1. 1 Chapter 8 Operating Assets: Property, Plant, and Equipment, Natural Resources, and Intangibles Financial Accounting, Alternate 4e by Porter and Norton

2. 2 Buildings and improvement$ 1,242.9 Machinery and equipment 3,191.1 Construction in progress 310.7 $ 4,744.7 Land 223.8 $ 4,968.5 Less accumulated depreciation (2,588.7) Property, plant, and equipment (net)$ 2,379.8 Johnson Controls, Inc. Property, Plant, and Equipment Book Value At Cost

3. 3 Acquisition Cost of P,P&E l All costs necessary to acquire asset and prepare for intended use Purchase Price + Taxes Installation Costs Transportation Charges

4. 4 Group Asset Purchases Allocate cost of lump-sum purchase based on fair market values Cost $100,000 $75,000 $25,000 Allocated Cost Land = $30,000 Building = $90,000 Fair Market Value 75% 25% % of Market Value

5. 5 Capitalization of Interest l Interest can be included as part of the cost of an asset if: » company constructs asset over time, and » borrows money to finance construction

6. 6 Depreciation of P,P & E Match cost of assets with periods benefited Straight-Line Units-of- Production Accelerated Methods via

7. 7 $9,000 3-year life Straight-Line Method l Allocates cost of asset evenly over its useful life $3,000 Year 1 $3,000 Year 2 $3,000 Year 3

8. 8 Units-of-Production Method l Allocate asset cost based on number of units produced over its useful life depreciation = per unit

9. 9 Double-Declining-Balance Method l Double the straight-line rate on a declining balance (book value) l Accelerated method - higher amount of depreciation in early years Straight-Line Rate

10. 10 Depreciation Example On January 1, Kemp Company purchases a machine for $20,000. The life of the machine is estimated at five years, after which it is expected to be sold for $2,000.

11. 11 Depreciation Example Calculate Kemp's depreciation of the machine for years 1 - 5 using the straight- line, units-of-production and double- declining-balance depreciation methods. $20,000 cost - $2,000 residual value = $18,000 to be depreciated

12. 12 Straight-Line Depreciation Depreciation = Cost - Residual Value Life = $20,000 - $2,000 5 years = $3,600 $18,000 5-year life $3,600 Year 1 $3,600 Year 2 $3,600 Year 3 $3,600 Year 4 $3,600 Year 5

13. 13 Units-of-Production Depreciation l Kemp’s estimated machine production: Yr. 1 3,600 units Yr. 2 3,600 units Yr. 3 3,600 units Yr. 4 3,600 units Yr. 5 3,600 units Total 18,000 units

14. 14 Units-of-Production Depreciation Depreciation = Cost - Residual Value per unit Life in Units = $20,000 - $2,000 18,000 = $ 1.00

15. 15 l Kemp’s depreciation in 2004: 4,000 units x $1/unit = $ 4,000 Units-of-Production Depreciation

16. 16 Double-Declining-Balance Depreciation DDB rate = (100% / useful life) x 2 = (100% / 5 years) x 2 = 40%.40 Initially ignore residual value

17. 17 Double-Declining-Balance Depreciation Year 1 Depreciation = Beginning book value x rate = $20,000 x 40% = $8,000 BeginningEnding YearRateBook Value Depreciation Book Value 140% $20,000 $8,000 $12,000

18. 18 Double-Declining-Balance Depreciation Year 2 Depreciation = Beginning book value x rate = $12,000 x 40% = $4,800 BeginningEnding YearRateBook Value Depreciation Book Value 140% $20,000 $8,000 $12,000 240% $12,000 4,800 7,200

19. 19 Double-Declining-Balance Depreciation BeginningEnding YearRateBook Value Depreciation Book Value 140% $20,000 $8,000 $12,000 240% 12,000 4,800 7,200 340% 7,200 2,880 4,320 440% 4,320 1,728 2,592 540% 2,592 592 2,000 $18,000 Final year’s depreciation = amount needed to equate book value with salvage value = Residual Value

20. 20 Straight-Line vs. DDB Depreciation

21. 21 Reasons for Choosing Straight-Line Depreciation l Simplicity l Reporting to stockholders l Comparability l Bonus plans

22. 22 Reasons for Choosing Accelerated Methods l Technological rate of change and competitiveness l Minimize taxable income l Comparability Income Taxes

23. 23 Changes in Depreciation Estimates l Recompute depreciation schedule using new estimates l Record prospectively (i.e., change should affect current and future years only) Useful life is 7 years vs. 5?

24. 24 Depreciation Change in Estimate $20,000 machine originally expected to be depreciated over 5 years. After 2 years, useful life is increased to 7 years. $3,600 planned $3,600 Yr. 1Yr. 2Yr. 3 Example: revise estimate Yr. 4Yr. 5

25. 25 Depreciation Change in Estimate l $12,800 remaining book value allocated prospectively over remaining life revise estimate Example: $2,160 $3,600 $2,160 Yr. 1Yr. 2Yr. 3Yr. 4 Yr. 5 Yr. 6Yr. 7

26. 26 Capital vs. Revenue Expenditures Income Statement l Revenue Expenditure » Expense immediately Balance Sheet l Capital Expenditure » Treat as asset addition to be depreciated over a period of time

27. 27 Capital vs. Revenue Expenditures  Capitalize  Expense General Guidelines: » Increase asset life » Increase asset productivity » Normal maintenance » Material expenditures

28. 28 Capital Expenditures $20,000 machine originally expected to be depreciated over 5 years. After 2 years, overhaul machine at cost of $3,000. Machine life is increased by 3 years. Example: replace engine $3,600 planned $3,600 Yr. 1Yr. 2Yr. 3 Yr. 4Yr. 5

29. 29 Capital Expenditures l $12,800 remaining book value + $3,000 capital expenditure depreciated prospectively over remaining life replace engine Example: Yr. 1Yr. 2Yr. 3Yr. 4 $2,300 $3,600 $2,300 Yr. 5Yr. 6Yr. 7Yr. 8

30. 30 Disposal of Operating Assets l Record depreciation up to date of disposal l Compute gain or loss on disposal Proceeds > Book Value = Gain Proceeds < Book Value = Loss

31. 31 Disposal of Operating Assets l Sell truck (cost $20,000; accumulated depreciation $9,000) for $12,400 Asset cost$20,000 Less: Accumulated depreciation 9,000 Book value 11,000 Sale price 12,400 Gain on sale of asset $ 1,400 Example:

32. 32 Natural Resources (in thousands) Boise Cascade Corporation Partial Balance Sheet Property and Equipment: Land and land improvements$ 70,731 Buildings and improvements 709,127 Machinery and equipment 4,678,112 Less: accumulated depreciation (2,915,940) 2,542,030 Timber, timberlands, and timber deposits 328,720 $2,870,750

33. 33 Natural Resources l Resource consumed as it is used l Expense called depletion vs. depreciation l Depletion method similar to units of production

34. 34 (In millions) Walt Disney and Co. Consolidated Balance Sheets (partial) Operating assets: Parks, resorts and other property, at cost Attractions, buildings and equipment$ 18,917 Accumulated depreciation (8,133) 10,784 Projects in process 1,148 Land 848 12,780 Intangible assets, net 2,776 Goodwill 17,083 Intangible Assets

35. 35 Patents Intangible Assets l Long-term assets with no physical properties Goodwill Trademarks Copyrights

36. 36 Intangible Assets l Includes cost to acquire and prepare for intended use + Purchase Price Acquisition Costs (i.e. legal fees, registration fees, etc.)

37. 37 Research & Development l Must be expensed in period incurred l Difficult to identify future benefits

38. 38 Amortization of Intangibles l Normally recorded using straight-line method l Reported net of accumulated amortization l Amortized over legal or useful life, whichever is shorter

39. 39 Amortization of Intangibles ML Company developed a patent for $10,000. The patent’s legal life is 20 years, but its anticipated useful life is 5 years. Example:

40. 40 Amortization of Intangibles ML Company’s annual amortization: Patent approval costs$10,000 Divide by: Lesser of legal or useful life 5 years Annual amortization$ 2,000

41. 41 Amortization of Intangibles ML Company’s Balance Sheet Presentation: Upon End of acquisition Yr. 1Yr. 5 Long-term Assets: Intangible assets, net of accum. amortization $10,000$8,000 $ 0

42. 42 Long-term Assets and the Statement of Cash Flows Operating Activities Net income xxx Depreciation and amortization + Gain on sale of asset – Loss on sale of asset + Investing Activities Purchase of asset – Sale of asset + Financing Activities

43. 43 Analyzing Long-term Assets Average Life = Property, Plant & Equipment Depreciation Expense What is the average depreciable period (or life) of the company’s assets?

44. 44 Analyzing Long-term Assets Average Age = Accumulated Depreciation Depreciation Expense Are assets old or new?

45. 45 Analyzing Long-term Assets Asset Turnover = Net Sales Average Total Assets How productive are the company’s assets?

46. 46 End of Chapter 8