1. 9–19–1 Copyright © Cengage Learning. All rights reserved. Chapter 9 Long-Term Assets Useful life of more than one year Used in the operation of a business Not intended for resale Long-term assets might include:  Equipment  Vehicles  Property  Trademarks

2. 9–29–2 Copyright © Cengage Learning. All rights reserved. Carrying Value The unexpired cost of an asset (also called book value) Unexpired Cost = Cost – Accumulated Depreciation On the Balance Sheet:

3. 9–39–3 Copyright © Cengage Learning. All rights reserved. Classification of Long-Term Assets and Methods of Accounting for Them

4. 9–49–4 Copyright © Cengage Learning. All rights reserved. Asset Impairment When is an asset deemed impaired? When a long-term asset loses some or all of its potential to generate revenue before the end of its useful life Asset Impairment The carrying value of a long-term asset exceeds its fair value

5. 9–59–5 Copyright © Cengage Learning. All rights reserved. Acquiring Long-Term Assets How do companies make the decision to acquire long-term assets? Capital Budgeting Method of Evaluation Net Present Value Method Evaluates the purchase based on the net present value of acquisition cost, net annual savings in cash flows, and disposal price © Royalty-Free/Corbis

6. 9–69–6 Copyright © Cengage Learning. All rights reserved. Net Present Value Method Illustrated Apple Computer is considering the purchase of a $100,000 customer relations software package. Management estimates that the company will save $40,000 in net cash flows per year for four years, the usual life of the software. The software should be worth $20,000 at the end of that period. The interest rate is 10 percent compounded annually. Cash flows related to the purchase of the computer would be as follows: Present value Tables 1 and 2 can now be used to place the cash flows on a comparable basis.

7. 9–79–7 Copyright © Cengage Learning. All rights reserved. Example of Net Present Value Method (hwk E4) As long as the net present value is positive, Apple will earn a return of at least 10 percent. The return is greater than 10 percent on the investment. Based on this analysis, Apple should purchase the software.

8. 9–89–8 Copyright © Cengage Learning. All rights reserved. Financing Long-Term Assets Financing alternatives: Use cash flow from operations Issue common stock Issue long-term notes Issue bonds Investors may investigate whether a company has free cash flow to finance long-term assets. Free cash flow is cash that remains after deducting funds committed to operations at current levels © Royalty Free PhotoDisc Collection/ Getty Images

9. 9–99–9 Copyright © Cengage Learning. All rights reserved. The Matching Rule and Long-Term Assets When a company purchases an asset, it may choose to capitalize it, thus deferring an expense to a later period 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 periods?

10. 9–10 Copyright © Cengage Learning. All rights reserved. Long-Term Asset Accounting Policies Each company must determine how it will treat 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?

11. 9–11 Copyright © Cengage Learning. All rights reserved. Acquisition Cost of Property, Plant, and Equipment © Royalty Free PhotoDisc Collection/ Getty Images

12. 9–12 Copyright © Cengage Learning. All rights reserved. What Are Expenditures? (hwk E6) Payments or obligations to make a future payment for an asset or for a service Capital Expenditure Revenue Expenditure Expenditure for the purchase or expansion of a long- term asset Expenditure for the repair, maintenance, and operation of a long-term asset

13. 9–13 Copyright © Cengage Learning. All rights reserved. Capital Expenditures Outlays for plant assets, natural resources, and intangible assets Additions, which are enlargements to the physical layout of a plant asset Betterments, which are improvements to a plant asset but that do not add to the plant’s physical layout Extraordinary repairs, which are repairs that significantly enhance a plant asset’s estimated useful life or residual value

14. 9–14 Copyright © Cengage Learning. All rights reserved. Acquisition Costs Includes all expenditures reasonable and necessary to get an asset in place and ready for use Installation costs Freight Insurance while in transit Testing and setup Are these items considered acquisition costs? Repair costs Interest charges on purchase No © Royalty Free/ Corbis

15. 9–15 Copyright © Cengage Learning. All rights reserved. Acquiring Land Costs that should be debited to the Land account include: Purchase price Agent commissions Legal fees Accrued taxes paid by purchaser Grading 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. 9–16 Copyright © Cengage Learning. All rights reserved. Acquiring 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 © Royalty Free/ Corbis

17. 9–17 Copyright © Cengage Learning. All rights reserved. Building Construction Costs Materials and labor Overhead and other indirect costs Architects’ fees Insurance during construction Interest on construction loans Lawyers’ fees Building permits Outside contractors © Royalty Free/ Corbis

18. 9–18 Copyright © Cengage Learning. All rights reserved. Leasehold Improvements Improvements to leased property that become the property of the lessor at the end of the lease Classified as tangible assets in the property, plant, and equipment section of the balance sheet Costs of leasehold improvements are depreciated or amortized over the remaining term of the lease or the useful life of the improvement, whichever is shorter. © Royalty Free/ Getty Images

19. 9–19 Copyright © Cengage Learning. All rights reserved. Acquiring Equipment Acquisition costs include: 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

20. 9–20 Copyright © Cengage Learning. All rights reserved. Group Purchases (example SE 4 hwk E 8) Land and other assets may sometimes be purchased for a lump sum Because buildings are depreciable and land is not, the purchase price must be allocated to each asset ABC Co. buys a building and the land on which it is situated for a lump sum of $170,000. Assume that appraisals yield estimates of $20,000 for the land and $180,000 for the building if purchased separately. Allocate as follows:

21. 9–21 Copyright © Cengage Learning. All rights reserved. What Is Depreciation? The periodic allocation of the cost of a tangible asset (other than land and natural resources) over the asset’s estimated useful life All tangible assets except land have a limited useful life (physical deterioration and obsolescence limit useful life) Depreciation refers to the allocation of the cost of a plant asset to the periods that benefit from the asset, not to the asset’s physical deterioration or decrease in market value Depreciation is not a process of valuation; it is a process of allocation

22. 9–22 Copyright © Cengage Learning. All rights reserved. Four Factors That Affect the Computation of Depreciation 1. Cost Net purchase price of an asset plus all reasonable and necessary expenditures to get it in place and ready for use 2. Residual value The portion of an asset’s acquisition cost that a company expects to recover when it disposes of the asset 3. Depreciable cost Cost less residual value 4. Estimated useful life Total number of service units expected from a long-term asset

23. 9–23 Copyright © Cengage Learning. All rights reserved. Accounting for Depreciation Depreciation is recorded at the end of the accounting period by an adjusting entry

24. 9–24 Copyright © Cengage Learning. All rights reserved. Methods of Accounting for Depreciation Accelerated method of depreciation that results in larger amounts of depreciation in earlier years of the asset’s life and smaller amounts in later years Spreads the depreciable cost evenly over the estimated useful life of the asset Based on the assumption that depreciation is solely the result of use and that passage of time plays no role in the depreciation process Declining-balance method Straight-line method Production method

25. 9–25 Copyright © Cengage Learning. All rights reserved. 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 Illustrated

26. 9–26 Copyright © Cengage Learning. All rights reserved. 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

27. 9–27 Copyright © Cengage Learning. All rights reserved. A delivery truck costs $20,000 and has an estimated residual value of $2,000 at the end of its estimated useful life of 90,000 miles. Assume the truck was driven 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 year 5. The unit of output or use should be appropriate for that asset Production Method

28. 9–28 Copyright © Cengage Learning. All rights reserved. There is a direct relation between the amount of depreciation each year and the units of output or use. Accumulated depreciation increases each year in direct relation to units of output or use. The carrying value decreases each year in direct relation to units of output or use until the estimated residual value is reached. Depreciation Schedule, Production Method

29. 9–29 Copyright © Cengage Learning. All rights reserved. Declining-Balance Method Based on the passage of time Assumes that many kinds of plant assets are most efficient when new Is consistent with the matching rule Any fixed rate can be used Most common rate is twice the straight-line depreciation percentage (called double- declining-balance method) © Royalty Free PhotoDisc Collection/ Getty Images

30. 9–30 Copyright © Cengage Learning. All rights reserved. Double-Declining-Balance Method Illustrated A delivery truck costs $20,000 and has an estimated residual value of $2,000. Its estimated useful life is 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.

31. 9–31 Copyright © Cengage Learning. All rights reserved. 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 Method

32. 9–32 Copyright © Cengage Learning. All rights reserved. Graphic Comparison of Three Methods of Determining Depreciation (examples SE 5-7 hwk E10 P4)

33. 9–33 Copyright © Cengage Learning. All rights reserved. Group Depreciation Companies often group similar assets to calculate depreciation Group depreciation is used in all fields of industry and business Average length of time assets of the same type are expected to last © Royalty Free C Squared Studios/ Getty Images

34. 9–34 Copyright © Cengage Learning. All rights reserved. Methods of Disposal Discard Sell for cash Exchange for another asset When plant assets are no longer useful… 1.Record depreciation for the partial year up to the date of disposal 2.Remove the carrying value of the asset

35. 9–35 Copyright © Cengage Learning. All rights reserved. Discarded Plant Assets Plant assets rarely last as long as their estimated lives Never depreciate past point at which carrying value equals residual value Total accumulated depreciation should never exceed total depreciable cost © Royalty Free/ Corbis

36. 9–36 Copyright © Cengage Learning. All rights reserved. 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 (8 years). Its residual value at the end of 8 years is estimated to be $600. On December 31, 2015, the balances of the relevant accounts were: Machinery Accumulated Depreciation, Machinery 13,000 9,300 On January 2, 2015, management disposed of the asset. Disposal of a Depreciable Asset

37. 9–37 Copyright © Cengage Learning. All rights reserved. Disposal of a Plant Asset 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 Accum. Depreciation, Machinery 9,300 Machinery 13,000 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.

38. 9–38 Copyright © Cengage Learning. All rights reserved. Selling a Plant Asset for Cash In addition to removing the carrying value of the asset, you will also record the cash received 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 © Royalty Free PhotoDisc Collection/ Getty Images

39. 9–39 Copyright © Cengage Learning. All rights reserved. Selling an Asset for Cash Cash Received = Carrying Value Received $3,700 cash for sale of machinery. Remove the carrying value of the asset and record receipt of cash:

40. 9–40 Copyright © Cengage Learning. All rights reserved. Selling an Asset for Cash Cash Received < Carrying Value Received $2,000 cash for sale of machinery. Remove the carrying value of the asset and record receipt of cash:

41. 9–41 Copyright © Cengage Learning. All rights reserved. Selling an Asset for Cash Cash Received > Carrying Value (example SE 8 hwk E 13) Received $4,000 cash for sale of machinery. Remove the carrying value of the asset and record receipt of cash:

42. 9–42 Copyright © Cengage Learning. All rights reserved. What Are Natural Resources? Assets that are converted to inventory by cutting, pumping, mining, or other extraction methods Timberlands Oil and Gas Reserves Mineral Deposits Record at acquisition cost and show on the balance sheet as long-term assets

43. 9–43 Copyright © Cengage Learning. All rights reserved. Depletion of Natural Resources (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 © Royalty-Free/Corbis

44. 9–44 Copyright © Cengage Learning. All rights reserved. Recording Depletion Expense A mine that cost $3,600,000 has an estimated 3,000,000 tons of coal. The estimated residual value of the mine 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.

45. 9–45 Copyright © Cengage Learning. All rights reserved. Depreciation of Closely Related Plant Assets (example SE 9 hwk E 15) Closely related long-term assets are those assets necessary to extract the resource (Conveyors, drilling, and pumping devices) If the life of the asset is longer than the life of the resource, depreciate on the same basis as the depletion is computed If the life of the asset is shorter than the life of the resource, depreciate over the shorter life of the asset © Royalty Free C Squared Studios/ Getty Images

46. 9–46 Copyright © Cengage Learning. All rights reserved. What Is an Intangible Asset? Goodwill Trademarks Brand names Copyrights Patents Leaseholds Software Customer lists Long-term, nonphysical asset whose value comes from the rights or advantages afforded its owner © Royalty Free C Squared Studios/ Getty Images

47. 9–47 Copyright © Cengage Learning. All rights reserved. Importance of Intangibles For some companies, intangible assets make up a substantial portion of total assets

48. 9–48 Copyright © Cengage Learning. All rights reserved. Accounting for Intangible Assets Intangibles developed by a firm for its own benefit Intangibles acquired from others Record as expenseRecord as asset; amortize over the shorter of useful life or legal life (not to exceed 40 years)

49. 9–49 Copyright © Cengage Learning. All rights reserved. Difficult Issues When Accounting for Intangibles  How to account for the initial carrying value?  How to account for that amount under normal business conditions (periodic write-off or amortization)?  How to account for the amount if the value declines substantially and permanently?  How to estimate an intangible asset’s value and useful life?

50. 9–50 Copyright © Cengage Learning. All rights reserved. Intangible Assets Illustrated Later 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.

51. 9–51 Copyright © Cengage Learning. All rights reserved. Intangible Assets Illustrated (hwk E 17) The patent becomes worthless after only 1 year. Record the write-off: If the patent becomes worthless before it is fully amortized, the remaining carrying value is written off as a loss by removing it from the Patents account. © Royalty Free C Squared Studios/ Getty Images

52. 9–52 Copyright © Cengage Learning. All rights reserved. Research and Development Costs The FASB requires that all R&D costs be treated as revenue expenditures and charged to expense in the period in which they are incurred. Why? Too difficult to trace specific costs to specific profitable developments Costs of research and development are continuous and necessary for the success of a business and so should be treated as current expenses Studies show that 30 to 90 percent of all new product fail and 75 percent of new-product expenses go to unsuccessful products

53. 9–53 Copyright © Cengage Learning. All rights reserved. Computer Software Costs Costs incurred in developing computer software for sale or lease or for a firm’s internal use are research and development costs until the product has proved technologically feasible Costs incurred before technologically feasible should be charged to expense as incurred Once a working program is ready, all costs are recorded as assets Amortize over the estimated economic life using the straight-line method

54. 9–54 Copyright © Cengage Learning. All rights reserved. Goodwill A company’s good reputation Customer satisfaction Good management Manufacturing efficiency Good location Goodwill exists when a purchaser pays more for a business than the fair market value of the business’s net assets Goodwill should not be recorded unless it is paid for in connection with the purchase of a whole business Goodwill = Purchase price – FMV of identifiable net assets © Royalty Free/ Corbis