1. Copyright © Cengage Learning. All rights reserved. Chapter 9 Long-Term Assets

2. Copyright © Cengage Learning. All rights reserved. 9-2 Management Issues Related to Long-Term Assets Objective 1 –Define long-term assets, and explain the management issues related to them.

3. Copyright © Cengage Learning. All rights reserved. 9-3 Information about long-term acquisitions can be found under investing activities in the statement of cash flows Long-Term Assets Assets have a useful life greater than one year Used in operation of a business Are not intended for resale to customers

4. Copyright © Cengage Learning. All rights reserved. 9-4 Long-Term Assets for Selected Industries

5. Copyright © Cengage Learning. All rights reserved. 9-5 Long-Term Assets and Corresponding Expenses

6. Copyright © Cengage Learning. All rights reserved. 9-6 Carrying Value The unexpired cost of an asset Unexpired Cost = Cost – Accumulated Depreciation Also called book value Carrying value is reduced if a long-term asset loses some or all of its revenue generating potential before the end of its useful life –Called asset impairment PV of Expected Cash Flows from Asset < Carrying Value –Carrying value is reduced to fair value (present value of future cash flows) Is an application of conservatism

7. Copyright © Cengage Learning. All rights reserved. 9-7 Carrying Value of Long-Term Assets on Balance Sheet

8. Copyright © Cengage Learning. All rights reserved. 9-8 Favorably impacts profitability for that current period Management must use ethical judgments when resolving two issues: 1.How much of the total cost of a long-term asset should be allocated to expense in the current period? 2.How much should be retained on the balance sheet as an asset that will benefit future period? Applying the Matching Rule When a company purchases an asset, it may choose to capitalize it, thus deferring an expense to a later period

9. Copyright © Cengage Learning. All rights reserved. 9-9 Long-Term Assets 1.How is the cost of the long-term asset determined? 2.How should the expired portion of the cost of the long-term asset be allocated against revenues over time? 3.How should subsequent expenditures, such as repairs and additions, be treated? 4.How should disposal of the long-term asset be recorded?

10. Copyright © Cengage Learning. All rights reserved. 9-10 Issues in Accounting for Long-Term Assets

11. Copyright © Cengage Learning. All rights reserved. 9-11 Acquisition Cost of Property, Plant, and Equipment Objective 2 –Distinguish between capital expenditures and revenue expenditures, and account for the cost of property, plant, and equipment.

12. Copyright © Cengage Learning. All rights reserved. 9-12 Expenditures Payments or obligations to make future payments for assets or services Capital expenditure –An expenditure for the purchase or expansion of a long- term asset Revenue expenditure –An expenditure for the repair, maintenance, and operation of a long-term asset

13. Copyright © Cengage Learning. All rights reserved. 9-13 Capital Expenditures Outlays for plant assets, natural resources, and intangible assets Additions to the physical layout of a plant asset like a building (debit asset account) Betterments, or improvements, to a plant asset (debit asset account) Extraordinary repairs that significantly enhance a plant asset’s estimated useful life or residual value (debit accumulated depreciation)

14. Copyright © Cengage Learning. All rights reserved. 9-14 General Approach to Acquisition Costs Include all expenditures reasonable and necessary to get the asset in place and ready for use Include costs of installing and testing a machine; freight, insurance while in transit, and installation Interest charges are not included in the acquisition cost

15. Copyright © Cengage Learning. All rights reserved. 9-15 Specific Applications: Land Costs that should be debited to the Land account include: Purchase price Agent commissions Legal fees Accrued taxes paid by purchaser Draining Land preparation fees Assessments for local improvements Landscaping Sample Improvements to real estate like fences, driveways, or parking lots have a limited life. They should be recorded in an account called Land Improvements, not the Land account.

16. Copyright © Cengage Learning. All rights reserved. 9-16 Buildings Acquisition costs include: –Purchase price –Repairs and other expenditures required to put it in usable condition Buildings are subject to depreciation because they have a limited useful life.

17. Copyright © Cengage Learning. All rights reserved. 9-17 Costs of Building Construction Materials Labor Overhead and other indirect costs Architects’ fees Insurance during construction Interest on construction loans Lawyers’ fees Building permits Outside contractors

18. Copyright © Cengage Learning. All rights reserved. 9-18 Equipment Acquisition costs: –Purchase price (less cash discounts) –All expenditures connected with purchasing the equipment and preparing it for use. Freight Insurance in transit Excise taxes and tariffs Buying expenses Installation costs Cost of test runs Equipment is subject to depreciation because it has a limited useful life.

19. Copyright © Cengage Learning. All rights reserved. 9-19 Stop & Review Q.Dyeing a carpet may make it look almost new. Why isn’t this a capital expenditure?

20. Copyright © Cengage Learning. All rights reserved. 9-20 Depreciation Objective 3 –Compute depreciation under the straight-line, production, and declining-balance methods.

21. Copyright © Cengage Learning. All rights reserved. 9-21 Depreciation: Limited Life of Tangible Assets 1.All tangible assets except land have a limited useful life, because of physical deterioration and obsolescence. –Physical deterioration Results from use and exposure to the elements –Obsolescence Process of becoming out of date

22. Copyright © Cengage Learning. All rights reserved. 9-22 Allocation of Cost Depreciation means the allocation of the cost of a plant asset to the periods that benefit from the service of that asset. –Does not refer to an asset’s Physical deterioration Decrease in market value over time

23. Copyright © Cengage Learning. All rights reserved. 9-23 Not a Process of Valuation Depreciation is a process of allocation Accounting records are not indicators of changing price levels As an asset wears out or becomes obsolete, depreciation must be recorded

24. Copyright © Cengage Learning. All rights reserved. 9-24 Factors in Computing Depreciation 1.Cost –Net purchase price –All reasonable and necessary expenditures to get the asset in place and ready for use 2.Residual value (Salvage value) –An asset’s estimated scrap, salvage, or trade-in value as of the estimated date of disposal –Also called salvage value or disposal value

25. Copyright © Cengage Learning. All rights reserved. 9-25 Factors in Computing Depreciation (cont’d) 3.Depreciable cost –Cost less residual value –Depreciable cost is allocated over the useful life of an asset 4.Estimated useful life –Total number of service units expected from a long-term asset –May be measured in years, miles, units, or similar measures

26. Copyright © Cengage Learning. All rights reserved. 9-26 Accounting for Depreciation Depreciation is recorded at the end of the accounting period by an adjusting entry.

27. Copyright © Cengage Learning. All rights reserved. 9-27 Methods of Computing Depreciation The most common methods –Straight-line method (based upon usable life) –Production method (based upon number of usable units asset is expected to provide) –Declining-balance method

28. Copyright © Cengage Learning. All rights reserved. 9-28 A delivery truck costs $20,000 and has an estimated residual value of $2,000 at the end of its estimated useful life of 5 years. Straight-Line Method Asset’s depreciable cost is spread evenly over its estimated useful life.

29. Copyright © Cengage Learning. All rights reserved. Copyright © Houghton Mifflin Company. All rights reserved. 9-29 The amount of depreciation is the same each year Accumulated depreciation increases uniformly The carrying value decreases uniformly until it reaches the estimated residual value Depreciation Schedule Straight-Line Method

30. Copyright © Cengage Learning. All rights reserved. 9-30 A delivery truck costs $20,000 and has an estimated residual value of $2,000 at the end of its estimated useful life of five years. Assume the truck was used 20,000 miles during year 1; 30,000 miles during year 2; 10,000 miles during year 3; 20,000 miles during year 4; and 10,000 miles during the fifth year. The unit of output or use should be appropriate for that asset Production Method Based on the assumption that depreciation is solely the result of use and that passage of time plays no role in the depreciation process.

31. Copyright © Cengage Learning. All rights reserved. Copyright © Houghton Mifflin Company. All rights reserved. 9-31 Declining-Balance Method An accelerated method of depreciation that results in large amounts of depreciation in earlier years of the asset’s life and smaller amounts in later years. Is based on the passage of time. Assumes that many kinds of plant assets are most efficient when new. Is consistent with matching rule –Allocates more depreciation to earlier years if benefits received in earlier years are greater.

32. Copyright © Cengage Learning. All rights reserved. 9-32 A delivery truck costs $20,000 and has an estimated residual value of $2,000 at the end of its estimated useful life of 5 years. Under the straight-line method, the depreciation rate for each year is 20 percent. Under the double-declining-balance method, the depreciation rate for each year is 40 percent. This fixed rate is applied to the remaining carrying value at the end of each year. Double-Declining-Balance Method Illustrated

33. Copyright © Cengage Learning. All rights reserved. 9-33 Note that the fixed rate is always applied to the carrying value at the end of the previous year Depreciation is greatest in the first year and declines each year after that The depreciation in the last year is limited to the amount necessary to reduce the carrying value to the residual value ($2,592 - $2,000 = $592) Depreciation Schedule Double-Declining-Balance

34. Copyright © Cengage Learning. All rights reserved. 9-34 Comparison of Depreciation Methods

35. Copyright © Cengage Learning. All rights reserved. 9-35 Depreciation for Partial Years Businesses often purchase assets during the year, thus depreciation is calculated for a partial year. Can be computed to the nearest month Can use the half-year convention 3One-half year’s depreciation is taken if the asset is purchased in the first half of the year. 3A full year’s depreciation is taken if the asset is purchased in the last half of the year.

36. Copyright © Cengage Learning. All rights reserved. 9-36 Accelerated Cost Recovery for Tax Purposes Rapid write-offs of plant assets is encouraged by federal income tax law. Depreciation allowed for tax purposes differs from depreciation calculated for the financial statements. A small company can expense the first $250,000 of equipment expenditures rather than recording them as assets. Allows an accelerated method of writing off expenditures that are recorded as assets.

37. Copyright © Cengage Learning. All rights reserved. 9-37 Disposal of Depreciable Assets Objective 4 –Account for the disposal of depreciable assets.

38. Copyright © Cengage Learning. All rights reserved. 9-38 Disposal of Depreciable Assets Discarded Sold for cash

39. Copyright © Cengage Learning. All rights reserved. 9-39 KOT Company purchased a machine on January 2, 2009, for $13,000 and planned to depreciate it on a straight-line basis over its estimated useful life of 8 years. Its residual value at the end of 8 years was estimated to be $600. Depreciation Expense = (13,000-600)/8 = 1550; Acc Dep = 1550x6 = 9,300 On December 31, 2014, the balances of the relevant accounts were as follows: Machinery Accum. Depreciation, Machinery 13,000 9,300 On January 2, 2015, management disposed of the asset. Disposal of a Plant Asset

40. Copyright © Cengage Learning. All rights reserved. 9-40 Machinery Accum. Depreciation, Machinery 13,000 9,300 Remove the carrying value of the asset.  Carrying value is computed by subtracting accumulated depreciation from the acquisition cost of the asset. If the asset is fully depreciated, the carrying value is zero. If the asset is not fully depreciated, a loss is recorded. 9,300 13,000 Bal. -0- Gains and losses on disposal of plant assets are classified as other revenues and expenses on the income statement. Discarded Plant Asset

41. Copyright © Cengage Learning. All rights reserved. 9-41 Plant Assets Sold for Cash The entry to record plant assets sold for cash is similar to that of discarding of a plant asset. –The receipt of cash is also recorded. If cash received = carrying value, no gain or loss is recorded. If cash received < carrying value, loss is recorded. If cash received > carrying value, gain is recorded.

42. Copyright © Cengage Learning. All rights reserved. 9-42 Received $3,700 cash for sale of machinery. Remove the carrying value of the asset: Selling an Asset for Cash Cash Received = Carrying Value

43. Copyright © Cengage Learning. All rights reserved. 9-43 Received $2,000 cash for sale of machinery. Remove the carrying value of the asset: Selling an Asset for Cash Cash Received < Carrying Value

44. Copyright © Cengage Learning. All rights reserved. 9-44 Received $4,000 cash for sale of machinery. Remove the carrying value of the asset: Selling an Asset for Cash Cash Received > Carrying Value

45. Copyright © Cengage Learning. All rights reserved. 9-45 Natural Resources Objective 5 –Identify the issues related to accounting for natural resources, and compute depletion.

46. Copyright © Cengage Learning. All rights reserved. 9-46 Shown on the balance sheet as long-term assets Are recorded at acquisition cost As the asset is converted to inventory, the asset account must be proportionally reduced Examples: Timberlands Oil and Gas Reserves Mineral Deposits Natural Resources Are converted to inventory by cutting, pumping, mining, or other extraction methods

47. Copyright © Cengage Learning. All rights reserved. 9-47 Depletion 1.The exhaustion of a natural resource, and 2.the proportional allocation of the cost of a natural resource to the units extracted. Costs are allocated much like the production method of depreciation

48. Copyright © Cengage Learning. All rights reserved. 9-48 A mine that cost $3,600,000 has an estimated 3,000,000 tons of coal. The estimated residual value of the coal is $600,000. During the first year, 230,000 tons of coal are mined and sold. Natural resources that have been extracted but not sold are considered inventory and are not recorded as an expense until the year sold. Recording Depletion Expense

49. Copyright © Cengage Learning. All rights reserved. 9-49 Development and Exploration Costs in the Oil and Gas Industry Accounted for under one of two methods –Successful efforts accounting Cost recorded as an asset and depleted over the estimated life of the resource For an unsuccessful exploration, written off immediately as a loss More conservative method –Full-costing method All costs, including costs of dry wells, are recorded as assets and depleted over the estimated life of the producing resources. Improves earnings performance in the early years Either method is allowed under GAAP.

50. Copyright © Cengage Learning. All rights reserved. 9-50 Intangible Assets Objective 6 –Identify the issues related to accounting for intangible assets, including research and development costs and goodwill.

51. Copyright © Cengage Learning. All rights reserved. 9-51 Intangible Assets Long-term assets with no physical substance Have a value based on rights, privileges, or advantages coming to or belonging to the owner Accounted for at acquisition cost –Patents –Copyrights –Leaseholds and leasehold improvements –Franchises –Licenses –Trademarks and brand names and goodwill Goodwill and trademarks should not appear on the balance sheet unless they have been purchased from another party at a price established in the marketplace.

52. Copyright © Cengage Learning. All rights reserved. 9-52 Accounting Issues for Intangible Assets Accounting issues are similar to other long-term assets. Issues include: –Determining an initial carrying amount –Accounting for periodic write-off or amortization –Accounting for that amount if the value declines substantially and permanently Because of its intangibility, its value and useful life may be difficult to estimate.

53. Copyright © Cengage Learning. All rights reserved. 9-53 Accounting for Intangible Assets Record as expenses –Intangible assets developed by a company for its own benefit. Record as assets –Intangible assets acquired from others Amortize over the shorter of their useful life or their legal life (not to exceed 40 years). If an intangible asset becomes worthless before it is fully amortized, the remaining carrying value should be written off as a loss.

54. Copyright © Cengage Learning. All rights reserved. 9-54 WATER Bottling Company purchases a patent on a unique bottle cap for $36,000. The patent will last for 20 years, but the product using the cap will be sold only for the next six years. Record the purchase of the patent: Record the annual amortization expense: Notice that the Patents account is directly reduced by the amount of amortization expense, whereas depreciation or depletion is accumulated in separate contra accounts for other long-term assets. Intangible Assets Illustrated

55. Copyright © Cengage Learning. All rights reserved. 9-55 Research and Development Costs Expenses of funding development of new products, testing of existing and proposed products, and pure research. Treat as revenue expenditures and charged to expense in the period when incurred. Are continuous and necessary for the success of a business and should be treated as current expenses. Do not necessarily result in future benefits (assets).

56. Copyright © Cengage Learning. All rights reserved. 9-56 Goodwill Exists when a purchaser pays more for a business than the fair market value of the net assets if purchased separately. Should not be recorded unless it is paid for in connection with the purchase of a whole business. Goodwill = Purchase price - FMV of identifiable assets

57. Copyright © Cengage Learning. All rights reserved. 9-57 Chapter Review 1.Define long-term assets, and explain the management issues related to them. 2.Distinguish between capital expenditures and revenue expenditures, and account for the cost of property, plant, and equipment. 3.Compute depreciation under the straight-line, production, and declining-balance methods.

58. Copyright © Cengage Learning. All rights reserved. 9-58 Chapter Review (cont’d) 4.Account for the disposal of depreciable assets. 5.Identify the issues related to accounting for natural resources, and compute depletion. 6.Identify the issues related to accounting for intangible assets, including research and development costs and goodwill.