1. 1 Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Chapter 8 Operating Assets: Property, Plant, and Equipment, Natural Resources, and Intangibles

2. 2 Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Property, Plant and Equipment: Land $ 35,113 Buildings 192,323 Machinery and equipment 354,469 Capitalized leases 23,271 Leasehold improvements 82,643 924,832 Less: accumulated depreciation 203,408 549,108 Tools, dies and molds, net 187,349 $ 736,457 Mattel, Inc. Partial Balance Sheet Book Value At Cost

3. 3 Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Acquisition Cost of P,P&E l All costs necessary to acquire asset and prepare for intended use Invoice Price + Taxes Installation Costs Freight Charges

4. 4 Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Group Asset Purchases Allocate cost of lump-sum purchase based on fair market values Cost $500,000 $385,000 $115,000 Allocated Cost Land = $120,000 Building = $400,000 Fair Market Value 77% 23% % of Market Value

5. 5 Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. 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 Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Depreciation of P,P & E Match Cost of Assets with periods benefited Straight-Line Units of Production Accelerated Methods via

7. 7 Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. $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 Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Units-of-Production Method l Allocate asset cost based on number of units produced over its useful life depreciation = per unit

9. 9 Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. 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 Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Depreciation Example On January 1, Owens Manufacturing Company purchases a machine for $10,000. The life of the machine is estimated at three years, after which it is expected to be sold for $1,000.

11. 11 Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Depreciation Example Calculate Owens's depreciation of the machine for years 1 - 3 using the straight- line, units-of-production and double declining balance depreciation methods. $10,000 cost - $1,000 residual value = $9,000 to be depreciated

12. 12 Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Straight-Line Depreciation Depreciation = Cost - Residual Value Life = $10,000 - $1,000 3 years = $3,000 $9,000 3 year life $3,000 Year 1 $3,000 Year 2 $3,000 Year 3

13. 13 Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Units-of-Production Depreciation l Owen’s estimated machine production: Yr. 1 10,000units Yr. 2 20,000 units Yr. 3 15,000 units Total 45,000 units

14. 14 Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Units-of-Production Depreciation Depreciation = Cost - Residual Value per unit Total Units in Life = $10,000 - $1,000 45,000 = $.20

15. 15 Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. l Owen’s annual depreciation: Yr. 1 10,000 units x $.20/unit = $2,000 Yr. 2 20,000 units x $.20/unit = 4,000 Yr. 3 15,000 units x $.20/unit = 3,000 $9,000 Units-of-Production Depreciation

16. 16 Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Double declining-balance Depreciation DDB rate = (100% / useful life) x 2 = (100% / 3 years) x 2 = 66.7%.667 Initially ignore residual value

17. 17 Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Double declining-balance Depreciation Year 1 Depreciation = Beginning book value x rate = $10,000 x 66.7% = $6,667 BeginningEnding YearRateBook Value Depreciation Book Value 166.7% $10,000 $6,667 $3,333

18. 18 Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Double declining-balance Depreciation Year 2 Depreciation = Beginning book value x rate = $3,333 x 66.7% = $2,233 BeginningEnding YearRateBook Value Depreciation Book Value 166.7% $10,000 $6,667 $3,333 266.7% $ 3,333 2,233 1,100

19. 19 Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Double declining-balance Depreciation BeginningEnding YearRateBook Value Depreciation Book Value 166.7% $10,000 $6,667 $3,333 266.7% $ 3,333 2,233 1,100 366.7% $ 1,100 100 1,000 $9,000 Final year’s depreciation = amount needed to equate book value with salvage value = Residual Value

20. 20 Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Straight-line vs. DDB Depreciation

21. 21 Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Reasons for Choosing Straight-Line Depreciation l Simplicity l Reporting to stockholders l Comparability l Bonus plans

22. 22 Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Reasons for Choosing Accelerated Methods l Technological rate of change and competitiveness l Minimize taxable income Income Taxes

23. 23 Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. 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 Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Depreciation Change in Estimate $9,000 truck originally expected to be depreciated over 3 years. After 2 years, useful life is increased to 4 years. $3,000 planned $3,000 Yr. 1Yr. 2Yr. 3 Example: revise estimate

25. 25 Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Depreciation Change in Estimate l $3,000 remaining book value allocated prospectively over remaining life Yr. 1Yr. 2Yr. 3Yr. 4 revise estimate $1,500 $3,000 Example:

26. 26 Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. 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 Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Capital vs. Revenue Expenditures  Capitalize  Expense General Guidelines: » Increase asset life » Increase asset productivity » Normal maintenance

28. 28 Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Capital Expenditures $9,000 truck originally expected to be depreciated over 3 years. After 2 years, replace engine at cost of $2,000. Truck life is increased by 2 years. $3,000 planned $3,000 Yr. 1Yr. 2Yr. 3 Example: replace engine

29. 29 Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Capital Expenditures l $3,000 remaining book value + $2,000 capital expenditure depreciated prospectively over remaining life $2,500 Yr. 1Yr. 2Yr. 3Yr. 4 replace engine $3,000 Example:

30. 30 Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. 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 Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Disposal of Operating Assets l Sell truck (cost $10,000; accumulated depreciation $6,000) for $3,500 Sales price$ 3,500 Less book value: Asset cost$10,000 Less: accumulated depreciation 6,000 4,000 = Loss on sale($ 500) Example:

32. 32 Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Natural Resources (in thousands) Boise Cascade Corporation Partial Balance Sheet Property Property and Equipment: Land and land improvements$ 63,307 Buildings and improvements 575,509 Machinery and equipment 4,082,724 Less: accumulated depreciation (2,150,385) 2,571,155 Timber, timberlands, and timber deposits 270,570 $2,841,725

33. 33 Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. 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 Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Intangible Assets (in millions) Time Warner, Inc. Partial Balance Sheet Operating Assets: Property, plant and equipment, net$ 1,991 Music catalogues, contracts and copyrights 876 Cable television and sports franchises 2,868 Goodwill 11,919

35. 35 Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Patents Intangible Assets l Long-term assets with no physical properties Goodwill Trademarks Copyrights

36. 36 Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. 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 Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Research & Development l Must be expensed in period incurred l Difficult to identify future benefits

38. 38 Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. 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 Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Amortization of Intangibles Discovery Corporation purchases a patent for $2,000 and incurs $1,000 in legal and registration fees. The patent’s remaining legal life is 12 years, but its anticipated useful life is 5 years. Example:

40. 40 Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Amortization of Intangibles Discovery’s Annual Amortization: Purchase price$2,000 Acquisition costs 1,000 Total 3,000 divide by: lesser of legal or useful life 5 years Annual amortization$ 600

41. 41 Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Amortization of Intangibles Discovery’s Balance Sheet Presentation: Upon End of PurchaseYr. 1Yr. 5 Long-term Assets: Intangible assets, net of accum. amortization $3,000$2,400 $ 0

42. 42 Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Analyzing Long-term Assets Average Life = Property, Plant & Equipment Depreciation Expense What is the average depreciable period of the company’s assets?

43. 43 Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Analyzing Long-term Assets Average Age = Accumulated Depreciation Depreciation Expense Are assets old or new?

44. 44 Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Analyzing Long-term Assets Asset Turnover = Net Sales Average Total Assets How productive are the company’s assets?

45. 45 Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Long-term Assets and the Statement of Cash Flows Operating Activities Net income xxxx Depreciation and Amortization + Gain on sale of asset - Loss on sale of asset + Investing Activities Purchase of asset - Sale of asset + Financing Activities Exhibit 8-8

46. 46 Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. End of Chapter 8