Chapter 8 Operating Assets Property Plant and Equipment

Chapter 8 Operating Assets: Property, Plant, and Equipment, and Intangibles © 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

Learning Objectives LO 1 LO 2 LO 3 LO 4 LO 5 LO 6 Understand balance sheet disclosures for operating assets. Determine the acquisition cost of an operating asset. Explain how to calculate the acquisition cost of assets purchased for a lump sum. Describe the impact of capitalizing interest as part of the acquisition cost of an asset. Compare depreciation methods and understand the factors affecting the choice of method. Understand the impact of a change in the estimate of the asset life or residual value. © 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

Learning Objectives (continued) LO 7 Determine which expenditures should be capitalized as asset costs and which should be treated as expenses. LO 8 Analyze the effect of the disposal of an asset at a gain or loss. LO 9 Understand the balance sheet presentation of intangible assets. LO 10 Understand the proper amortization of intangible assets. LO 11 Explain the impact that long-term assets have on the statement of cash flows. LO 12 Understand how investors can analyze a company’s operating assets. © 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

Module 1 Acquisition of Operating Assets q Operating assets appear on the balance sheet and companies account for the acquisition of assets Module 1 © 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

Operating Assets q Presented in two categories on the balance sheet: Ø Property, Plant and Equipment Ø Intangible Assets q Essential to a company’s long-term future Ø Used to produce the goods or services the company sells to customers q Presented at their acquisition cost Module 1: LO 1 © 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

Balance Sheet Presentation of Property, Plant, and Equipment q Balance sheet uses one line item for property, plant, and equipment and presents the details in the notes Module 1: LO 1 © 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

Acquisition of Property, Plant, and Equipment q Initially recorded at acquisition cost or original cost q Includes all cost normally necessary to acquire an asset and prepare it for its intended use Ø Purchase price Ø Taxes paid at time of purchase (for example, sales tax) Ø Transportation charges Ø Installation costs Module 1: LO 2 © 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

Group Purchase q Firm purchases several assets as a group and pays a lump-sum amount q Acquisition cost of each asset is separately measured on the basis of the proportion of the fair market value of each Module 1: LO 3 © 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

q q q Example 8 -1—Determining Cost When a Group of Assets Is Purchased Assume that on January 1, Exer. Co purchased a building and the land on which it is situated for $100, 000 The accountant established the assets’ fair market value on January 1 as follows: Land $30, 000 Building 90, 000 Total 120, 000 Based on the estimated market values, the purchase price should be allocated as follows: To land $100, 000 × $30, 000/$120, 000 = $25, 000 To building $100, 000 × $90, 000/$120, 000 = $75, 000 Module 1: LO 3 © 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

Example 8 -1—Determining Cost When a Group of Assets Is Purchased (continued) q The journal entry to record the purchase in Example 8 -1 would be as follows: Module 1: LO 3 © 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

Capitalization of Interest q The interest on borrowed money should be treated as an expense of the period q If a company constructs an asset over a period of time and borrows money to finance the construction Ø The interest incurred during the construction period is not treated as interest expense Ø The interest must be included as part of the acquisition cost of the asset Module 1: LO 4 © 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

Land Improvements q The acquisition cost of land should be kept in a separate account because land has an unlimited life and is not subject to depreciation q Costs associated with land should be recorded in an account such as Land Improvements Ø Example: costs of paving a parking lot and landscaping costs Ø Have a limited life Ø Should be depreciated over their useful lives Module 1: LO 4 © 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

Module 2 Depreciation and Disposal of Operating Assets q A company records depreciation of operating assets and certain factors affect the choice of depreciation method q A company accounts for repairs of the asset and there is an effect of disposal of an asset at a gain or loss Module 2 © 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

Use and Depreciation of Property, Plant, and Equipment q Depreciation: the allocation of the original cost of an asset to the periods benefited by its use q Methods of depreciation: Ø Ø Ø Straight-line Units-of-production Accelerated depreciation q The method chosen should be one that best matches the expense to the revenue generated by the asset Module 2: LO 5 © 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

Straight-Line Method q Allocates the cost of the asset evenly over time Depreciation = Acquisition Cost – Residual Value Life Module 2: LO 5 © 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

Example 8 -2—Computing Depreciation Using the Straight Line Method q q q Assume that on January 1, 2016, Exer. Co, a manufacturer of exercise equipment, purchased a machine for $20, 000 The machine’s estimated life would be five years, and its residual value at the end of 2020 would be $2, 000 The annual depreciation should be calculated as follows: Depreciation = Acquisition Cost – Residual Value Life = ($20, 000 -$2, 000)/5 = $3, 600 Module 2: LO 5 © 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

Example 8 -2—Computing Depreciation Using the Straight Line Method (continued) q q An asset’s book value is defined as its acquisition cost minus its total amount of accumulated depreciation The book value of the machine in this example is $16, 400 at the end of 2016: Book Value = Acquisition Cost – Accumulated Depreciation = $20, 000 -$3, 600 = $16, 400 Module 2: LO 5 © 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

Example 8 -2—Computing Depreciation Using the Straight Line Method (continued) q q An asset’s book value is defined as its acquisition cost minus its total amount of accumulated depreciation The book value of the machine in this example is $16, 400 at the end of 2016: Book Value = Acquisition Cost – Accumulated Depreciation = $20, 000 - (2 x $3, 600) = $12, 800 Module 2: LO 5 © 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

Units-of-Production Method q Depreciation is determined as a function of the number of units the asset produces Depreciation = Acquisition Cost – Residual Value Total Number of Units in Asset’s Life q The annual depreciation for a given year can be calculated based on the number of units produced during that year, as follows: Annual Depreciation = Depreciation per Unit x Units Produced in Current Year Module 2: LO 5 © 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

Example 8 -3—Computing Depreciation Using the Units-of. Production Method q q q Exer. Co has estimated that the total number of units that will be produced during the asset’s five-year life is 18, 000 During 2016, Exer. Co produced 4, 000 units The depreciation per unit for Exer. Co’s machine can be calculated as follows: Depreciation = Acquisition Cost – Residual Value Total Number of Units in Asset’s Life = ($20, 000 - $2, 000)/18, 000 = $1 per unit Module 2: LO 5 © 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

q Example 8 -3—Computing Depreciation Using the Units-of. Production Method (continued) The amount of depreciation that should be recorded as an expense for 2016 is $4, 000 Annual Depreciation = Depreciation per Unit x Units Produced in Current Year = $1 per Unit x 4, 000 Units = $4, 000 Module 2: LO 5 © 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

Accelerated Depreciation Method q Higher amount of depreciation is recorded in the early years than in later years q Double-declining-balance method: recorded at twice the straight-line rate, but the balance is reduced each period Module 2: LO 5 © 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

Example 8 -4—Computing Depreciation Using the Double. Declining-Balance Method q q Assume that Exer. Co wants to depreciate its asset using the double-decliningbalance method The straight-line rate for the Exer. Co asset with a five-year life is as follows: 100% / 5 Years = 20% q The second step is to double the straight-line rate, as follows: 2 x 20% = 40% Module 2: LO 5 © 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

Example 8 -4—Computing Depreciation Using the Double-Declining-Balance Method (continued) q q This rate will be applied in all years to the asset’s book value at the beginning of each year As depreciation is recorded, the book value declines and a constant rate is applied to a declining amount However, the machine cannot be depreciated below its residual value The amount of depreciation for 2016 would be calculated as follows: Depreciation = Beginning Book Value x Rate = $20, 000 x 40% = $8, 000 Module 2: LO 5 © 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

Example 8 -4—Computing Depreciation Using the Double-Declining-Balance Method (continued) q The amount of depreciation for 2017 would be calculated as follows: Depreciation = Beginning Book Value x Rate = ($20, 000 - $8, 000) x 40% = $4, 800 Module 2: LO 5 © 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

Exhibit 8 -1—Comparision of Depreciation and Book Values of Straight-Line and Double-Declining Balance Methods Module 2: LO 5 © 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

Exhibit 8 -2—Management’s Choice of Depreciation Method Module 2: LO 5 © 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

Change in Depreciation Estimate q Change in the life of the asset or in its residual value q Recorded prospectively Ø The depreciation recorded in prior years is not corrected or restated Ø The new estimate should affect the current year and future years Module 2: LO 6 © 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

Example 8 -5—Calculating a Change in Depreciation Estimate q q q Exer. Co purchased a machine on January 1, 2016, for $20, 000 and estimates that the machine’s life would be five years and its residual value at the end of five years would be $2, 000 At the beginning of 2018, Exer. Co believes that the total machine life will be seven years, or another five years beyond the two years the machine has been used The amount to be depreciated over that time period should be calculated as follows: Module 2: LO 6 © 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

Example 8 -5—Calculating a Change in Depreciation Estimate (continued) q q The remaining depreciable amount should be recorded as depreciation over the remaining life of the machine The depreciation amount for 2018 and the following four years would be $2, 160: Depreciation = Remaining Depreciable Amount/Remaining Life = $10, 800/5 Years = $2, 160 Module 2: LO 6 © 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

Example 8 -5—Calculating a Change in Depreciation Estimate (continued) q The journal entry to record depreciation for the year 2018 is as follows: Module 2: LO 6 © 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

Capital versus Revenue Expenditures q Capital expenditure: a cost that improves the asset and is added to the asset account (item treated as asset) q Revenue expenditure: a cost that keeps an asset in its normal operating condition and is treated as an expense (item treated as an expense of the period) Module 2: LO 7 © 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

Capital versus Revenue Expenditures Module 2: LO 7 © 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

Example 8 -6—Capitalizing Costs of a Major Repair q q At the beginning of 2018, Exer. Co made a $3, 000 overhaul to the machine, extending its life by three years The amount to be depreciated over that time period should be calculated as follows: Module 2: LO 7 © 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

Example 8 -6—Capitalizing Costs of a Major Repair (continued) q Beginning in 2018, the company should record depreciation of $2, 300 per year, computed as follows: Depreciation = Remaining Depreciable Amount/Remaining Life = $13, 800/6 Years = $2, 300 Module 2: LO 7 © 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

Example 8 -6—Capitalizing Costs of a Major Repair (continued) q The journal entry to record the overhaul in Example 8 -6 is as follows: Module 2: LO 7 © 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

Example 8 -6—Capitalizing Costs of a Major Repair (continued) q The entry to record depreciation for the year 2018 is as follows: Module 2: LO 7 © 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

Disposal of Property, Plant, and Equipment q Occurs when the asset is sold, traded, or discarded q Update depreciation to the date of disposal and calculate gain or loss Ø A gain occurs when the selling price of the asset exceeds its book value Ø A loss occurs when the selling price of the asset is less than its book value q Gain or loss is reported in the Other Income or Expense category of the income statement Module 2: LO 8 © 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

Example 8 -7—Calculating the Gain on Sale of an Asset q q q Assume that Exer. Co purchased a machine on January 1, 2016, for $20, 000, estimating its life to be five years and the residual value to be $2, 000 Exer. Co sold the machine on July 1, 2018 Depreciation for the six-month period from January 1 to July 1, 2018, is $1, 800 ($3, 600 per year 1/2 year ¼ $1, 800) and should be recorded as follows: Module 2: LO 8 © 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

Example 8 -7—Calculating the Gain on Sale of an Asset (continued) q q After the July 1 entry, the balance of the Accumulated Depreciation— Machine account is $9, 000, which reflects depreciation for the 2½ years from the date of purchase to the date of sale The entry to record the sale is as follows: Module 2: LO 8 © 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

Loss on Sale of Assets q q q The calculation of a loss on the sale of an asset is similar to that of a gain Depreciation must be recorded to the date of sale, July 1 Following is the entry to record the sale of the asset: Module 2: LO 8 © 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

Example 8 -8—Calculating the Loss on Sale of an Asset q Assume that Exer. Co sold the asset on July 1, 2018, for $10, 000. The loss could be calculated as follows: Module 2: LO 8 © 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

IFRS and Property, Plant, and Equipment q IFRS requires estimates of residual value and the life of the asset be reviewed at least annually Ø FASB standards does not require the annual review q The international standards also indicate that companies should determine the components of an asset and depreciate each component separately q International Standards allow companies to revalue the assets to reflect their fair market values Ø FASB does not allow the revaluing to fair market value Module 2: LO 8 © 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

Module 3 Intangible Assets q Intangible assets on the balance sheet are important Module 3 © 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

Intangible Assets with no physical properties q Recorded as assets, because they provide future economic benefits to the company q Long-term assets and should be shown separately from property, plant, and equipment q Module 3: LO 9 © 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

Exhibit 8 -3—Most Common Intangible Assets Module 3: LO 9 © 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

Acquisition Cost of Intangible Assets q Includes costs to acquire and prepare it for its intended use q Includes: Ø Purchase Price Ø Acquisition costs • Costs that are incurred after acquisition and that are necessary to the existence of the asset Module 3: LO 9 © 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

Exhibit 8 -4—The Nike, Inc. , Consolidated Assets Section and Intangibles Notes Module 3: LO 9 © 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

Research and Development Costs q Costs incurred in the discovery of new knowledge q According to FASB, all such expenditures must be treated as expenses in the period incurred Ø Patent account should not include the costs of research and development of a new product Module 3: LO 9 © 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

Amortization of Intangibles q Intangibles with finite life must be amortized Ø Recorded over the legal life or the useful life, whichever is shorter Ø Mostly recorded using the straight-line method q Intangibles with indefinite life are not amortized Ø Example: trademark, goodwill, license and broadcast Module 3: LO 10 © 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

Example 8 -9—Calculating the Amortization of Intangibles q q q Assume that Nike developed a patent for a new shoe product on January 1, 2016 Costs involved with patent approval were $10, 000, and the company wants to record amortization on the straight-line basis over a five-year life with no residual value Nike should record amortization over the useful life as $10, 000/5 years ¼ $2, 000 Module 3: LO 10 © 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

Example 8 -9—Calculating the Amortization of Intangibles (continued) q The accounting entry to record the amortization for 2016 is as follows: Module 3: LO 10 © 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

Example 8 -9—Calculating the Amortization of Intangibles (continued) q q Rather than use an accumulated amortization account, some companies decrease (credit) the intangible asset account directly In that case, the preceding transaction is recorded as follows: Module 3: LO 10 © 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

Goodwill and Impairments q As per the FASB, goodwill should be treated as an intangible asset with an indefinite life and that companies should not record amortization expense related to goodwill q Each year, assets with indefinite life should be checked for impairment q If an impairment has occurred, a loss should be recognized Module 3: LO 10 © 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

Goodwill and Impairments q q Assume that Nike learns on January 1, 2017, when accumulated amortization is $2, 000 (or the book value of the patent is $8, 000), that a competing company has developed a new product that renders Nike’s patent worthless Nike has a loss of $8, 000 and should record an entry to write off the asset as follows: Module 3: LO 10 © 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

IFRS and Intangible Assets q International standards are more flexible than the FASB standards in allowing the use of fair market values for intangible assets Ø Active market must exist Ø Fair value must be possible to determine q Research and development costs Ø FASB: all such costs should be treated as an expense Ø IFRS: Research costs be treated as an expense and development costs can be capitalized as an asset Module 3: LO 10 © 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

Module 4 Cash Flow and Analysis Issues q Operating assets can impact the cash flows of the company and investors analyze a company’s operating assets Module 4 © 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

Exhibit 8 -5—Long-Term Assets and the Statement of Cash Flows Module 4: LO 11 © 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

Analyzing Long-Term Assets for Average Life q What is the average depreciable period (or life) of the company’s assets? Average Life = Property, Plant, and Equipment Depreciation Expense Module 4: LO 12 © 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

Analyzing Long-Term Assets for Average Age q Are assets old or new? Average Age = Accumulated Depreciation Expense Module 4: LO 12 © 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

Analyzing Long-Term Assets for Asset Turnover q How productive are the company’s assets? Asset Turnover = Net Sales Average Total Assets Module 4: LO 12 © 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

Review LO 1 Understand balance sheet disclosures for operating assets. • Operating assets are the major productive assets of many companies, and investors must be able to evaluate the long-term potential of these assets for a return on their investments. • Operating assets may be classified as either tangible or intangible assets. • Tangible assets are referred to as property, plant, and equipment (or fixed assets). • Intangible assets include goodwill, patents, copyrights, and various types of intellectual property. © 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

Review LO 2 Determine the acquisition cost of an operating asset. • Assets classified as property, plant, and equipment (or fixed assets) are initially recorded at the cost to acquire the assets, also referred to as historical cost or original cost. • Acquisition costs include those costs that are normal and necessary to acquire the asset and prepare it for its intended use. Generally, acquisition costs include purchase price, taxes paid at time of purchase, transportation charges, and installation costs. © 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

Review LO 3 Explain how to calculate the acquisition cost of assets purchased for a lump sum. • If more than one asset is purchased for a single sum of money, the acquisition costs must be allocated between the assets. • In these cases, the purchase price should be allocated between the assets acquired based on the proportion of the fair market value each asset represents of the total purchase price. LO 4 Describe the impact of capitalizing interest as part of the acquisition cost of an asset. • Generally, the interest on borrowed money used to acquire assets should not be capitalized; instead, it should be treated as an expense of the period. © 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

Review LO 5 Compare depreciation methods and understand the factors affecting the choice of method. • Several depreciation methods are available, including straight-line, units-of-production, and accelerated depreciation methods. • In theory, the depreciation method that best allocates the original cost of the asset to the periods benefited by the use of the asset should be chosen. LO 6 Understand the impact of a change in the estimate of the asset life or residual value. • Occasionally, an estimate of the asset’s life or residual value must be modified after the depreciation process has begun. This is an example of an accounting change that is referred to as a change in estimate. © 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

Review LO 7 Determine which expenditures should be capitalized as asset costs and which should be treated as expenses. • Capital expenditures are added to the acquisition cost of an asset and are depreciated over time. • Revenue expenditures are not treated as part of the cost of the asset, but as an expense on the income statement in the period incurred. LO 8 Analyze the effect of the disposal of an asset at a gain or loss. • The gain or loss on an asset is the difference between the sales (or exchange) price and the book value of the asset, where book value is the acquisition cost less any accumulated depreciation on the asset. © 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

Review LO 9 Understand the balance sheet presentation of intangible assets. • Intangible assets are long-term assets that should be shown separately from property, plant, and equipment on the balance sheet. LO 10 Understand the proper amortization of intangible assets. • The amortization of intangibles is a process similar to that of depreciating capital assets. • If an intangible asset has a finite useful life, amortization expense must be taken on the asset over the legal life or useful life, whichever is shorter. © 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

Review LO 11 Explain the impact that long-term assets have on the statement of cash flows. • Long-term assets impact the statement of cash flows when they are acquired, depreciated, and sold. • Cash used to acquire long-term assets or cash received on the sale of long-term assets is reflected in the Investing Activities section of the statement of cash flows. • Depreciation and amortization are noncash expenses recorded on the accrual income statement. • Accordingly, net income on a cash basis must be arrived at by adding depreciation and amortization back to accrual net income. © 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

Review LO 12 Understand how investors can analyze a company’s operating assets. • Investors are interested in how productive a company’s operating assets are. • The Ratios are a valuable tool that can be used to examine the productivity of operating assets with the asset turnover ratio. © 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

End of Chapter 8 © 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.