1. 11-1 PowerPoint Presentation by Douglas Cloud Professor Emeritus of Accounting Pepperdine University © Copyright 2007 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star Logo, and South-Western are trademarks used herein under license. Task Force Image Gallery clip art included in this electronic presentation is used with the permission of NVTech Inc. F13 11 Investing Activities Financial Accounting Ingram and Albright 6 th edition Information for Decisions

2. 11-2ObjectivesObjectives Once you have completed this chapter, you should be able to—

3. 11-3 2.Apply appropriate measurement rules to the purchase, depreciation, and disposal of plant assets. 3.Apply appropriate measurement rules to the purchase and use of natural resources. ObjectivesObjectives ContinuedContinued 1.Identify types of long-term assets, their purposes, and the measurement basis companies use to record their assets.

4. 11-4 5.Explain accounting issues associated with intangible and other long-term assets. 6.Summarize the effects of investing activities on a company’s financial statements. ObjectivesObjectives 4.Apply appropriate measurement rules to the purchase, valuation, and sale of long-term and short-term investments.

5. 11-51 ObjectiveObjective Identify types of long- term assets, their purposes, and the measurement basis companies use to record their assets.

6. 11-6 Types of Assets Current assets are those that management expects to convert to cash or consume during the coming fiscal year.

7. 11-7 Types of Assets Current assets: Cash$ 17,510 Accounts receivable15,400 Merchandise inventory75,920 Supplies2,480 Prepaid expenses 3,500 Total current assets$114,810 Long-term investments4,000 Property, plant, and equipment$572,467 Less: Accumulated depreciation 53,630 Property and equipment, net518,837 Intangible assets1,000 Other long-term assets 850 Total assets$640,097

8. 11-8 Long-term assets include assets that are used by a company to produce and sell its products. Types of Assets These assets provide benefits to a company that extend beyond the coming fiscal year or operating cycle.

9. 11-9 Current assets: Cash$ 17,510 Accounts receivable15,400 Merchandise inventory75,920 Supplies2,480 Prepaid expenses 3,500 Total current assets$114,810 Long-term investments4,000 Property, plant, and equipment$572,467 Less: Accumulated depreciation 53,630 Property and equipment, net518,837 Intangible assets1,000 Other long-term assets 850 Total assets$640,097 Types of Assets

10. 11-10 Types of Assets Long-term assets usually are divided into four categories: 1.Long-term investments 2.Property, plant, and equipment 3.Intangible assets 4.Other assets

11. 11-11 Long-term investments are investments in financial securities of other companies. Types of Assets

12. 11-12 Property, plant, and equipment includes investments in tangible assets that a company intends to use in the future to produce or sell its product. Types of Assets

13. 11-13 Intangible assets are those that provide legal rights or benefits to a company, such as patents, copyrights, trademarks, and goodwill. Types of Assets

14. 11-14 Other assets include miscellaneous resources that are important to a particular company, such as long-term receivables and a building that the company is trying to sell. Types of Assets

15. 11-15 2 2 Apply appropriate measurement rules to the purchase, depreciation, and disposal of plant assets. ObjectiveObjective

16. 11-16 Plant Asset Cost Amount paid for the asset Cost of transportation Site preparation Installation Construction necessary to make the asset usable for its intended purpose

17. 11-17 Plant Asset Cost On September 12, 2008, Favorite Cookie Company purchased a small parcel of property. The company paid $400,000 for the property, which included a building and office equipment. An appraiser determines that 70% of the cost should be allocated to the building, 20% to the land, and 10% to the equipment. ContinuedContinued

18. 11-18 Plant Asset Cost ASSETS = LIABILITIES + OWNERS’ EQUITY + OWNERS’ EQUITY Date Accounts Cash Other Assets Contributed Capital Retained Earnings 9/12Land80,000 Buildings280,000 Equipment40,000 Cash–400,000

19. 11-19 Expenditures made to acquire new plant assets, extend the asset’s life, or enhance the value of an existing plant asset are known as capital expenditures. Plant Asset Cost

20. 11-20 Expenditures to repair or maintain plant assets that do not extend the life or enhance the value are known as operating expenditures. Plant Asset Cost

21. 11-21 Plant Asset Cost On October 31, 2008, Favorite Cookie Company spent $10,000 to renovate the building. This renovation included $7,500 for replacement of the building’s roof and $2,500 for painting. The roof replacement extended the life of the building, so it is a capital expenditure. The painting is ordinary maintenance; thus, an operating expenditure. ContinuedContinued

22. 11-22 Plant Asset Cost ASSETS = LIABILITIES + OWNERS’ EQUITY + OWNERS’ EQUITY Date Accounts Cash Other Assets Contributed Capital Retained Earnings 10/31Buildings7,500 Maintenance Expense–2,500 Cash–10,000

23. 11-23DepreciationDepreciation Most depreciation methods fall into three general categories:  Straight-line depreciation allocates an equal amount of the cost of a plant asset to expense during each fiscal period of the asset’s expected useful life.  Accelerated depreciation allocates a larger portion of the cost of a plant asset to expense early in the asset’s life. ContinuedContinued

24. 11-24DepreciationDepreciation  Units-of-production depreciation produces a level amount of depreciation expense per unit of output (rather than per fiscal period).

25. 11-25 Favorite Cookie Company purchased equipment on January 1, 2007, at a cost of $50,000. Management expects the equipment to have a four-year life and a $2,000 residual value. Residual or salvage value is the amount management expects to receive for an asset at the end of the asset’s useful life. Straight-Line Depreciation

26. 11-26 Favorite Cookie Company purchased equipment on January 1, 2007, at a cost of $50,000. Management expects the equipment to have a four-year life and a $2,000 residual value. Cost – Residual Value Expected Life Straight-Line Depreciation

27. 11-27 Favorite Cookie Company purchased equipment on January 1, 2007, at a cost of $50,000. Management expects the equipment to have a four-year life and a $2,000 residual value. Cost – Residual Value Expected Life $50,000 - $2,000 4 years = $12,000 Straight-Line Depreciation

28. 11-28 Straight-Line Depreciation DepreciationDepreciation ASSETS = LIABILITIES + OWNERS’ EQUITY + OWNERS’ EQUITY Date Accounts Cash Other Assets Contributed Capital Retained Earnings 12/31Depreciation Expense–12,000 Accumulated Depreciation–12,000

29. 11-29 Accumulated Depreciation is a contra-asset account that offsets Equipment. Straight-Line Depreciation

30. 11-30 The book value of a plant asset is the net cost of the asset after accumulated depreciation has been subtracted. Straight-Line Depreciation

31. 11-31 Exhibit 2 Straight-Line Depreciation Schedule An equal amount of depreciation is recorded each fiscal year. 2007 2008 2009 2010

32. 11-32 At the end of 2008, Favorite Cookie Company’s managers decide that they will be able to use the equipment for three more years (for a total of five years), at which time the equipment will have a residual value of $2,000. Book Value – Residual Value Expected Remaining Life Straight-Line Depreciation

33. 11-33 At the end of 2008, Favorite Cookie Company’s managers decide that they will be able to use the equipment for three more years (for a total of five years), at which time the equipment will have a residual value of $2,000. Book Value – Residual Value Expected Remaining Life $26,000 – $2,000 3 years = $8,000 Straight-Line Depreciation

34. 11-34 Exhibit 3 Revised Straight-Line Depreciation Schedule 2007 2008 2009 2010 2011 $50,000$12,000$12,000$38,000 38,00012,00024,00026,000 26,0008,00032,00018,000 18,0008,00040,00010,000 10,0008,00048,0002,000 ****** *Changed from Exhibit 2

35. 11-35 Accelerated Depreciation If Favorite Cookie Company used double- declining balance depreciation for the equipment purchased at the beginning of 2007, it would compute depreciation as follows: Double-declining-balance depreciation expense = Book value x 2 Expected useful life

36. 11-36 Accelerated Depreciation If Favorite Cookie Company used double- declining balance depreciation for the equipment purchased at the beginning of 2007, it would compute depreciation as follows: Double-declining-balance depreciation expense = $50,000 x 2424 = $25,000

37. 11-37 Depreciation Book Depreciation Year Expense = Value x Rate 2007$25,000$50,0002/4 200812,50025,0002/4 20096,25012,5002/4 20104,250 Accelerated Depreciation

38. 11-38 Beginning Ending Book Depreciation Accumulated Book Year Value Expense Depreciation Value 2007$50,000$25,000$25,000$25,000 200825,00012,50037,50012,500 200912,5006,25043,7506,250 20106,2504,25048,0002,000 Exhibit 4 Double-Declining Balance Depreciation Schedule

39. 11-39 Reasons for Using Accelerated Depreciation 1.In some cases, an asset is more useful earlier in its life than later, and the useful life may be difficult to estimate. 2.Depreciation expense is deductible in computing taxable income and income taxes. The second reason is the most common reason for using accelerated depreciation.

40. 11-40 Exhibit 5 Comparison of Straight-Line and Accelerated Depreciation Methods in 2007 Income before depreciation and taxes$100,000$100,000 Depreciation expense 12,000 25,000 Pretax income88,00075,000 Income taxes (35%) 30,800 26,250 Net income$ 57,200$ 48,750 Straight-LineAccelerated

41. 11-41 At the beginning of 2008, Favorite Cookie Company purchased a truck for $30,000. Management expects the useful life of the truck to be 100,000 miles, at which time it will be sold for $10,000. Cost – Residual Value Estimated Units Units-of-Production Depreciation

42. 11-42 At the beginning of 2008, Favorite Cookie Company purchased a truck for $30,000. Management expects the useful life of the truck to be 100,000 miles, at which time it will be sold for $10,000. Cost – Residual Value Estimated Units Units-of-Production Depreciation $30,000 – $10,000 100,000 miles = $0.20 per mile

43. 11-43 If the truck were driven 12,000 miles in 2008, Favorite Cookie Company would record depreciation expense of $2,400 (12,000 x $0.20). Units-of-Production Depreciation

44. 11-44 Disposing of Plant Assets Favorite Cookie Company sells equipment on February 10, 2008 for $8,000. The equipment cost the company $20,000 when purchased. Accumulated depreciation on the equipment at the time it is sold is $14,000.

45. 11-45 Disposing of Plant Assets ASSETS = LIABILITIES + OWNERS’ EQUITY + OWNERS’ EQUITY Date Accounts Cash Other Assets Contributed Capital Retained Earnings 2/10Cash8,000 Accumulated Depreciation14,000 Equipment–20,000 Gain on Asset Sale2,000

46. 11-46 Exercise 11-5 Click the button to skip this exercise. If you experience trouble making the button work, type 51 and press “Enter.” Press “Enter” or left click the mouse for solution. Camey Corporation purchased delivery equipment on January 1 at a cost of $300,000. The equipment is expected to have a useful life of seven years or 250,000 miles, and to have no salvage value. The company’s fiscal year-end is December 31. During the year, the equipment was used for 80,000 miles. How much depreciation expense should be recorded during the first year using the straight-line method?

47. 11-47 Exercise 11-5 $300,000 7 years = $42,857 ContinuedContinued

48. 11-48 Exercise 11-5 Press “Enter” or left click the mouse for solution. $300,000 x 2/7 = $85,714 ContinuedContinued Camey Corporation purchased delivery equipment on January 1 at a cost of $300,000. The equipment is expected to have a useful life of seven years or 250,000 miles, and to have no salvage value. The company’s fiscal year-end is December 31. During the year, the equipment was used for 80,000 miles. How much depreciation expense should be recorded during the first year using the double-declining balance method?

49. 11-49 Exercise 11-5 Camey Corporation purchased delivery equipment on January 1 at a cost of $300,000. The equipment is expected to have a useful life of seven years or 250,000 miles, and to have no salvage value. The company’s fiscal year-end is December 31. During the year, the equipment was used for 80,000 miles. How much depreciation expense should be recorded during the first year using the units-of-production method? Press “Enter” or left click the mouse for solution. $300,000 ÷ 250,000 = $1.20 per mile 80,000 x $1.20 = $96,000 ContinuedContinued

50. 11-50 Exercise 11-5 Assume that revenue for the year is $376,300 and that all expenses, other than for depreciation, total $225,492. Would the use of one depreciation method instead of another have a material effect on the income statement? (Ignore taxes) Press “Enter” or left click the mouse for solution. S/L DDB UofP Revenue$376,300$376,300$376,300 All expenses (except depreciation)(225,492)(225,492)(225,492) Depreciation (42,857) (85,714) (96,000) Net income$107,951$ 65,094$ 54,808

51. 11-51 3 3 Apply appropriate measurement rules to the purchase and use of natural resources. ObjectiveObjective

52. 11-52 Natural Resources Depletion is the systematic allocation of the cost of natural resources to the periods that benefit from their use.

53. 11-53 Natural Resources Silicon Company bought land containing minerals on April 1, 2007 for $8 million. ASSETS = LIABILITIES + OWNERS’ EQUITY + OWNERS’ EQUITY Date Accounts Cash Other Assets Contributed Capital Retained Earnings 4/1Mineral Rights8,000,000 Cash–8,000,000

54. 11-54 Natural Resources The land is estimated to contain 80,000 tons of minerals; thus, the estimated cost per ton was $100 ($8,000,000 ÷ 80,000). In 2007, Silicon mined the land and removed 16,000 tons of minerals. The value of the asset consumed was $1.6 million ($100 x 16,000 tons).

55. 11-55 Natural Resources ASSETS = LIAB. + OWNERS’ EQUITY + OWNERS’ EQUITY Date Accounts Cash Other Assets Contrib. Capital Retained Earnings 12/31Cost of Goods Sold–1,600,000 Mineral Rights–1,600,000

56. 11-56 GAAP require that companies report natural resources at their book value (cost – accumulated depletion). Natural Resources

57. 11-57 4 4 Apply appropriate measurement rules to the purchase, valuation, and sale of long-term and short-term investments. ObjectiveObjective

58. 11-58 Long-Term and Short- Term Investments GAAP differentiate between two types of investments: 1.investments that give the investor significant influence or control over the company issuing the security, and 2.investments that do not.

59. 11-59 Investments that do not yield significant influence fall into three categories: 1.Held-to-maturity securities are investments in debt securities that the investor has the intent and ability to hold until the debt’s maturity date. Reported as long-term assets on balance sheet except during the year just prior to maturity. Long-Term and Short- Term Investments

60. 11-60 Investments that do not yield significant influence fall into three categories: 2.Trading securities are investments in either debt or equity securities that a company buys and sells on a regular basis. Reported on balance sheet as current assets. Long-Term and Short- Term Investments

61. 11-61 Investments that do not yield significant influence fall into three categories: 3.Available-for-sale securities are investments in securities that a company could sell but that it does not trade regularly. Reported on balance sheet as a current asset or noncurrent asset, depending on management’s expectation regarding date of sale. Long-Term and Short- Term Investments

62. 11-62 Held-To-Maturity Securities Only debt securities fall into the held-to-maturity securities category.

63. 11-63 Held-To-Maturity Securities Big Foods Corporation bought Favorite Cookie Company bonds on January 1, 2008. Big Foods paid $208,201 for the bonds which mature in 2012 at their face value of $200,000. The bonds pay annual interest at 8% on December 31.

64. 11-64 Held-To-Maturity Securities ASSETS = LIABILITIES + OWNERS’ EQUITY + OWNERS’ EQUITY Date Accounts Cash Other Assets Contributed Capital Retained Earnings 1/1Long-Term Investment208,201 Cash–208,201

65. 11-65 Held-To-Maturity Securities On December 31, 2008, Big Foods receives its first interest payment of $16,000 (8% x $200,000). Big Foods determines that $1,426 of the $8,201 premium paid for the investment should be amortized at this time.

66. 11-66 Held-To-Maturity Securities ASSETS = LIABILITIES + OWNERS’ EQUITY + OWNERS’ EQUITY Date Accounts Cash Other Assets Contributed Capital Retained Earnings 12/31Cash16,000 Long-Term Investment–1,426 Interest Income14,574

67. 11-67 If bonds are held as trading securities or available-for-sale securities, they will be reported on the balance sheet at current market value. Trading Securities and Available-for- Sale Securities—Investments in Debt

68. 11-68 When the investment’s amortized cost is different from its current market value, an unrealized holding gain or loss is recognized. Trading Securities and Available-for- Sale Securities—Investments in Debt

69. 11-69 On December 31, 2008 the market price of Favorite Cookie Company bonds owned by Big Foods is $205,000. An adjusting entry is needed to update the balance of the investment account from the amortized cost of $206,775 to the current market value of $205,000. Trading Securities and Available-for- Sale Securities—Investments in Debt

70. 11-70 Trading Securities and Available-for- Sale Securities—Investments in Debt ASSETS = LIABILITIES + OWNERS’ EQUITY + OWNERS’ EQUITY Date Accounts Cash Other Assets Contributed Capital Retained Earnings 12/31Unrealized Holding Loss–1,775 Long-Term Investment–1,775

71. 11-71 The unrealized holding gain or loss on available-for-sale securities is reported as part of Other Comprehensive Income. Trading Securities and Available-for- Sale Securities—Investments in Debt

72. 11-72 Trading Securities and Available-for- Sale Securities—Investments in Equity Big Foods Corporation purchased 10,000 shares of Favorite Cookie Company common stock for $12 per share on October 1, 2008. Assume these are available-for-sale securities that are not expected to be sold anytime soon.

73. 11-73 Trading Securities and Available-for- Sale Securities—Investments in Equity ASSETS = LIABILITIES + OWNERS’ EQUITY + OWNERS’ EQUITY Date Accounts Cash Other Assets Contributed Capital Retained Earnings 10/1Long-Term Investment120,000 Cash–120,000

74. 11-74 On December 31, 2008, the closing market price of Favorite Cookie Company stock was $14 per share. Thus, the value of Big Foods’ investment has increased by $20,000 [($14 – $12) x 10,000 shares] Trading Securities and Available-for- Sale Securities—Investments in Equity

75. 11-75 *This is included as part of Other Comprehensive Income in the stockholders’ equity section of the balance sheet. Trading Securities and Available-for- Sale Securities—Investments in Equity ASSETS = LIABILITIES + OWNERS’ EQUITY + OWNERS’ EQUITY Date Accounts Cash Other Assets Contributed Capital Retained Earnings 12/31Long-Term Investment20,000 Unrealized Holding Gain20,000*

76. 11-76 Big Foods’ management changes its mind and sells Favorite Cookie Company stock on April 20, 2009, at a price of $17 per share. Sale of 10,000 shares at $17 per share$170,000 Investment(120,000) Realized gain on sale of stock$ 50,000 Trading Securities and Available-for- Sale Securities—Investments in Equity

77. 11-77 Exhibit 6 Balance Sheet Excerpts and Supporting Computations for Big Foods Corporation for Long- Term Investments 2008

78. 11-78 Trading Securities and Available-For- Sale Securities—Investments in Equity ASSETS = LIABILITIES + OWNERS’ EQUITY + OWNERS’ EQUITY Date Accounts Cash Other Assets Contributed Capital Retained Earnings 4/20Cash170,000 Unrealized Holding Gain–20,000 Long-Term Investment–140,000 Invest. Income50,000

79. 11-79 Short-Term Investments Investments in short-term marketable securities are accounted for at market value.

80. 11-80 Exhibit 7 Investments in Marketable Securities

81. 11-81 Exercise 11-12 Click the button to skip this exercise. If you experience trouble making the button work, type 87 and press “Enter.” Press “Enter” or left click the mouse for solution. Long Shore Company purchased 1,000 shares of ABX Company’s common stock for $30 each. It was a small investment, but Long Shore intended to hold the investment for the long term. (a) Record the initial purchase of the shares in Long Shore’s accounting system.

82. 11-82 Exercise 11-12 ContinuedContinued ASSETS = LIABILITIES + OWNERS’ EQUITY + OWNERS’ EQUITY Date Accounts Cash Other Assets Contributed Capital Retained Earnings a.Long-Term Investment30,000 Cash–30,000

83. 11-83 Exercise 11-12 Press “Enter” or left click the mouse for solution. At year-end, the total market value of the shares had increased to $33,500. (b) Show any entry to the accounting system that should be made at the end of the first year. Current market value$33,500 Cost(30,000) Unrealized gain$ 3,500ContinuedContinued

84. 11-84 *This is included as part of Other Comprehensive Income in the stockholders’ equity section of the balance sheet. Exercise 11-12 ContinuedContinued ASSETS = LIABILITIES + OWNERS’ EQUITY + OWNERS’ EQUITY Date Accounts Cash Other Assets Contributed Capital Retained Earnings b.Long-Term Investment3,500 Unrealized Holding Gain3,500*

85. 11-85 Exercise 11-12 Press “Enter” or left click the mouse for solution. On July 1, six months into the following year, Long Shore decided to sell the investment at its then-current market price of $35 per share. (c) Show how the sale of the investment would be recorded in the accounting system.

86. 11-86 Exercise 11-12 ASSETS = LIABILITIES + OWNERS’ EQUITY + OWNERS’ EQUITY Date Accounts Cash Other Assets Contributed Capital Retained Earnings c.Cash35,000 Gain on Sale of Stock5,000 Long-Term Investment–33,500 Unrealized Holding Gain–3,500

87. 11-87 5 5 Explain accounting issues associated with intangible and other long-term assets. ObjectiveObjective

88. 11-88 Intangible Assets  Copyrights  Patents  Brand names  Trademarks Intangible assets are legal rights that the company owns.

89. 11-89 GAAP require that intangibles other than goodwill be amortized over a period of 40 years or less, usually on a straight-line basis. Intangible Assets

90. 11-90 Goodwill is the excess of the purchase price of a company over the fair market value of its net assets. Intangible Assets

91. 11-91 Big Foods Corporation purchased Value-Right Company on January 1, 2008, for $5 million. The acquired company’s assets and liabilities were appraised and determined at $8 million and $3.5 million, respectively. Intangible Assets

92. 11-92 Market value of Value-Right Co. assets$8,000,000 Market value of Value-Right Co. liabilities3,500,000 Market value of Value-Right Co. net assets$4,500,000 Amount paid by Big Foods Corporation5,000,000 Goodwill$ 500,000 Intangible Assets

93. 11-93 Goodwill remains on a company’s balance sheet at cost unless the value of the goodwill is impaired. Intangible Assets

94. 11-94 Long-term assets that are not included in one of the other primary categories are considered other long-term assets. Other Long-Term Assets

95. 11-95 An example of this type of asset is deferred charges. Deferred charges are the assets that result when a company prepays expenses that produce long-term benefits. Other Long-Term Assets

96. 11-96 6 6 Summarize the effects of investing activities on a company’s financial statements. ObjectiveObjective

97. 11-97 Exhibit 8 Financial Statement Presentation of Investing Activities

98. 11-98 Exhibit 9 Investing Activities from Favorite Cookie Company’s Statement of Cash Flows Cash flow from (for) investing activities: Purchase of property and equipment$(365,000) Sale of property and equipment8,000 Purchase of investments(6,000) Sale of investments 2,000 Net cash flow for investing activities$(361,000)

99. 11-99 When one company owns 20% to 50% of the common stock of another company, generally it has significant influence and uses the equity method to account for its investment. Other Investment Issues

100. 11-100 Big Foods purchased 30,000 shares of Little Market Corporation’s 100,000 shares at $20 per share on January 1, 2007. Other Investment Issues

101. 11-101 Equity Method ASSETS = LIABILITIES + OWNERS’ EQUITY + OWNERS’ EQUITY Date Accounts Cash Other Assets Contributed Capital Retained Earnings 1/1Long-Term Investment600,000 Cash–600,000

102. 11-102 At the end of the year, Little Market reported a net income of $500,000. Big Foods records 30% of this as investment income. Equity Method ASSETS = LIABILITIES + OWNERS’ EQUITY + OWNERS’ EQUITY Date Accounts Cash Other Assets Contributed Capital Retained Earnings 12/31Long-Term Investment150,000 Investment Income150,000

103. 11-103 Also at the end of the year, Little Market paid dividends of $200,000. Big Foods received 30% ($60,000). Equity Method ASSETS = LIABILITIES + OWNERS’ EQUITY + OWNERS’ EQUITY Date Accounts Cash Other Assets Contributed Capital Retained Earnings 12/31Cash60,000 Long-Term Investment–60,000

104. 11-104 T HE E ND C HAPTER 11

105. 11-105