1. 1 © Copyright 2007 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star Logo, and South-Western are trademarks used herein under license. FINANCIAL ACCOUNTING 2 ND EDITION BY DUCHAC, REEVE, & WARREN 9 Fixed & Intangible Assets

2. 2 LEARNING GOALS When you finish this chapter, you should be able to

3. 3 1.Define, classify, account for cost of fixed assets. 2.Compute depreciation using straight-line, units-of-production, declining balance. 3.Account for disposal of fixed assets. LEARNING GOALS Continued

4. 4 LEARNING GOALS 4. Describe, account for intangible assets: patents, copyrights, goodwill. 5.Describe how depreciation expense is reported in income statement, balance sheet. 6.Analyze utilization of fixed assets.

5. 5 MARRIOTT INTERNATIONAL, INC. Marriott International, Inc.  Hotel properties are Marriott’s major long- term fixed assets  Must balance supply, demand for rooms  Over-investing in fixed assets can lead to financial difficulty

6. 6 LEARNING GOALS 1 Define, classify, account for cost of fixed assets.

7. 7 LG 1 Why is a “major purchase” different? Major purchase is expensive & long-lived.

8. 8 FIXED ASSETS Fixed assets are –Long term or relatively permanent –Tangible, i.e., physical –Owned, used by business –Not held for resale Also called Property, Plant, & Equipment (PPE) Fixed assets are –Long term or relatively permanent –Tangible, i.e., physical –Owned, used by business –Not held for resale Also called Property, Plant, & Equipment (PPE) LG 1

9. 9 EXHIBIT 1 Fixed assets comprise a major portion of total assets for most firms LG 1

10. 10 CLASSIFYING COSTS Expenditures must be classified as –Expenses –Investments –Fixed assets Expenditures must be classified as –Expenses –Investments –Fixed assets LG 1

11. 11 EXHIBIT 2 Expense No Yes Fixed Assets Investments No Yes When is a purchased item a fixed asset? LG 1

12. 12 ASSET COST Cost of asset includes –All amounts spent to get asset in place –All amounts spent to get asset ready to use LG 1

13. 13 EXERCISE 9-1a Press “Enter” or click left mouse button for answer. Indicate which costs to acquire a printing press should be debited to the asset. 1.Freight 2.Special foundation 3.Sales tax on purchase 4.Insurance while in transit 5.Fee paid for installation 6.New parts to replace damaged parts LG 1 Click button to skip this exercise

14. 14 LG 1 What happens if the firm buys land, building, & equipment for 1 price? The price must be allocated among 4 assets on a percentage basis.

15. 15 EXHIBIT 3 Continued Allocate to land LG 1

16. 16 EXHIBIT 3 Continued Allocate to building LG 1

17. 17 EXHIBIT 3 Allocate to equipment Continued LG 1

18. 18 EXHIBIT 3 Allocate to land improvements LG 1

19. 19 LG 1 What kinds of expenditures do companies make on fixed assets? Two types of expenditures are capital and revenue expenditures.

20. 20 CAPITAL & REVENUE EXPENDITURES Money spent on assets after they are acquired are divided between –Capital expenditures –Improve asset –Extend useful life –Revenue expenditures –Ordinary maintenance & repairs LG 1

21. 21 ENTRY: Repairs & Maintenance Repairs expense Cash 300 Paid cash for repairs and maintenance Decreases operating cash flow Decreases assets, equity on balance sheet Increases expenses on income statement LG 1 SCFBSIS E

22. 22 ENTRY: Asset Improvements Delivery Truck Cash 5,500 Paid cash for hydraulic lift for truck Decreases investing cash flow No net change assets on balance sheet No effect on income statement LG 1 SCFBSIS

23. 23 REVENUE EXPENDITURES Revenue expenditures –Are ordinary repairs & maintenance –Benefit only current period –Increase (debit) repairs & maintenance expense Revenue expenditures –Are ordinary repairs & maintenance –Benefit only current period –Increase (debit) repairs & maintenance expense LG 1

24. 24 CAPITAL EXPENDITURES Capital expenditures –Are asset improvement –Benefit current & future periods –Increase (debit) fixed asset Capital expenditures –Are asset improvement –Benefit current & future periods –Increase (debit) fixed asset LG 1

25. 25 EXERCISE 9-5a (partial) Press “Enter” or click left mouse button for answer. Hicks incurred the following costs related to trucks and vans in operating a delivery service. Identify the capital expenditures. 1.Replaced radio with new radio with greater range. 2.Overhauled engine on 3-yr. old truck 3.Changed oil all trucks, vans 4.Installed security systems 5.Changed radiator fluid on 4-yr. Old truck 6.Installed hydraulic lift LG 1 Click button to skip this exercise

26. 26 EXERCISE 9-5b (partial) Press “Enter” or click left mouse button for answer. Hicks incurred the following costs related to trucks and vans in operating a delivery service. Identify the revenue expenditures. 1.Replaced radio with new radio with greater range. 2.Overhauled engine on 3-yr. old truck 3.Changed oil all trucks, vans 4.Installed security systems 5.Changed radiator fluid on 4-yr. Old truck 6.Installed hydraulic lift LG 1 Click button to skip this exercise

27. 27 LEARNING GOALS 2 Compute depreciation using straight-line, units-of-production, declining balance.

28. 28 EXHIBIT 4 LG 2

29. 29 LG 2 What are some methods of depreciation? We examine 3 depreciation methods.

30. 30 DEPRECIATION METHODS 3 methods to calculate depreciation expense –Straight-line depreciation Same amount of depreciation each year –Units of production depreciation Depreciation varies with asset use –Declining balance Accelerated method provides more depreciation in earlier years 3 methods to calculate depreciation expense –Straight-line depreciation Same amount of depreciation each year –Units of production depreciation Depreciation varies with asset use –Declining balance Accelerated method provides more depreciation in earlier years LG 2

31. 31 STRAIGHT-LINE DEPRECIATION Depreciation expense = (Cost – Residual value) / Useful life LG 2

32. 32 12/31 ENTRY: Straight-line Depreciation 12/31 Depreciation Exp Accumulated Depr 4,400 Recognized depreciation expense No effect cash flow Decreases assets, equity on balance sheet Increases expenses on income statement LG 2 SCFBSIS E

33. 33 EXERCISE 9-15a Press “Enter” or click left mouse button for answer. A backhoe acquired on 1/5 for $84,000 has an estimated useful life of 12 years and no residual value. Determine the depreciation for each of the first 2 years by straight-line depreciation. LG 2 Click button to skip this exercise Depreciation expense = (Cost – Residual value) / Useful life ($84,000 - $0)/12 = $7,000 year 1 & 2

34. 34 UNITS-OF-PRODUCTION DEPRECIATION Depreciation expense = {(Cost – Residual value)/ Productive activity} * Current activity LG 2

35. 35 12/31 ENTRY: Units-of- Production Depreciation 12/31 Depreciation Exp Accumulated Depr 4,620 Recognized depreciation expense No effect cash flow Decreases assets, equity on balance sheet Increases expenses on income statement LG 2 SCFBSIS E

36. 36 EXERCISE 9-13 Press “Enter” or click left mouse button for answer. A diesel-powered generator with cost of $345,000 and residual value of $18,000, has an expected operating life of 75,000 hours. In July, the generator was used 1,250 hours. Calculate depreciation by units-of-production depreciation. LG 2 Click button to skip this exercise {($345,000 - $18,000)/75,000} * 1,250 = $5,450 Depreciation expense = {(Cost – Residual value)/ Productive activity} * Current activity

37. 37 DECLINING-BALANCE DEPRECIATION Depreciation expense = 2*(1/Life) * (Cost – Accumulated Depreciation) For double-declining balance: LG 2

38. 38 12/31 ENTRY: Double-Declining- Balance Depreciation 12/31 Depreciation Exp Accumulated Depr 9,600 Recognized depreciation expense No effect cash flow Decreases assets, equity on balance sheet Increases expenses on income statement LG 2 SCFBSIS E

39. 39 EXERCISE 9-15b Press “Enter” or click left mouse button for answer. A backhoe acquired on 1/5 for $84,000 has an estimated useful life of 12 years and no residual value. Determine the depreciation for each of the first 2 years by double-declining balance depreciation. LG 2 Click button to skip this exercise 2 * (1/12) *($84,000 - $0) = $14,000 in year 1 2*(1/12) *($84,000 - $14,000) = $11,667 in year 2 Depreciation expense = 2*(1/Life) * (Cost – Accumulated Depreciation)

40. 40 LG 2 What happens when estimates are revised? Assume book value is 88,000 when residual value revised to 8,000 and remaining life extended to 8 years.

41. 41 REVISED DEPRECIATION LG 2 (Book value – Revised residual value) / Remaining useful life (88,000 – 8,000) / 8 yrs. 10,000 per year (Book value – Revised residual value) / Remaining useful life (88,000 – 8,000) / 8 yrs. 10,000 per year

42. 42 LEARNING GOALS 3 Account for disposal of fixed assets.

43. 43 ASSET DISPOSAL Assets can be –Discarded –Sold First, bring depreciation expense up to date Assets can be –Discarded –Sold First, bring depreciation expense up to date LG 3

44. 44 2/14 ENTRY: Discarding Asset 2/14 Accumulated Depr. Equipment 25,000 Discard an asset No effect cash flow Decreases assets, equity on balance sheet Increases expenses on income statement LG 3 SCFBSIS

45. 45 10/12 ENTRY: Selling Asset 10/12 Cash Accumulated Depr Loss Equipment 1,000 7,750 1,250 10,000 Sell an asset Increase investing cash flow Decreases assets, equity on balance sheet Increases expenses on income statement LG 3 SCFBSIS

46. 46 LEARNING GOALS 4 Describe, account for intangible assets: patents, copyrights, goodwill.

47. 47 INTANGIBLE ASSETS Intangible assets are –Long term or relatively permanent –Without physical properties –Owned, used by business –Not held for resale Intangible assets are –Long term or relatively permanent –Without physical properties –Owned, used by business –Not held for resale LG 4

48. 48 INTANGIBLE ASSETS: Examples Examples of intangible assets are –Patents –Copyrights, trademarks –Goodwill Cost of intangible assets is amortized over useful (legal life) LG 4

49. 49 INTANGIBLE ASSETS: Definitions Patent –Exclusive right to produce, sell goods with 1 or more unique features Copyright –Exclusive to publish, sell literary, artistic, musical composition Trademark –Name, term, symbol used to identify business, product LG 4

50. 50 AMORTIZING COST Amortization –Term used to match cost of intangible asset against revenue over useful (legal) life Amortization similar to straight-line depreciation Amortization expense = (Cost – Residual value) / Useful life LG 4

51. 51 12/31 ENTRY: Amortization 12/31 Amortization Exp Patents 20,000 Recognized amortization expense No effect cash flow Decreases assets, equity on balance sheet Increases expenses on income statement LG 4 SCFBSIS E

52. 52 INTANGIBLE ASSET: Goodwill Goodwill –Arises when one business buys another business –Created when purchase price of business greater than fair market value of net assets –Not amortized; impaired value adjusted LG 4

53. 53 IMPAIRMENT ENTRY Loss from Impaired Goodwill Goodwill 54,000,000,000 Recognized impairment of goodwill No effect cash flow Decreases assets, equity on balance sheet Increases expenses on income statement LG 4 SCFBSIS E

54. 54 LEARNING GOALS 5 Describe how depreciation is reported in income statement, balance sheet.

55. 55 LG 5 EXHIBIT 10 PP&E reduced by accumulated depreciation

56. 56 LEARNING GOALS 6 Analyze utilization of fixed assets.

57. 57 OPERATIONAL UTILIZATION ANALYSIS Operational utilization measures efficient use of operational assets Operational Utilization = Annual Usage/ Total Annual Capacity Operational utilization measures efficient use of operational assets Operational Utilization = Annual Usage/ Total Annual Capacity LG 6

58. 58 EXHIBIT 11 Operational Utilization Ratio Examples LG 6

59. 59 FINANCIAL UTILIZATION Financial utilization measures efficient revenue generation of operational assets Fixed Asset Turnover = Revenue/ Ave. Book Value Fixed Assets Financial utilization measures efficient revenue generation of operational assets Fixed Asset Turnover = Revenue/ Ave. Book Value Fixed Assets LG 6

60. 60 MARRIOTT’S FINANCIAL UTILIZATION: Basic Information 12/31/04 (millions) 1/2/04 (millions) Property, equipment (net) $2,389$2,513 Revenue 2004$10,099 The higher the ratio, the more efficient the utilization of fixed assets LG 6

61. 61 MARRIOTT’S FIXED ASSET TURNOVER Marriott’s fixed asset turnover for 2004 is $10,099/{($2,389 + $2,513)/2} = 4.12 Marriott’s fixed asset turnover for 2004 is $10,099/{($2,389 + $2,513)/2} = 4.12 LG 6

62. 62 ANALYSIS: Fixed Asset Turnover Marriott’s fixed asset turnover of 4.12 means Marriott earned $4.12 in revenue for every $1 of fixed assets in 2004. LG 6

63. 63 THE END CHAPTER 9