Chapter 9 LongLived Tangible and Intangible Assets Power

Learning Objective 9 -1 Define, classify, and explain the nature of long-lived assets. 9 -2

Definition and Classification Actively Used in Operations l l l 9 -3 Value represented by rights that produce benefits. Will not be up within the next year Intangibles withused a limited life, such as patents and copyrights, are subject to Examples amortization. l Land Intangibles Intangible Tangiblewith an l Assets subject to depreciation unlimited (or indefinite) and equipment No Physical life, such as goodwill and n. Buildings Physical trademarks, n. Furniture. Substance and fixtures Substanceare not amortized.

Learning Objective 9 -2 Apply the cost principle to the acquisition of long-lived assets. 9 -4

Acquisition of Tangible Assets Acquisition cost includes: 1. purchase price, and 2. all expenditures needed to prepare the asset for its intended use. Recording costs as assets is called capitalizing the costs. 9 -5

Acquisition of Tangible Assets l Purchase cost Legal fees Survey fees Title search fees l Purchase/construction cost l Legal fees l Appraisal fees l Architect fees l Purchase/construction cost l Sales taxes l Transportation costs l Installation costs l Land l l Buildings Equipment 9 -6

Acquisition of Tangible Assets Basket Purchase The total cost of a combined purchase of land building is allocated in proportion to their relative market values. On January 1, Jones purchased land building for $400, 000 cash. The appraised values are building, $325, 000, and land, $175, 000. How much of the $400, 000 purchase price will be assigned to the building and land accounts? 9 -7

Acquisition of Tangible Assets Component Allocation IFRS takes the idea of a basket purchase one step further. The cost of an individual asset’s components is allocated among each significant component and then depreciated separately over that component’s useful life. 9 -8

Acquisition of Tangible Assets Cedar Fair purchased a new ride for $26, 000 less a $1, 000 discount. Cedar Fair paid $125, 000 for transportation and $625, 000 for installation of the ride. Prepare the journal entry for the acquisition assuming Cedar Fair signed a note payable for the new roller coaster and paid cash for the transportation and installation costs. 1 Analyze Assets Cash Equipment 2 -750, 000 +25, 750, 000 Liabilities + Stockholders’ Equity Note Payable +25, 000 Record Equipment Cash Note Payable 9 -9 = 25, 750, 000 25, 000

Maintenance Costs Incurred during Use 9 -10

Depreciation Expense Depreciation is a cost allocation process that matches costs of operational assets with periods benefited by their use. Acquisition Cost Allocation Balance Sheet 9 -11 Expense Income Statement Depreciation Expense Depreciation for the current year Income Statement Accumulated Depreciation Total of depreciation to date for an asset Balance Sheet

Depreciation Expense The effects of $130 of depreciation on the accounting equation and the journal entry to record them follow: 1 Analyze Assets = Liabilities Accumulated Depreciation (+x. A) -130 2 + Stockholders’ Equity Depreciation Expense (+E) -130 Record Depreciation Expense Accumulated Depreciation (+x. A) 130 Depreciation calculations require three amounts for each asset: Acquisition cost. Estimated useful life. Estimated residual value. 9 -12

Depreciation Expense 2013 Depreciation Includes $125 for 2013 Book value 2013 9 -13

Learning Objective 9 -3 Apply various depreciation methods as economic benefits are used up over time. 9 -14

Depreciation Methods Straight-line Units-of-production Declining balance We will use the following information to illustrate three methods of depreciation: At the beginning of the year, Cedar Fair purchased a new go-kart Ride for $62, 500. The ride has an estimated useful life of 3 years or 100, 000 miles and an estimated residual value of $2, 500. 9 -15

Straight-Line Method ($62, 500 - $2, 500) × 9 -16 1 3 = $20, 000 per year

Units-of-Production Method The ride has a 100, 000 -mile estimated useful life. If the ride is used 30, 000 miles in the first year, what is the amount of depreciation expense? ($62, 500 - $2, 500) × 9 -17 30, 000 100, 000 = $18, 000

Units-of-Production Method 9 -18

Declining-Balance Method What is the amount of depreciation for each of the first two years? First Year Second Year × 2 3 = $41, 667 ($62, 500 - $41, 667) × 2 3 = $13, 889 ($62, 500 - $0) Cost – Accumulated Depreciation Annual computation ignores residual value. 9 -19

Double-Declining-Balance Method Third Year ($62, 500 - $55, 556) × 2 3 = $4, 629 Depreciation expense is limited to the amount that reduces book value to the estimated residual value. 9 -20

Summary of Depreciation Methods 9 -21

Partial Year Depreciation Calculations When a plant asset is acquired during the year, depreciation is calculated for the fraction of the year the asset is owned. June 30 9 -22

Tax Depreciation 9 -23

Learning Objective 9 -4 Explain the effect of asset impairment on the financial statements. 9 -24

Asset Impairment Losses Cedar Fair recorded a write-down of $25, 000 on equipment. 1 Analyze Assets Equipment -25, 000 2 Liabilities + Stockholders’ Equity Loss on Impairment (+E) -25, 000 Record Loss on Impairment Equipment 9 -25 = 25, 000, 000

Learning Objective 9 -5 Analyze the disposal of longlived tangible assets. 9 -26

Disposal of Tangible Assets Update depreciation to date of disposal. Record the disposal. dr Cash (+A) dr Accumulated Depreciation (-x. A) cr Equipment (-A) cr Gain on Disposal (+R, +SE) Gain if cash received is greater than asset’s book value 9 -27 Book value

Disposal of Tangible Assets Update depreciation to date of disposal. Record the disposal. dr Cash (+A) dr Loss on Disposal (+E, -SE) dr Accumulated Depreciation (-x. A) cr Equipment (-A) Loss if cash received is less than asset’s book value 9 -28 Book value

Disposal of Tangible Assets Cedar Fair sold one of its junior roller coasters for $50, 000 cash at the end of its 6 th year of use. The equipment originally cost $100, 000, and was depreciated using the straight-line method with zero residual value and a useful life of 10 years. The amount of depreciation per year is: a. b. c. d. 9 -29 $0. $5, 000. $10, 000. $20, 000. Annual Depreciation: ($100, 000 - $0) ÷ 10 Years = $10, 000 per year

Disposal of Tangible Assets Cedar Fair sold one of its junior roller coasters for $50, 000 cash at the end of its 6 th year of use. The equipment originally cost $100, 000, and was. Accumulated depreciated using the straight-line method Depreciation = with zero residual value and a useful life of 10 years. (6 yrs. × $10, 000) = $60, 000 The equipment’s value at date BV = Cost book - Accumulated Depreciation sale -is: BV = of $100, 000 $60, 000 = $40, 000 a. a. b. b. c. c. d. d. 9 -30 $40, 000. $30, 000. $17, 000. $16, 500.

Disposal of Tangible Assets Cedar Fair sold one of its junior roller coasters for $50, 000 cash at the end of its 6 th year of use. The equipment originally cost $100, 000, and was depreciated using the straight-line method with zero residual value and a useful life of 10 years. The equipment’s sale resulted in: a. b. c. d. 9 -31 a gain of $10, 000. a loss of $30, 000. a loss of $10, 000. a gain of $50, 000. Gain = Cash Received - Book Value Gain = $50, 000 - $40, 000 = $10, 000

Disposal of Tangible Assets Analyze and prepare the journal entry to record Cedar Fair’s sale of the equipment. 1 Analyze Assets = Liabilities Equipment -100, 000 Accumulated Depreciation (-x. A) +60, 000 Cash +50, 000 2 Stockholders’ Equity Gain on Disposal (+R) +10, 000 Record Cash Accumulated Deprecation (-x. A) Equipment Gain on Disposal 9 -32 + 50, 000 60, 000 10, 000

Learning Objective 9 -6 Analyze the acquisition, use, and disposal of long-lived intangible assets. 9 -33

Intangible Assets Often provide exclusive rights or privileges. Noncurrent assets without physical substance. Intangible Assets Useful life is often difficult to determine. 9 -34 Usually acquired for operational use.

Intangible Assets Record at current cash equivalent cost, including purchase price, legal fees, and filing fees. Amortize intangibles with limited lives over the shorter of their economic lives or legal lives using the straight -line method. 9 -35

Trademarks and Copyrights A trademark is a symbol, design, or logo associated with a business. Internally developed trademarks have no recorded asset cost. Purchased trademarks are recorded at cost. A copyright is an exclusive right granted by the federal government to protect artistic or intellectual properties. Legal life is life of creator plus 70 years. 9 -36 Amortize cost over the period benefited.

Patents and Licensing Rights A patent is an exclusive right granted by the federal government to sell or manufacture an invention. Cost is purchase price plus legal cost to defend. Amortize cost over the shorter of useful life or 20 years. Licensing rights grant limited permission to use a product or service according to specific terms and conditions. You may be using computer software that is made available to you through a campus licensing agreement. 9 -37

Technology Assets Technology assets include software and Web development work. Usually used up over a relatively short time (3 – 7 years) 9 -38

Franchises A franchise provides legally protected rights to sell products or provide services purchased by a franchisee from the franchisor. 9 -39

Goodwill Purchase Price > Fair Market Value of Net Assets Acquired 9 -40 Occurs when one company buys another company. Only purchased goodwill is an intangible asset. Is not amortized. Is impairment tested and may be written down.

Amortization of Limited Life Intangible Asset Assume Cedar Fair purchased a patent for an uphill water-coaster for $800, 000 and intends to use it for 20 years. Each year, the company would record $40, 000 in Amortization Expense ($800, 000 ÷ 20 years). 1 Analyze Assets = Liabilities Accumulated Amortization (+x. A) -40, 000 2 Stockholders’ Equity Amortization Expense (+E) -40, 000 Record Amortization Expense Accumulated Amortization (+x. A) 9 -41 + 40, 000

Summary of Accounting Rules for Long-Lived Assets 9 -42

Learning Objective 9 -7 Interpret the fixed asset turnover ratio. 9 -43

Turnover Analysis Fixed = Asset Turnover Net Sales Revenue Average Net Fixed Assets This ratio measures the sales dollars generated by each dollar invested in fixed assets. For the year 2013, Cedar Fair had $1, 135 of revenue. End-of-year fixed assets were $1, 500 and beginning-of-year fixed assets were $1, 540. (All numbers in millions. ) 9 -44

Turnover Analysis 9 -45

Learning Objective 9 -8 Describe factors to consider when comparing companies’ long-lived assets. 9 -46

Impact of Depreciation Differences Accelerated depreciation, in the early years of an asset’s useful life, results in higher depreciation expense, lower net income, and lower book value than would result using straight-line depreciation. Selling an asset with a low book value, resulting from accelerated depreciation, might result in a gain. Selling the same asset with a higher book value, resulting from straight-line depreciation, might result in a loss. 9 -47

Supplement 9 A Natural Resources Copyright © 2016 by Mc. Graw-Hill Education

Learning Objective 9 -S 1 Analyze and report depletion of natural resources 9 -49

Natural Resources Depletion is the process of allocating a natural resource’s cost over the period of its extraction. Depletion is similar in concept to depreciation. Depletion that is computed for a period is first added to inventory and then expensed when the inventory is sold. Total depletion cost 9 -50 Inventory for sale Cost of goods sold Unsold Inventory

Supplement 9 B Changes in Depreciation Copyright © 2016 by Mc. Graw-Hill Education

Learning Objective 9 -S 2 Calculate changes in depreciation arising from changes in estimates or capitalized cost. 9 -52

Changes in Depreciation Estimates Predicted residual value Predicted useful life So depreciation is an estimate Over the life of an asset, new information may come to light that indicates the original estimates need to be revised. 9 -53

Changes in Depreciation Estimates Cedar Fair purchased equipment that cost $60, 000 with an estimated useful life of 20 years and an estimated salvage value of $3, 000. Shortly after the start of year 5, Cedar Fair changed the initial estimated useful life to 25 years and lowered the estimated salvage value to $2, 400, 000. Calculate depreciation expense for year 5 and thereafter using the straight-line method. 9 -54

Changes in Depreciation Estimates When our estimates change, the new depreciation is: Book value at date of change – Residual value at date of change Remaining useful life at date of change 9 -55

Chapter 9 Solved Exercises M 9 -4, M 9 -5, M 9 -6, E

M 9 -4 Computing Book Value (Straight-Line Depreciation) A machine that cost $400, 000 has an estimated residual value of $40, 000 and an estimated useful life of four years. The company uses straight-line depreciation. Calculate its book value at the end of year 3. ($400, 000 - $40, 000) × 1 4 = $90, 000 per year Depreciation Accumulated Undepreciated Expense Depreciation Balance (debit) (credit balance) (book value) Year $ 1 9 -57 $ 90, 000 $ 400, 000 90, 000 310, 000 2 90, 000 180, 000 220, 000 3 90, 000 270, 000 130, 000

M 9 -5 Computing Book Value (Units-of-Production Depreciation) A machine that cost $400, 000 has an estimated residual value of $40, 000 and an estimated useful life of 20, 000 machine hours. The company uses units-ofproduction depreciation and ran the machine 3, 000 hours in year 1, 8, 000 hours in year 2, and 6, 000 hours in year 3. Calculate its book value at the end of year 3. 1 st Year Depreciation ($400, 000 - $40, 000) × 2 nd Year Depreciation ($400, 000 - $40, 000) × 3 rd Year Depreciation ($400, 000 - $40, 000) × 9 -58 3, 000 20, 000 = $54, 000 8, 000 20, 000 = $144, 000 6, 000 20, 000 = $108, 000

M 9 -5 Computing Book Value (Units-of-Production Depreciation) A machine that cost $400, 000 has an estimated residual value of $40, 000 and an estimated useful life of 20, 000 machine hours. The company uses units-ofproduction depreciation and ran the machine 3, 000 hours in year 1, 8, 000 hours in year 2, and 6, 000 hours in year 3. Calculate its book value at the end of year 3. Year Depreciation Accumulated Undepreciated Expense Depreciation Balance (debit) (credit balance) (book value) Hours $ 9 -59 1 3, 000 2 8, 000 3 6, 000 $ 54, 000 $ 400, 000 54, 000 346, 000 144, 000 198, 000 202, 000 108, 000 306, 000 94, 000

M 9 -6 Computing Book Value (Double-Declining-Balance Depreciation) A machine that cost $400, 000 has an estimated residual value of $40, 000 and an estimated useful life of four years. The company uses double-declining-balance depreciation. Calculate its book value at the end of year 3. Round to the nearest dollar. 1 st Year Depreciation ($400, 000 - $0) × 2 nd Year Depreciation ($400, 000 - $200, 000) × 3 rd Year Depreciation 2 4 = $100, 000 2 ($400, 000 – ($200, 000 + $100, 000) × 4 9 -60 $200, 000 = $50, 000

M 9 -6 Computing Book Value (Double-Declining-Balance Depreciation) A machine that cost $400, 000 has an estimated residual value of $40, 000 and an estimated useful life of four years. The company uses double-declining-balance depreciation. Calculate its book value at the end of year 3. Round to the nearest dollar. Depreciation Accumulated Undepreciated Expense Depreciation Balance (debit) (credit balance) (book value) Year $ 1 9 -61 $ 200, 000 $ 400, 000 200, 000 2 100, 000 300, 000 100, 000 3 50, 000 350, 000

E 9 -6 Computing Depreciation under Alternative Methods Solar Innovations Corporation bought a machine at the beginning of the year at a cost of $22, 000. The estimated useful life was five years, and the residual value was $2, 000. Assume that the estimated productive life of the machine is 10, 000 units. Expected annual production was: year 1, 2, 000 units; year 2, 3, 000 units; year 3, 2, 000 units; year 4, 2, 000 units; and year 5, 1, 000 units. Required: 1. Complete a depreciation schedule for each of the alternative methods. a. Straight-line. b. Units-of-production. c. Double-declining-balance. 1 a. Straight-line Year 0 1 2 3 4 5 9 -62 Depreciation Expense (debit) Accumulated Depreciation (credit balance) Book Value $ ($22, 000 - $2, 000) ($22, 000 - $2, 000) x x x 1/5 1/5 1/5 = = = $4, 000 $4, 000 $ 4, 000 8, 000 12, 000 16, 000 20, 000 22, 000 18, 000 14, 000 10, 000 6, 000 2, 000

E 9 -6 Computing Depreciation under Alternative Methods 1 b. Units-of-production Depreciation Expense (debit) Year 0 1 2 3 4 5 Accumulated Depreciation (credit balance) Book Value $ ($22, 000 - $2, 000) ($22, 000 - $2, 000) x x x 2, 000/10, 000 3, 000/10, 000 2, 000/10, 000 1, 000/10, 000 = = = $4, 000 $6, 000 $4, 000 $2, 000 $ 4, 000 10, 000 14, 000 18, 000 20, 000 22, 000 18, 000 12, 000 8, 000 4, 000 2, 000 1 c. Double-declining-balance Year 0 1 2 3 4 5 9 -63 Depreciation Expense (debit) Accumulated Depreciation (credit balance) Book Value $ ($22, 000 - $0) x 2/5 = $8, 800 ($22, 000 - $8, 800) x 2/5 = $5, 280 ($22, 000 - $14, 080) x 2/5 = $3, 168 ($22, 000 - $17, 248) x 2/5 = $1, 901 $2, 851 - $2, 000 = $851 $ 8, 800 14, 080 17, 248 19, 149 20, 000 22, 000 13, 200 7, 920 4, 752 2, 851 2, 000

E 9 -6 Computing Depreciation under Alternative Methods Required: 2. Which method will result in the highest net income in year 2? Does this higher net income mean the machine was used more efficiently under this depreciation method? § The method that will result in the highest net income is the one that reports the lowest depreciation expense. ü Straight-line depreciation method yields the lowest depreciation expense in year 2 ($4, 000), and therefore results in the highest net income in year 2. § This higher net income does not mean the equipment was used more efficiently. It only means a smaller amount of the asset’s cost was allocated to depreciation expense in year 2 using straight-line depreciation. 9 -64

E 9 -7 Computing Depreciation under Alternative Methods Sonic Corporation purchased and installed electronic payment equipment at its drive-in restaurants in San Marcos, TX, at a cost of $27, 000. The equipment has an estimated residual value of $1, 500. The equipment is expected to process 255, 000 payments over its three-year useful life. Per year, expected payment transactions are 61, 200, year 1; 140, 250, year 2; and 53, 550, year 3. Required: Complete a depreciation schedule for each of the alternative methods. 1. Straight-line. 2. Units-of-production. 3. Double-declining-balance. 1. Straight-line ($27, 000 - $1, 500) × 9 -65 1 3 = $8, 500 per year

E 9 -7 Computing Depreciation under Alternative Methods 1. Straight-line Year Depreciation Expense (debit) Accumulated Depreciation (credit balance) Undepreciated Balance (book value) $ 1 $ $ 8, 500 18, 500 2 8, 500 17, 000 10, 000 3 8, 500 25, 500 1, 500 $ 9 -66 8, 500 27, 000 25, 500

E 9 -7 Computing Depreciation under Alternative Methods 2. Units-of-production 1 st Year Depreciation ($27, 000 - $1, 500) × 61, 200 255, 000 = $6, 120 × 140, 250 255, 000 = $14, 025 × 53, 550 255, 000 = $5, 355 2 nd Year Depreciation ($27, 000 - $1, 500) 3 rd Year Depreciation ($27, 000 - $1, 500) 9 -67

E 9 -7 Computing Depreciation under Alternative Methods 2. Units-of-production Year Depreciation Expense (Debit) Accumulated Depreciation (credit balance) Undepreciated Balance (book value) $ 1 6, 120 2 3 6, 120 20, 880 14, 025 20, 145 6, 855 5, 355 25, 500 1, 500 25, 500 9 -68 27, 000 $

E 9 -7 Computing Depreciation under Alternative Methods 3. Double-declining-balance 1 st Year Depreciation ($27, 000 - $0) × 2 nd Year Depreciation ($27, 000 - $18, 000) × 3 rd Year Depreciation [$27, 000 – ($18, 000 + $6, 000)] × 9 -69 2 3 = $18, 000 2 3 = $6, 000 2 3 = $2, 000

E 9 -7 Computing Depreciation under Alternative Methods 3. Double-declining-balance Year 1 2 3 Depreciation Expense (debit) $ $ 18, 000 6, 000 1, 500 2, 000 25, 500 26, 000 Undepreciated Balance (book value) $ 27, 000 9, 000 18, 000 3, 000 24, 000 1, 500 1, 000 25, 500 26, 000 Accumulated Depreciation Balance $ Below residual value Depreciation expense is limited to the amount that reduces book value to the estimated residual value. 9 -70

E 9 -9 Demonstrating the Effect of Book Value on Reporting an Asset Disposal Fed. Ex Corporation is the world’s leading express-distribution company. In addition to the world’s largest fleet of all-cargo aircraft, the company has more than 54, 000 ground vehicles that pick up and deliver packages. Assume that Fed. Ex sold a delivery truck for $16, 000. Fed. Ex had originally purchased the truck for $28, 000, and had recorded depreciation for three years. Required: 1. Calculate the amount of gain or loss on disposal, assuming that Accumulated Depreciation was: (a) $12, 000, (b) $10, 000, and (c) $15, 000. Case a b c $ 16, 000 Cost 28, 000 Less: Accumulated Depreciation 12, 000 10, 000 15, 000 Book Value 16, 000 18, 000 13, 000 - $ (2, 000) Sale price Gain (Loss) 9 -71 $ $ 3, 000

E 9 -9 Demonstrating the Effect of Book Value on Reporting an Asset Disposal Required: 2. Using the following structure, indicate the effects (accounts, amounts, and + or -) for the disposal of the truck in each of the three preceding situations. Assets = Liabilities + Stockholders’ Equity Case (a) Book Value = $16, 000 Assets = Cash + 16, 000 Equipment - 28, 000 Accumulated Depreciation (-x. A)+ 12, 000 9 -72 Liabilities + Stockholders’ Equity

E 9 -9 Demonstrating the Effect of Book Value on Reporting an Asset Disposal Case (b) Book Value = $18, 000 Assets = Cash + 16, 000 Equipment - 28, 000 Liabilities + Stockholders’ Equity Loss of Disposal (+E)- 2, 000 Accumulated Depreciation (-x. A) + 10, 000 Case (c) Book Value = $13, 000 Assets = Cash + 16, 000 Equipment - 28, 000 Accumulated Depreciation (-x. A) + 15, 000 9 -73 Liabilities + Stockholders’ Equity Gain on Disposal (+R) + 3, 000

E 9 -9 Demonstrating the Effect of Book Value on Reporting an Asset Disposal Required: 3. Based on the three preceding situations, explain how the amount of depreciation recorded up to the time of disposal affects the amount of gain or loss on disposal. The gain or loss reported on disposal is directly affected by the book value of the asset, which itself is affected by the amount of depreciation recorded before the disposal. With the same sale price of $16, 000 in each case. . . § A larger amount of depreciation recorded before disposal results in lower book value and a gain on disposal (case 1 c). § A smaller amount depreciation recorded before disposal results in higher book value and a loss on disposal (case 1 b). 9 -74

E 9 -9 Demonstrating the Effect of Book Value on Reporting an Asset Disposal Required: 4. Prepare the journal entry to record the disposal of the truck for each situation in requirement 1. Case (a) Book value = $16, 000 Cash Accumulated Depreciation-Equipment(-x. A) Equipment 16, 000 12, 000 28, 000 Case (b) Book value = $18, 000 Cash Accumulated Depreciation -Equipment(-x. A) Loss on Disposal Equipment 9 -75 16, 000 10, 000 28, 000

E 9 -9 Demonstrating the Effect of Book Value on Reporting an Asset Disposal Required: 4. Prepare the journal entry to record the disposal of the truck for each situation in requirement 1. Case (c) Book value = $13, 000 Cash Accumulated Depreciation-Equipment (-x. A) Gain on Disposal Equipment 9 -76 16, 000 15, 000 3, 000 28, 000

End of Chapter 9 9 -77