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Chapter 11 Long-Lived Assets Mark Higgins.

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1 Chapter 11 Long-Lived Assets Mark Higgins

2 Tangible Long-Lived Assets
PowerPoint Slides Tangible Long-Lived Assets Tangible long-lived assets (also sometimes referred to as plant assets) are resources that: have physical substance. are recorded at cost in accordance with the cost principle of accounting. the cost consists of all expenditures necessary to acquire the asset and make it ready for its intended use. 3

3 Examples: Tangible Long-Lived Assets
PowerPoint Slides Examples: Tangible Long-Lived Assets Tangible long-lived assets include: buildings equipment, machinery leasehold improvements land improvements land 3

4 PowerPoint Slides Cost of Building When a new building is constructed, its cost consists of: the contract price architect's fees building permits excavation costs interest costs during the construction period 8

5 Cost of Equipment The cost of equipment consists of the:
PowerPoint Slides Cost of Equipment The cost of equipment consists of the: cash purchase price sales tax freight charges insurance during transit paid by the purchaser expenditures required in assembling, installing and testing the unit. In essence, all the costs associated with placing the asset in service (i.e., ready for use) 9

6 PowerPoint Slides Land Improvements The cost of land improvements includes all expenditures necessary to make the improvements ready for their intended use. For example, the cost of a parking lot would include the amount paid for paving, fencing, and lighting. 6

7 Land The cost of land includes: the cash purchase price
PowerPoint Slides Land The cost of land includes: the cash purchase price closing costs, such as title and attorney's fees real estate brokers’ commissions accrued property taxes and other liens on the land assumed by the purchaser all necessary costs incurred in making land ready for its intended use 5

8 PowerPoint Slides Depreciable Assets Depreciation applies to the following tangible assets: Buildings Leasehold Improvements Equipment Land improvements NOTE: Land is not a depreciable asset, since it does not have a finite useful life 12

9 Capitalization Versus Expense
PowerPoint Slides Capitalization Versus Expense Capitalization is the act of recognizing costs that provide a future economic benefit by setting up an asset account. Tangible assets whether purchased or self-constructed are almost always recognized Intangible assets that are acquired are generally recognized. Internally generated (i.e., self-constructed) intangibles (e.g., trained employees) are generally NOT recognized. 33

10 PowerPoint Slides Depreciation Depreciation is the rational and systematic process of allocating the cost of a tangible asset over its useful (service) life. 11

11 GAAP Versus Economic Values
GAAP fails to accurately reflect economic values of tangible assets because it: Makes incorrect assumptions regarding the pattern of future cash flows from the fixed asset Ignores interest GAAP fails to accurately reflect economic values of intangible assets because: Self-produced intangibles are not recorded

12 Accumulated Depreciation
PowerPoint Slides Accumulated Depreciation The balance in the Accumulated Depreciation (a contra asset account) represents the total amount of the asset's cost that has been expensed to date. 14

13 Factors in Computing Depreciation
PowerPoint Slides Factors in Computing Depreciation Cost--historical cost of the asset. Useful life--estimate of the expected productive life, also called service life, of the asset. Salvage value--an estimate of the asset's value at the end of its useful life. NOTE: Salvage value is not used for double-declining balance. 16

14 Depreciation Methods The following methods of depreciation are
PowerPoint Slides Depreciation Methods The following methods of depreciation are acceptable under generally accepted accounting principles (GAAP): Straight-line Units-of-Activity Declining-Balance Sum-of-the-Years’-Digits 17

15 PowerPoint Slides Straight-line Method Straight-line depreciation is the most widely used method of depreciation. Under the straight-line method, depreciation is the same for each year of the asset's useful life. 19

16 The asset's useful life measured in years
PowerPoint Slides Straight-line Method Annual depreciation under straight-line method: Depreciable Cost* ________________________________________________________________________________________________________ The asset's useful life measured in years *(cost of the asset minus its salvage value) 20

17 Straight-line Method On January 1, 2004, Rhody purchases equipment
PowerPoint Slides Straight-line Method On January 1, 2004, Rhody purchases equipment for $60,000. The equipment has a useful life of 8 years and a salvage value of $4,000. Annual depreciation under the straight-line method is $7,000. $60,000 - $4, $56,000 ____________________________________________________ = _________________________________ = $7,000 20

18 Straight-line Method Journal Entry: Depreciation expense 7,000
PowerPoint Slides Straight-line Method Journal Entry: Depreciation expense ,000 Accumulated Depreciation 7,000 20

19 PowerPoint Slides Straight-line Method Assume Rhody purchases the equipment on April 1, Annual depreciation under straight-line method is $5,250. $7,000 x 9 = $5,250 12 Journal Entry: Depreciation expense ,250 Accumulated depreciation 5,250 Note: This illustrates that an entity can only depreciate an asset for time it was placed in service for that year (i.e., 9 months). 20

20 Units-of-Activity Method
PowerPoint Slides Units-of-Activity Method Under the units-of-activity method, the life of an asset is expressed in terms of the total units of production or the use expected from the asset. 23

21 Units of Activity Method
PowerPoint Slides Units of Activity Method Under the units of activity method, depreciation is calculated as: Depreciable Cost* x Yearly activity (i.e., use) Total expected activity *(Original cost of the asset – salvage value) 20

22 Units-of-Activity Method
PowerPoint Slides Units-of-Activity Method On January 1, 2004, Rhody purchases a truck for $50,000. The truck has a useful life of 80,000 miles and a salvage value of $5,000. The truck was driven 16,000 miles during Annual depreciation under the units-of-activity method is $9,000. $50,000 - $5,000 = $45,000 depreciable cost $45,000 x 16,000 = $ 9,000 80,000 23

23 Declining-Balance Method
PowerPoint Slides Declining-Balance Method The declining-balance method is an accelerated method. Accelerated methods of depreciation result in more depreciation in the early years of an asset's life and less depreciation in the later years of an asset's life than does the straight-line approach. 22

24 Double-Declining Method
PowerPoint Slides Double-Declining Method The depreciation under the double-declining method is calculated as: Depreciable Cost* ______________________________________________________________________ x Asset's useful life in years *(original cost - accumulated depreciation) NOTE: In year 1, accumulated depreciation is zero. 20

25 Double-Declining Method
PowerPoint Slides Double-Declining Method On January 1, 2004, Rhody purchases equipment for $60,000. The equipment has a useful life of 8 years and a salvage value of $4,000. The depreciation under the double-declining method is $15,000. $60,000 - $ $60,000 ____________________________________________________ = ____________________________ = $7,500 $7,500 x 2 = $15,000 20

26 Double-Declining Method
PowerPoint Slides Double-Declining Method What is Rhody’s depreciation expense for 2005? The depreciation under the double-declining method is $11,250. $60,000 - $15, $ 45,000 ____________________________________________________ = ____________________________ = $5,625 $5,625 x 2 = $11,250 20

27 Sum-of-the-Years’-Digits
PowerPoint Slides Sum-of-the-Years’-Digits The sum-of-the-years’-digits method is an accelerated method. As with the double-declining balance method, it will result in more depreciation in the early years of an asset's life and less depreciation in the later years of an asset's life. 22

28 Sum-of-the-Years’-Digits
PowerPoint Slides Sum-of-the-Years’-Digits Depreciation under the sum-of-the-years’-digits is calculated as: Original cost – salvage value x Asset years left Total asset years 20

29 Sum-of-the-Years’-Digits
PowerPoint Slides Sum-of-the-Years’-Digits On January 1, 2004, Rhody purchases equipment for $60,000. The equipment has a useful life of 8 years and a salvage value of $4,000. The depreciation under sum-of-the-years’-digits is $12,444 ($60,000 - $4,000) = $56,000 x = $12,444 36* *( ) = 36 20

30 Disposal of Plant Assets
PowerPoint Slides Disposal of Plant Assets Whether a plant asset is sold, retired, or traded in, the company must determine the book value of the plant asset at the time of disposal. Book value is the difference between the cost of the plant asset and the accumulated depreciation to date. If disposal occurs mid-year, the depreciation for the fraction of the year to the date of disposal must be recorded. 36

31 Sale of Plant Assets Book Value: Original Cost
PowerPoint Slides Sale of Plant Assets Book Value: Original Cost - Accumulated Depreciation Book Value of Asset Gain on Sale: If sales proceeds > book value of the asset Loss on Sale: If sales proceeds < book value of the asset. 38

32 PowerPoint Slides Sale of Plant Assets On January 1, 2004, Rhody sells equipment for $20,000. The original cost of the equipment is $40,000 and the accumulated depreciation is $24,000. What is Rhody’s gain or loss? 38

33 Sale of Plant Assets Rhody has a gain of $4,000.
PowerPoint Slides Sale of Plant Assets Rhody has a gain of $4,000. Sales proceeds $20,000 Net book value * ,000 Gain on sale $ 4,000 * Net book value is original cost minus accumulated depreciation. 38

34 Sale of Plant Assets Journal Entry: Cash 20,000
PowerPoint Slides Sale of Plant Assets Journal Entry: Cash ,000 Acc. Depreciation 24,000 Equipment ,000 Gain ,000 39

35 Asset Impairment The market value has significantly decreased.
PowerPoint Slides Asset Impairment GAAP requires that an entity review its tangible assets and determine if an asset is impaired. An asset might be impaired if: The market value has significantly decreased. The asset’s utilization has changed. The entity forecasts losses from the asset’s continued use. Adverse business conditions affect the asset. Self-constructed assets cost significantly more than originally estimated. 41

36 PowerPoint Slides Asset Impairment Once an entity determines that an impairment might have taken place, it must perform an impairment test. This test requires that the entity compare the estimated undiscounted future cash flows of the asset to the asset’s current book value. 41

37 PowerPoint Slides Asset Impairment If the undiscounted cash flows EXCEED the current book value, no impairment exists and no entry is required. If the undiscounted cash flows ARE LESS THAN the current book value, the asset is impaired and a “write-down” is required. This “write-down” will equal: The difference between the asset’s current book value and the present value of the expected future cash flows.   41

38 Example: Asset Impairment
PowerPoint Slides Example: Asset Impairment On December 31, 2004, Rhody determines that the undiscounted cash flows are less than the current book value ($16,000) of the equipment. Rhody determines that the present value of the future cash flows is $10,500. What adjustment must Rhody make to the value of its equipment? 38

39 Example: Asset Impairment
PowerPoint Slides Example: Asset Impairment Rhody must recognize a loss on the value of the equipment by writing the asset down to its present value of $10,500. The journal entry would be : Loss on impairment 4,500 Accumulated Depreciation – Equip. 4,500 NOTE: The loss is reflected in the income statement 38

40 Analyzing Plant Assets
PowerPoint Slides Analyzing Plant Assets The three measures by which plant assets are evaluated are: Average useful life Average age of plant assets Asset turnover ratio 41

41 Average Useful Life To determine average useful life of assets:
PowerPoint Slides Average Useful Life To determine average useful life of assets: average cost of plant assets* depreciation expense * Total cost (i.e. original cost before any accumulated depreciation) of plant assets at the beginning of the period plus total cost of plant assets at the end of the period divided by 2. 43

42 Average Age of Plant Assets
PowerPoint Slides Average Age of Plant Assets To determine the average age of plant assets: accumulated depreciation depreciation expense. 44

43 Asset Turnover Ratios To calculate total asset turnover ratio:
PowerPoint Slides Asset Turnover Ratios To calculate total asset turnover ratio: net sales average total assets To calculate fixed asset turnover ratio: average fixed assets (PP&E) 45

44 PowerPoint Slides Intangible Assets Intangible assets are rights, privileges, and competitive advantages that result from ownership of long-lived assets that do not possess physical substance. Examples of intangible assets include goodwill and purchased patents. 46

45 PowerPoint Slides Intangible Assets Intangible assets are recorded at cost and are expensed over the useful life of the intangible asset in a manner similar to depreciation. The term used to describe how an intangible asset is expensed is called amortization. Conceptual amortization and depreciation operate the same. 47

46 PowerPoint Slides Goodwill Goodwill represents the value of all favorable attributes that relate to a business enterprise, including exceptional management, desirable location, good customer relations, skilled employees, etc. When an entire business is purchased, goodwill is the difference between the purchase price of the business and the fair market value of the net assets (assets less liabilities) acquired. 58

47 Where in the Balance Sheet Are Long-Lived Assets Presented?
PowerPoint Slides Tangible assets are shown in the balance sheet under Property, Plant, and Equipment. Sometimes these assets are shown net (original cost minus accumulated depreciation). If shown net, then the firm must disclose accumulated depreciation in the footnotes. Intangibles, if material, are shown separately; otherwise they are shown as part of other assets. 60

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