Chapter 9 Long-Term Assets

Chapter 9 Long-Term Assets
Financial Accounting, 11e © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom

Learning Objectives Define long-term assets and explain the management issues related to them. Distinguish between capital expenditures and revenue expenditures and account for the cost of property, plant, and equipment. Compute depreciation under the straight-line, production, and declining-balance methods. Account for the disposal of depreciable assets. Identify the issues related to accounting for natural resources and compute depletion. Identify the issues related to accounting for intangible assets, including research and development costs and goodwill. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom

Long-Term Assets Long-term assets
Have a useful life of more than one year. Are used in the operation of a business. Are not intended for resale to customers. Include: Tangible Assets Natural Resources Intangible Assets © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom

Tangible Assets Tangible assets: Long-term assets that have physical substance. Examples: Buildings, equipment, and land. Accounted for through depreciation—the periodic allocation of the cost of a tangible long-lived asset over its estimated useful life. Land is not depreciated because it has an unlimited life. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom

Natural Resources Natural resources: Long-term assets purchased for the economic value that can be taken from the land and used up. Examples: Coal, oil, and lumber. Accounted for through depletion—the proportional allocation of the cost of a natural resource to the units extracted. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom

Intangible Assets Intangible assets: Long-term assets that have no physical substance, but have a value based on rights or advantages accruing to the owner. Examples: Copyrights and trademarks. Accounted for through amortization—the periodic allocation of the cost of the asset to the periods it benefits. Some intangible assets are not subject to amortization if their fair value is below their carrying value. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom

Accounting for Long-Term Assets
Carrying value (or book value): The unexpired part of an asset’s cost. Asset impairment: Occurs when the carrying value of a long-term asset exceeds its fair value. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom

Classification of Long-Term Assets and Methods of Accounting for Them
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom

EXAMPLE: Acquiring Long-Term Assets (slide 1 of 2)
The decision to acquire a long-term asset is a complex process that requires very careful analysis. Example: Apple’s management is considering buying a $100,000 customer-relations software package. Management estimates that the new software will reduce cash outflows by $40,000 per year over a period of four years, the usual life of new software, and that the software will be worth $20,000 at the end of that period: © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom

EXAMPLE: Acquiring Long-Term Assets (slide 2 of 2)
As long as the net present value is positive, Apple will earn at least 10 percent on the investment. In this example, however, the return would be greater than 10 percent because the net present value is a positive $40,460. Moreover, the net present value is large relative to the acquisition cost. Based on this analysis, Apple’s management should purchase the software. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom

Financing Long-Term Assets
Free cash flow: The amount of cash that remains after deducting the funds a company must commit to continue operating at its planned level. These commitments include current or continuing operations, interest, income taxes, dividends, and net capital expenditures (purchases of plant assets minus sales of plant assets). Free cash flow is an important and commonly cited measure of a company’s financial strength. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom

Applying the Matching Rule
How is the cost of the long-term asset determined? How should the expired portion of the cost of the long-term asset be allocated against revenues over time? How should subsequent expenditures, such as repairs and additions, be treated? How should disposal of the long-term asset be recorded? © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom

Issues in Accounting for Long-Term Assets

In the past year, Himera Company had cash flows from operating activities of $133,000. During the year, it expended $61,000 on property, plant, and equipment; sold property, plant, and equipment for $14,000; and paid dividends of $20,000. Calculate the company’s free cash flow. What does the result tell you about the company? SOLUTION Net cash flows from operating activities $133,000 Purchases of property, plant, and equipment (61,000) Sales of property, plant, and equipment 14,000 Dividends (20,000) Free cash flow $ 66,000 Himera’s operations provide sufficient cash flows to fund its current expansion and its payment of dividends without raising additional capital. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom

Acquisition Cost of Property, Plant, And Equipment
Expenditure: Payment or obligation to make a future payment for an asset or for a service. Capital expenditure: Purchase or expansion of a long-term asset. Include: Outlays for plant assets, natural resources, intangible assets. Additions: Enlargements to a plant asset’s physical layout. Betterments: Improvements to a plant asset that do not add to the plant’s physical layout. Extraordinary repairs: Repairs that significantly enhance a plant asset’s estimated useful life or residual value. Revenue expenditure: Ordinary repairs and maintenance needed to keep a long-term asset in good operating condition. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom

Distinction Between Capital and Revenue Expenditures

General Approach to Acquisition Costs
Cost of Asset = Cash + Additional Expenditures (freight, installation, etc.) © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom

Specific Applications (slide 1 of 2)
Land: Purchase debited to the Land account. Land Improvements: Improvements to real estate with a limited life are subject to depreciation; recorded in Land Improvements account. Buildings: Cost includes the purchase price of the building and all repairs and other expenditures required to put the building in usable condition. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom

Specific Applications (2 of 2)
Leasehold improvements: Improvements to leased property that become the property of the lessor (the owner of the property) at the end of the lease Equipment: The cost of equipment includes all expenditures connected with purchasing the equipment and preparing it for use. Group Purchases © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom

EXAMPLE: Group Purchases
Assume that appraisals yield estimates of $20,000 for the land and $180,000 for the building if purchased separately. In that case, 10 percent of the lump-sum price, or $17,000, would be allocated to the land, and 90 percent, or $153,000, would be allocated to the building. The allocation would be as follows: © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom

Match each term on the left with the corresponding action on the right by writing the appropriate letters in the blanks. _____ 1. Addition _____ 2. Betterment _____ 3. Extraordinary repair _____ 4. Land _____ 5. Land improvement _____ 6. Leasehold improvement _____ 7. Buildings _____ 8. Equipment _____ 9. Not a capital expenditure a. Purchase of a computer b. Purchase of a lighting system for a parking lot c. Repainting of an existing building d. Installation of a new roof that extends an existing building’s useful life e. Construction of a foundation for a new building f. Erection of a new storage facility at the back of an existing building g. Installation of partitions and shelves in a leased space h. Clearing of land in preparation for construction of a new building i. Installation of an improved heating system in an existing building SOLUTION 1. f; 2. i; 3. d; 4. h; 5. b; 6. g; 7. e; 8. a; 9. c © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom

Depreciation Depreciation: The periodic allocation of the cost of a tangible asset (other than land and natural resources) over the asset’s estimated useful life. Limitations to an asset’s useful life: Physical deterioration: Result of use or exposure to the elements (wind, sun). Obsolescence: Process of going out of date. Depreciation describes the gradual conversion of the cost of the asset into an expense. Depreciation is not a process of valuation. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom

Factors in Computing Depreciation
Cost: Net purchase price of an asset plus expenditures to get it in place and ready for use. Residual value: Portion of an asset’s acquisition cost that a company expects to recover when it disposes of the asset. Depreciable cost: An asset’s cost less its residual value. Estimated useful life: Total number of service units expected from a long-term asset. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom

Methods of Computing Depreciation
Straight-Line Method Production Method Declining-Balance Method © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom

Straight-Line Method Straight-line method: Asset’s depreciable cost is spread evenly over the estimated useful life of the asset. Based on the assumption that depreciation depends only on the passage of time Computed by dividing the depreciable cost Depreciation Expense = (Cost – Residual Value)/ Estimated Useful Life © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom

Depreciation Schedule, Straight-Line Method

Production Method Production method (or units of production method): Depreciation solely the result of use; passage of time plays no role in the process. Depreciation Expense = (Cost – Residual Value)/ Estimated Units of Useful Life Reasonable accurate estimate of asset’s output over its useful life. Appropriate unit used. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom

Depreciation Schedule, Production Method

Declining-Balance Method (slide 1 of 2)
Accelerated method of depreciation Relatively large amounts of depreciation in early years of an asset’s life and smaller amounts in later years. Assumes that many plant assets are most efficient when new. Declining-balance method of depreciation Applies a fixed rate to the carrying value of a tangible long-term asset; higher depreciation charges in the early years of the asset’s life. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom

Declining-Balance Method (slide 2 of 2)
Annual Depreciation Rate = Percent of Useful Life / Estimated Useful Life Double-declining-balance method Twice the straight-line rate is used. Depreciation is greatest in the first year and declines each year after that. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom

Depreciation Schedule, Double-Declining-Balance Method

Graphic Comparison of Three Methods of Determining Depreciation

Special Issues in Depreciation
Group Depreciation large companies group similar assets, such as machines, trucks, and pieces of office equipment, to calculate depreciation Depreciation for Partial Years Some companies use the half-year convention, in which one-half year of depreciation is taken in the year the asset is purchased and one-half year is taken in the year the asset is sold. Revision of Depreciation Rates Sometimes, it is necessary to revise the estimate of useful life so that the periodic depreciation expense increases or decreases. Then, to reflect the revision, the remaining depreciable cost of the asset is spread over the remaining years of useful life. Special Rules for Tax Purposes Economic Stimulus Act of 2008 allows a small company to expense the first $250,000 of equipment expenditures rather than recording them as assets and depreciating them over their useful lives. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom

On January 13, 2010, Louise Company purchased a company car for $47,500. Louise expects the car to last five years or 120,000 miles, with an estimated residual value of $7,500 at the end of that time. During 2011, the car is driven 24,000 miles. Louise’s year-end is December 31. Compute the depreciation for 2011 under each of the following methods: (1) straight-line, (2) production, and (3) double-declining-balance. Using the amount computed in (3), prepare the journal entry to record depreciation expense for the second year and show how the company car account would appear on the balance sheet. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom

SOLUTION © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom

Disposal of Depreciable Assets
Discarded Plant Assets Example: An equipment has a carrying value of $3,700 at the time of its disposal. The carrying value is computed as (cost $13,000 – accumulated depreciation $9,300). A loss equal to the carrying value should be recorded when the machine is discarded, as follows: © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom

Plant Assets Sold for Cash (slide 1 of 2)
Cash Received Equal to Carrying Value Cash Received Less Than Carrying Value © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom

Plant Assets Sold for Cash (slide 2 of 2)
Cash Received More Than Carrying Value © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom

Exchanges of Plant Assets
Businesses can dispose of plant and assets by trading them in on the purchase of other plant assets. Accounting for exchanges of plant and assets is similar to accounting for sales of plant assets for cash.

Louise Company sold a company car that cost $47,500 and on which $30,400 of accumulated depreciation had been recorded on January 2, the first day of business of the current year. For each of the following assumptions, prepare the journal entry (without explanation) for the disposal. (1) The car was sold for $17,100 cash. (2) The car was sold for $15,000 cash. (3) The car was sold for $20,000 cash. SOLUTION © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom

Natural Resources Depletion Depreciation of Related Plant Assets
Development and Exploration Costs in the Oil and Gas Industry © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom

EXAMPLE: Depletion (1 of 2)
Amine was purchased for $3,600,000 and it has an estimated residual value of $600,000 and contains an estimated 3,000,000 tons of coal. The depletion charge per ton of coal is $1, calculated as follows: Depletion Cost per Unit = (Cost – Residual Value)/Estimated Number of Units ($3,600,000 – $600,000)/3,000,000 Tons = $1 per Ton © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom

EXAMPLE: Depletion (2 of 2)

EXAMPLE: Depletion (slide 1 of 2)
A mine was purchased for $3,600,000 and it has an estimated residual value of $600,000 and contains an estimated 3,000,000 tons of coal. The depletion charge per ton of coal is $1, calculated as follows: Depletion Cost per Unit = (Cost – Residual Value)/Estimated Number of Units = ($3,600,000 – $600,000)/3,000,000 Tons = $1 per Ton © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom

EXAMPLE: Depletion (slide 2 of 2)
If 230,000 tons of coal are mined and sold during the first year, the depletion charge would be recorded as follows: © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom

Depreciation of Related Plant Assets
If the useful life of a long-term plant asset is less than the expected life of the resource, the shorter life should be used to compute depreciation. In such cases, or when an asset will not be abandoned after all reserves have been depleted, other depreciation methods, such as the straight-line or declining balance method, are appropriate. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom

Development and Exploration Costs in the Oil and Gas Industry
Successful efforts accounting: The cost of a successful exploration—for example, an exploration that produces an oil well—is a cost of the resource. Full-costing method: A method under which all costs, including the cost of dry wells, are recorded as assets and depleted over the estimated life of the resources. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom

Romero Mining Company paid $8,800,000 for land containing an estimated 40 million tons of ore. The land without the ore is estimated to be worth $2,000,000. The company spent $1,380,000 to erect buildings on the site and $2,400,000 on installing equipment. The buildings have an estimated useful life of 30 years, and the equipment has an estimated useful life of 10 years. Because of the remote location, neither the buildings nor the equipment has a residual value. The company expects that it can mine all the usable ore in 10 years. During its first year of operation, it mined and sold 2,800,000 tons of ore. Compute the depletion charge per ton. 4. Determine the depreciation expense for the year for the equipment Compute the depletion expense that Romero Mining should record for under two alternatives: (a) making the expense proportional to the its first year of operation. depletion and (b) using the straight-line method. Determine the depreciation expense for the year for the buildings, making it proportional to the depletion. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom

SOLUTION © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom

Intangible Assets (slide 1 of 2)
Purchased intangible assets are recorded at cost or at fair value when purchased as part of a group of assets. Definite useful life: The useful life of the assets is subject to a legal limit or can be reasonably estimated. Examples: Patents, copyrights, and leaseholds. Indefinite useful life: The useful life of the asset is not limited by legal, regulatory, contractual, competitive, economic, or other factors. Examples: Trademarks and brands. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom

Intangible Assets (slide 2 of 2)
Research and Development Costs Treated as revenue expenditures and charged to expense in the period in which incurred. Computer Software Costs Development costs considered research and development costs until the product has proved technologically feasible. Goodwill When a purchaser pays more for a business than the fair market value of the business’s net assets. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom

Accounting for Intangible Assets

For each of the following intangible assets, indicate (a) if the asset is to be amortized over its useful life or (b) if the asset is not amortized but only subject to an annual impairment test: 1. Goodwill 2. Copyright 3. Brand 4. Patent 5. Trademark SOLUTION 1. b; 2. a; 3. b; 4. a; 5. b © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom

Chapter 9 Long-Term Assets

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