Copyright 2012 Pearson Education Inc Publishing as Prentice

Plant Assets, Natural Resources & Intangibles Chapter 7 Copyright © 2012 Pearson Education Inc.

Plant Asset Terminology Asset Account (Balance Sheet) Related Expense Account (Income Statement) Plant assets Land Buildings, Machinery & Equipment Furniture & Fixtures Land Improvements Natural Resources Intangibles Copyright © 2012 Pearson Education Inc. Publishing as Prentice Hall. 3

Learning Objective 1 Measure and account for the cost of plant assets Copyright ©

Measuring the Cost of a Plant Asset Sum of all costs incurred to bring

Land • Purchase price • Commissions • Survey & legal fees, • Back property

Buildings • Constructed ▫ Architectural fees and contractors’ charges, ▫ Materials, labor, and overhead ▫ Interest on funds borrowed • Purchased ▫ ▫ Purchase price, Broker’s commission, Taxes paid Costs to repair and renovate Copyright © 2012 Pearson Education Inc. Publishing as Prentice Hall. 7

Equipment • • • Purchase price Transportation, Insurance in transit Sales tax Installation and

Land Improvements Leasehold Improvements • • • Improvements to lease property • Depreciated or amortized over lease term Parking lots Driveways Signs Fences Sprinkler systems Copyright © 2012 Pearson Education Inc. Publishing as Prentice Hall. 9

Lump-Sum (Basket) Purchases • Several assets purchased in a group at one price • Total cost is allocated based on their market values Asset Market value Total market value Land $100, 000 $500, 000 Building $400, 000 $500, 000 % of total market value Total cost Cost of each asset 20% $450, 000 $90, 000 80% $450, 000 $360, 000 = = 100% Copyright © 2012 Pearson Education Inc. Publishing as Prentice Hall. $450, 000 10

Learning Objective 2 Distinguish a capital expenditure from an immediate expense Copyright © 2012

CAPITAL EXPENDITURES • Increase capacity or extend useful life • Cost is added to an asset account EXPENSES • Do not extend capacity or useful life • Maintain or restore working order • Cost is recorded as an expense Distinction between the two requires judgment Copyright © 2012 Pearson Education Inc. Publishing as Prentice Hall. 12

Learning Objective Three Measure and record depreciation on plan assets Copyright © 2012 Pearson

Depreciation • Allocation of plant asset’s cost to expense over its life • Supports matching principle • Causes: ▫ Physical wear and tear ▫ Obsolescence • Land is NOT depreciated ▫ Unlimited useful life Copyright © 2012 Pearson Education Inc. Publishing as Prentice Hall. 14

Depreciation is NOT: Valuation process A fund to replace assets Copyright © 2012 Pearson

Amounts Needed for Depreciation ? ? ? Copyright © 2012 Pearson Education Inc. Publishing

Depreciation Methods Straight-line Units-of-production Double-declining-balance Copyright © 2012 Pearson Education Inc. Publishing as Prentice

Straight-Line (SL) Cost – Residual value Useful life, in years Results in equal amount

Accumulated depreciation increases Book value decreases Asset’s final book value = Residual value Copyright

Units-of-Production (UOP) Cost – Residual value Useful life in units Depreciation per unit Activity

Double-Declining-Balance (DDB) DDB rate Book value Straight-line rate x 2 (or 2/life in years) Cost minus accumulated depreciation Copyright © 2012 Pearson Education Inc. Publishing as Prentice Hall. 21

Residual Value: DDB Ignored until final year Final year depreciation Book value at the

DDB differences • First-year depreciation is based on asset’s full cost • Final year depreciation is a “plug” amount needed to reduce book value to residual value Copyright © 2012 Pearson Education Inc. Publishing as Prentice Hall. 23

Comparing Depreciation Methods Straight-line • Best for assets that generate revenue evenly • Best meets matching principle Units-ofproduction • Best for assets that wear out because of use Doubledecliningbalance • Best for assets that generate revenue early in useful life Copyright © 2012 Pearson Education Inc. Publishing as Prentice Hall. 24

Copyright © 2012 Pearson Education Inc. Publishing as Prentice Hall. 25

Depreciation Methods Used Units-of-production Other Accelerated 4% 1% 7% Straight-line 88% Copyright © 2012

Exercise 7 -19 A Straight-line Cost – Residual value Useful life, in years $

Exercise 7 -19 A Cost – Residual value Useful life in units Units-of-production Depreciation

Exercise 7 -19 A Depreciation per unit Units-of-production Activity for period (units, miles) Miles Depreciation expense 13, 500 12, 000 3, 500 6, 000 Copyright © 2012 Pearson Education Inc. Publishing as Prentice Hall. 29

Exercise 7 -19 A Double-declining-balance DDB rate Year Book value Depr. Exp. 2/Life in

Plant Asset Issues Long lives Income taxes affected by depreciation Gains and losses incurred when sold Future impact on adoption of International Standards Copyright © 2012 Pearson Education Inc. Publishing as Prentice Hall. 31

Depreciation for Tax Purposes Accelerated deprecation provides fastest tax deductions Tax deductions decrease tax payments Tax savings can be reinvested in business Copyright © 2012 Pearson Education Inc. Publishing as Prentice Hall. 32

Partial Year Depreciation Annual depreciation Months from date of purchase to end of year

Changing Useful Life Remaining depreciable book value (New) Estimated remaining useful life Copyright ©

Learning Objective Four Analyze the effect of a plant asset disposal Copyright © 2012

Disposal of Plant assets • Bring depreciation up-to-date to: ▫ Measure asset’s final book value ▫ Record expense up to date of disposal • Remove asset and related accumulated depreciation account from books Copyright © 2012 Pearson Education Inc. Publishing as Prentice Hall. 36

Disposing of Asset for No Proceeds JOURNAL Date Accounts and explanation Debit Credit Accumulated depreciation Equipment Disposed of fully depreciated asset Copyright © 2012 Pearson Education Inc. Publishing as Prentice Hall. 37

Selling a Plant Asset If cash received is greater than book value ? If

Exercise 7 -22 A 2/5 -year life = 40% DDB Rate Year Book value Depr. Exp. Accum. Depr. Book value 2012 2013 $5, 220 x 40% x 9/12 Cash received: < Book value: Copyright © 2012 Pearson Education Inc. Publishing as Prentice Hall. Loss = 39

Exercise 7 -22 A JOURNAL Date Accounts and explanation Debit Credit Aug 31 Copyright

Exchanging Plant Assets • Old assets traded in for new assets ▫ Nonmonetary exchange • Cost of plant asset received is equal the fair values of assets given up ▫ Old asset and any cash paid • Difference between fair value of old asset and its book value is a gain or loss Copyright © 2012 Pearson Education Inc. Publishing as Prentice Hall. 41

Learning Objective Five Apply GAAP for natural resources and intangible assets Copyright © 2012

Natural Resources • Include iron ore, oil and timber • Assets are physically used – depletion ▫ Distinct from depreciation ▫ Computed like units-of-production • If all of extracted resource is sold ▫ Amount depleted is recorded as an expense • If portion of extracted resource is not immediately sold ▫ Amount becomes inventory Copyright © 2012 Pearson Education Inc. Publishing as Prentice Hall. 43

Accounting for Depletion JOURNAL Accounts and explanation Debit Credit Oil reserve Cash Oil inventory Oil reserve Cost of oil sold Oil inventory Copyright © 2012 Pearson Education Inc. Publishing as Prentice Hall. 44

Intangible Assets • No physical form ▫ Carry special rights ▫ Include patents, copyrights and franchises • Two categories ▫ Finite lives Amortization recorded Straight-line method Intangible asset reduced directly ▫ Indefinite lives Tested for loss in value (impairment) Copyright © 2012 Pearson Education Inc. Publishing as Prentice Hall. 45

Accounting for Specific Intangibles Patents Copyrights Franchises & licenses Trademarks and trade names Goodwill

Patents • Granted by federal government • Give holder exclusive right to produce and

Copyrights • Granted by the federal government • Give holder exclusive rights to reproduce and sell a book, musical composition, film or other work of art • Extend 70 years after creator’s life ▫ Useful life is usually very short © Copyright © 2012 Pearson Education Inc. Publishing as Prentice Hall. 48

Trademarks and Trade Names • Distinctive identification of a product or service ▫ Also include advertising slogans • Useful life may be set by contract ▫ Or indefinite life • Indicated by TM or ® Copyright © 2012 Pearson Education Inc. Publishing as Prentice Hall. 49

Franchises and Licenses • Granted by private business or government • Give purchase right to sell a product or service with specified conditions • Include restaurant chains and sports organizations • Have indefinite life Copyright © 2012 Pearson Education Inc. Publishing as Prentice Hall. 50

Goodwill • Only recorded when an entire company is purchased • Defined as the excess of the purchase price of the company over the market value of its net assets • Represents earning power of company purchased • Not amortized Copyright © 2012 Pearson Education Inc. Publishing as Prentice Hall. 51

Learning Objective Six Explain the effect of an asset impairment on the financial statements

Asset Impairment • Both tangible and intangible asset musts be test yearly for impairment • Expected future cash flows less than asset’s book value • Carrying value adjusted to fair value Copyright © 2012 Pearson Education Inc. Publishing as Prentice Hall. 53

Impairment Steps 1. Net book value > Estimated future cash flows If yes, asset is impaired and proceed to step 2 2. Net book value Fair value Copyright © 2012 Pearson Education Inc. Publishing as Prentice Hall. Impairment loss 54

Recording Impairment Loss JOURNAL Date Accounts and explanation Debit Credit Impairment loss on long-term

Learning Objective Seven Analyze rate of return on assets Copyright © 2012 Pearson Education

Return on Assets (ROA) ? ? (Beginning total assets + Ending total assets)/2 Copyright

Du. Pont Analysis Net income Net profit margin Net sales Total asset turnover Average

ROA using Du. Pont Analysis ? ? Return on assets Copyright © 2012 Pearson

Learning Objective Eight Analyze the cash flow impact of long-lived asset transactions Copyright ©

Plant Asset Transactions on the Cash Flow Statement Item Depreciation Section Operating Description Added to net income as a reconciling item Sales of plant assets Investing Cash proceeds from sales of plant assets inflow Purchase of plant assets Investing Cash purchases outflow Copyright © 2012 Pearson Education Inc. Publishing as Prentice Hall. 61