful life of an asset is the same regardless of the method used. l Depreciation expense recorded in any one period will vary according to method used. l The straight-line method is used for financial accounting purposes (“the books”) by about 95 percent of companies because it is easy to use and to explain to financial statement users.

50. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2015 9- 49Disposal of of Operational Assets Operational Assets

51. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2015 9- 50 Horizontal Model Transaction Analysis Horizontal Model Transaction Analysis 1 70,000 70,000 70,000 FA 2 (55,000) 55,000 (55,000 ) IA 3 30,00030000 30,000 30,000 30,000 OA 4 + 9000 (9000) 9,000 (9000) B 45,000 55,000 9000 70,000 21000 Closed out 45,000 B Balance Sheet Income Statement Cashflow Assets = Liab.+ Equity Rev./ Exp. Statem’t Cash + Equip.- Acc.D.= A/P + C.C.+ R.E. Gains - Loss= N.I. OA,IA,FA

52. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2015 9- 51 Horizontal Model Transaction Analysis Horizontal Model Transaction Analysis 1 70,000 70,000 70,000 FA 2 (55,000) 55,000 (55,000 ) IA 3 30,00030000 30,000 30,000 30,000 OA 4 + 9000 (9000) 9,000 (9000) B 45,000 55,000 9000 70,000 21000 Closed out 45,000 B Balance Sheet Income Statement Cashflow Assets = Liab.+ Equity Rev./ Exp. Statem’t Cash + Equip.- Acc.D.= A/P + C.C.+ R.E. Gains - Loss= N.I. OA,IA,FA

53. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2015 9- 52 Horizontal Model Transaction Analysis Horizontal Model Transaction Analysis 1 70,000 70,000 70,000 FA 2 (55,000) 55,000 (55,000 ) IA 3 30,00030000 30,000 30,000 30,000 OA 4 + 9000 (9000) 9,000 (9000) B 45,000 55,000 9000 70,000 21000 Closed out 45,000 B Balance Sheet Income Statement Cashflow Assets = Liab.+ Equity Rev./ Exp. Statem’t Cash + Equip.- Acc.D.= A/P + C.C.+ R.E. Gains - Loss= N.I. OA,IA,FA 5 9000 (9000) 9,000 (9000) B 45,000 55,000 18,000 70,000 12,000 Closed out 45,000 B

54. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2015 9- 53 Horizontal Model Transaction Analysis Horizontal Model Transaction Analysis 1 70,000 70,000 70,000 FA 2 (55,000) 55,000 (55,000 ) IA 3 30,00030000 30,000 30,000 30,000 OA 4 + 9000 (9000) 9,000 (9000) B 45,000 55,000 9000 70,000 21000 Closed out 45,000 B 5 9000 (9000) 9,000 (9000) B 45,000 55,000 18,000 70,00012,000 Closed out 45,000 B Balance Sheet Income Statement Cashflow Assets = Liab.+ Equity Rev./ Exp. Statem’t Cash + Equip.- Acc.D.= A/P + C.C.+ R.E. Gains - Loss= N.I. OA,IA,FA

55. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2015 9- 54 Horizontal Model Transaction Analysis Horizontal Model Transaction Analysis 1 70,000 70,000 70,000 FA 2 (55,000) 55,000 (55,000 ) IA 3 30,00030000 30,000 30,000 30,000 OA 4 + 9000 (9000) 9,000 (9000) B 45,000 55,000 9000 70,000 21000 Closed out 45,000 B 5 9000 (9000) 9,000 (9000) B 45,000 55,000 18,000 70,00012,000 Closed out 45,000 B Balance Sheet Income Statement Cashflow Assets = Liab.+ Equity Rev./ Exp. Statem’t Cash + Equip.- Acc.D. = A/P + C.C.+ R.E. Gains - Loss= N.I. OA,IA,FA 6 6,000 (6000) 6,000 (6000)

56. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2015 9- 55 1. Update the depreciation on the asset to the date of disposal. 2. Record the disposal by... – Removing the asset cost (credit). – Removing the Accumulated Depreciation (debit). – Recording cash received (debit) or cash paid (credit). – Recording a loss (debit) or gain (credit). Disposal of Operational Assets

57. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2015 9- 56 l Compare cash received for the asset with the asset’s book value (BV). –If cash greater than BV, record a gain (credit). –If cash less than BV, record a loss (debit). –If cash equals BV, no gain or loss. Gain or Loss on Disposal? asset for sale How do we know if there is a Loss or Gain on the disposal?

58. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2015 9- 57 Compare cash received for the asset with the asset’s book value (BV). Disposal of Operational Assets How do we know if there is a Loss or Gain on the disposal? Cash received Equipment, cost Less: Accum. Dep. Equip, Book Value Gain (Loss) $26,000 $55,000 24,000 31,000 $ (5,000) - 5000.

59. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2015 9- 58 Horizontal Model Transaction Analysis Horizontal Model Transaction Analysis 1 70,000 70,000 70,000 FA 2 (55,000) 55,000 (55,000 ) IA 3 30,00030000 30,000 30,000 30,000 OA 4 + 9000 (9000) 9,000 (9000) B 45,000 55,000 9000 70,000 21000 Closed out 45,000 B 5 9000 (9000) 9,000 (9000) B 45,000 55,000 18,000 70,00012,000 Closed out 45,000 B Balance Sheet Income Statement Cashflow Assets = Liab.+ Equity Rev./ Exp. Statem’t Cash + Equip.- Acc.D.= A/P + C.C.+ R.E. Gains - Loss= N.I. OA,IA,FA 6 6,000 (6000) 6,000 (6000) 7 26,000 (55,000) (24,000) (5000) 5,000 (5000) 26,000 IA

60. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2015 9- 59 Journalize the Disposal Cash Accumulated Depreciation (to remove) Loss on Disposal of Equipment Equipment (original cost) What if there had been a GAIN on disposal? The GAIN would be a CREDIT in the journal entry above (and there would be more cash). $26,000 24,000 5,000 55,000

61. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2015 9- 60 Horizontal Model Transaction Analysis Horizontal Model Transaction Analysis 1 70,000 70,000 70,000 FA 2 (55,000) 55,000 (55,000 ) IA 3 30,00030000 30,000 30,000 30,000 OA 4 + 9000 (9000) 9,000 (9000) B 45,000 55,000 9000 70,000 21000 Closed out 45,000 B 5 9000 (9000) 9,000 (9000) B 45,000 55,000 18,000 70,00012,000 Closed out 45,000 B 6 6,000(6000) 6,000 (6000) 7 26,000 (55,000) (24,000) (5000) 5,000 (5000) 26,000 IA Balance Sheet Income Statement Cashflow Assets = Liab.+ Equity Rev./ Exp. Statem’t Cash + Equip.- Acc.D. = A/P + C.C.+ R.E. Gains - Loss= N.I. OA,IA,FA B 71,000 0 0 70,000 1,000 Closed out 71,000 B

62. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2015 9- 61 What’s the result? - For Year 3 How much depreciation expense is on the 2015 Income Statement? $6,000 How much Gain or Loss is on the 2015 Income Statement? $5,000 Loss on Disposal How much Accumulated Deprec. is on the 12/31/15 Bal. Sheet? $0 (We don’t have the equipment anymore.) What is the equipment’s Book Value (or Carrying Value) at the end of 2015? $0 (We don’t have the equipment anymore.)

63. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2015 9- 62 l Most corporations use the Modified Accelerated Cost Recovery System (MACRS) for tax purposes. (Could use straight-line depreciation.) l MACRS provides for rapid write-off of an asset’s cost in order to stimulate investment in modern facilities. l MACRS uses half-year convention and assumes no Salvage value. Depreciation and Federal Income Tax

64. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2015 9- 63 Same purchase recorded previously: On Jan. 1, 2013 equipment costing $55,000 was purchased. Estimated life = 5 yrs. Estimated Salvage value = $10,000. Depreciation and Federal Income Tax MACRS example Calculate the depreciation tax deduction assuming the equipment is classified as “5 year property.” Note: See tax tables in your text for 5-Yr. and 7-Yr. properties.

65. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2015 9- 64 IRS Table yr. % 120.00 232.00 319.20 411.52 511.52 6 5.76 Depreciation and Federal Income Tax MACRS example Equipm’t Cost x $55,000 = x 55,000 = $11,000 17,600 10,560 6,336 3,168 $55,000 Depreciation Deduction 100%= 100%

66. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2015 9- 65 Revising Estimates of Salvage Value or of Useful Life l When an estimate is revised, no changes are made to amounts reported in the past. l The new estimates are incorporated into the present and future calculations only. l Depreciation amounts are revised using the book value, estimated useful life and salvage value at beginning of the year of the revision.

67. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2015 9- 66 Revising Estimates of Salvage Value or of Useful Life - Example On Jan. 1, 2013 the Goodview Co. purchased Equipment costing $55,000. It was estimated to last 5 years and have a $10,000 Salvage value. Straight-line depreciation ($9,000) has been used. On Jan. 1, 2015 management determined that the equipment would last 4 years from this date, but would only be worth $5,000 at the end of that time. How much depreciation expense should be recorded each year starting on Dec. 31, 2015?

68. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2015 9- 67 Revising Estimates of Salvage Value or of Useful Life - Example The equipment has already been depreciated two years (‘08 and ‘09) at $9,000 per year. So, Accumulated Depreciation has an $18,000 balance at the beginning of 2015. Original Cost $55,000 Less: Accum. Dep. 18,000 = Book value, Jan. 1, ‘2015 37,000 Less: Revised Salvage Value-5,000 = Remainder to be depreciated 32,000 Divided by Remaining life 4 yrs. = New annual Depreciation expense $ 8,000 Starting in 2015

69. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2015 Continuing Expenditures for Plant Assets Costs That Are Expensed Costs That Are Expensed The cost of routine maintenance and minor repairs that are incurred to keep an asset in good working order are expensed as incurred. Assume the company spent $500 cash for routine maintenance on machinery. 8-68

70. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2015 9- 69 Continuing Expenditures for Plant Assets l Expenditures made to keep an asset in good working order are expensed in the period in which they are incurred. (normally expected repairs & maintenance) l Substantial costs spent to (1) improve the quality or (2) extend the life of an asset are capitalized.

71. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2015 9- 70 Accounting for capital expenditures: Extraordinary Repairs Ex: Overhaul l Extend the life? –viewed as canceling some of the previous depreciation –journal entry to reduce (debit) accumulated depreciation –new depreciation amount will be calculated using the revision approach.Betterments Ex: Attach snowplow to truck owned for 2 years. l Improve the quality? –viewed as an additional cost of the equipment –journal entry to increase (debit) the cost of the asset –new depreciation amount will be calculated using the revision approach.

72. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2015 9- 71 Extraordinary Expenditure Extend Useful Life Improve Quality Extraordinary Expenditure Extend Useful Life Improve Quality Over- haul Engine Original Cost Add Attach- ment Eqpt Cost 10,000 Accum Deprec 4,000 Net Book Value 6,000

73. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2015 9- 72 Extraordinary Expenditure Extend Useful Life Improve Quality Over- haul Engine Original Cost Add Attach- ment Eqpt Cost 10,000 Accum Deprec 2,000 = +2,000 4,000 Net Book Value 8,000 6,000

74. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2015 9- 73 Extraordinary Expenditure Extend Useful Life Improve Quality Over- haul Engine Original Cost Add Attach- ment Eqpt Cost 10,000 +2,000 = 12,000 Accum Deprec 2,000 = +2,000 4,000 Net Book Value 8,000 6,0008,000

75. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2015 9- 74 Natural Resources l Assets supplied by nature –Examples: gold, oil, and coal l Presented on balance sheet as non-current assets at cost minus all depletion to date. l Total cost of the asset is the cost of acquisition, exploration and development. l Cost is “written-off” as “Depletion Expense” over periods that related revenues are earned. (Usually, units-of-production method.)

76. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2015 9- 75 Natural Resources A depletion rate is calculated using the units-of-production method. Depletion Cost Per Unit Is Calculated As Follows: Total Cost of Natural Resource Estimated Number of Available Units of Natural Resource

77. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2015 9- 76 Natural Resources Martin Mining Company paid $10,000,000 cash to purchase land that is expected to yield 5,000,000 tons of coal. After all coal is extracted the land is not expected to have any salvage value. During 2006, the company extracted and sold 500,000 tons of coal. $10,000,000 – $0 5,000,000 tons =$2.00 per ton extracted and sold

78. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2015 9- 77 Natural Resources Martin Mining Company paid $10,000,000 cash to purchase land that is expected to yield 5,000,000 tons of coal. After all coal is extracted the land is not expected to have any salvage value. During 2006, the company extracted and sold 500,000 tons of coal.

79. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2015 9- 78 Intangible Assets l Noncurrent assets without physical substance that confer certain rights and privileges on the owner of the asset. –Examples: patents, copyrights, franchises and licenses, leaseholds, leasehold improvements, trademarks, and goodwill. l Purchased intangible assets are recorded at cost.

80. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2015 9- 79 Two Categories of Intangible Assets l Intangible assets with IDENTIFIABLE useful lives. – e.g. Patents and Copyrights They have a legal life, BUT they MAY become obsolete or worthless before their legal live is over. l Intangible assets with INDEFINITE useful lives. –e.g. Goodwill, Franchise, Trademark How long will the “name” of a restaurant keep attracting customers if new owners don’t serve good food and provide good service?

81. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2015 9- 80 Intangible Assets with IDENTIFIABLE Useful Lives l Amortize (write-off) over the shorter of their useful life or legal life. l Normally the straight-line method is used and the asset is reported on the balance sheet at book value without a related accumulated amortization account.

82. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2015 9- 81 Intangible Assets: Patents l A patent is an exclusive right granted by the federal government to sell or manufacture an invention. l A patent is amortized over the shorter of its useful life or 17-year legal life.

83. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2015 9- 82 Intangible Assets with IDENTIFIABLE Useful Lives Example: (1) A patent is purchased from a company for $20,000. (2) When purchased, there were 15 years remaining of the 17 year legal life, but management estimates that new technology will make this patent obsolete in 4 years. ($20,000/4=$5,000) Patent20,000 Amortization Expense 5,000 Cash20000 Patent 5000

84. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2015 9- 83 Chapter 9 The End

85. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2015 9- 84 Intangible Assets: Goodwill l Goodwill is the added value of a business that is attributable to favorable factors such as a good reputation, location, and superior products. PURCHASED l Goodwill must be PURCHASED by acquiring an existing business at a cost that is higher than the Fair Market Value of its physical assets (minus any liabilities assumed by the buying company). l Goodwill has an INDEFINITE useful life, so it must be tested for IMPAIRMENT each year.

86. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2015 9- 85 Intangible Assets with INDEFINITE Useful Lives l Must be tested for IMPAIRMENT each year. If the fair market value of the intangible asset is less than its book value, the value has been IMPAIRED (reduced). l To reduce the intangible asset to its new lower fair value an IMPAIRMENT LOSS is recorded and reported on the Income Statement. The intangible asset is reduced by the same amount.

87. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2015 9- 86 Intangible Assets: Goodwill (Example) Winona Co. purchased Rushford Co. by paying $1,500 cash for all of its assets, but also agreeing to assume its liabilities. Individual company balance sheets before purchase: Rushford Co. Winona Co. Assets: Liab.-A/P 200 Assets: Liab.-A/P 1000 Eq.,net 1000 C.Cap. 500 Cash 2000 C.Cap. 3000 Ret.Earn 300 Eq.,net 7000 Ret.Earn 5000 T. Assets 1000 T. L&Eq.1000 T.Assets 9000 T. L&Eq. 9000 An appraiser says the Fair Market Value of Rushford’s assets is $1,300.

88. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2015 9- 87 Intangible Assets: Goodwill (example) Cash Paid + Liab. Assumed = Total cost - FMV of Assets Acquired = Goodwill purchased Calculation of Goodwill $1,500 200 1,700 1,300 $ 400

89. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2015 9- 88 Stockholders’ Equity For Corporations Let’s Take a Quick Look at a Chapter 11

90. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2015 9- 89Corporations l A corporation is a popular form of business because... ÊIt is simple for individuals to purchase small amounts of stock. ËIt allows for an easy transfer of ownership through established markets, like the New York Stock Exchange. ÌIt provides stockholders with limited liability.

91. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2015 9- 90Corporations l Because a corporation is a separate legal entity, it can... –Own assets. –Incur liabilities. –Sue and be sued. –Enter into contracts independent of the stockholder owners. l Many Americans own stock through a mutual fund or pension program.

92. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2015 9- 91 Ownership of a Corporation l Owners of common stock generally receive the following rights: –Voting (in person or by proxy). –Distributions of profits (in the form of Dividends). –Distributions of assets in a liquidation. –Offers to purchase shares of a new stock issue (pro rata basis).

93. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2015 9- 92 Creating a Corporation l State laws govern the creation of corporations. l An application for a charter (or articles of incorporation) must include the corporation’s name and purpose, kinds and amounts of capital (common) stock authorized, and other detailed information.

94. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2015 9- 93 Creating a Corporation Once the state issues a charter, the stockholders elect a board of directors.

95. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2015 9- 94 Authorized, Issued, and Outstanding Capital Stock The maximum number of shares of capital stock that can be sold to the public is called the authorized number of shares. Authorized Shares

96. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2015 9- 95 Authorized, Issued, and Outstanding Capital Stock Authorized Shares Issued shares have been sold. Unissued shares have never been sold.

97. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2015 9- 96 Authorized, Issued, and Outstanding Capital Stock Authorized Shares Unissued Shares Outstanding Shares owned by stockholders. Issued Shares

98. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2015 9- 97 Authorized, Issued, and Outstanding Capital Stock Authorized Shares Unissued Shares Treasury Shares Outstanding Shares owned by stockholders. Issued Shares reacquired by the corporation.

99. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2015 9- 98 Common Stock l Basic voting stock of the corporation l Ranks after preferred stock for dividend and liquidation distribution. l Dividend rates are determined by the board of directors based on the corporation’s profitability and other factors.

100. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2015 9- 99 Chapter 8 (and a little 11) The End