Financial Accounting LongTerm Assets Chapter 7 Spiceland Thomas

Financial Accounting Long-Term Assets Chapter 7 Spiceland | Thomas | Herrmann Copyright © 2014 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

7 -2 Learning Objectives • Identify the major types of property, plant, and equipment • Identify the major types of intangible assets • Describe the accounting treatment of expenditures after acquisition • Calculate depreciation of property, plant, and equipment • Calculate amortization of intangible assets • Account for the disposal of long-term assets Copyright © 2014 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

7 -3 Learning Objectives • Describe the links among return on assets, profit margin, and asset turnover • Identify impairment situations and describe the two-step impairment process Copyright © 2014 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

7 -4 Long-Term Assets • • • Tangible assets Intangible assets Land improvements Buildings Equipment Natural resources • • • Patents Trademarks Copyrights Franchises Goodwill Copyright © 2014 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

7 -5 Part A Acquisitions Copyright © 2014 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

7 -6 Learning Objective 1 Identify the Major Types of Property, Plant, and Equipment Copyright © 2014 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

7 -7 Property, Plant, and Equipment • Capitalize: recording an expenditure as an asset • Recorded at: Cost of asset + All expenditures necessary to get it ready for use Copyright © 2014 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

7 -8 Land Improvements • Land: includes land used for operations • Land improvements include: • Parking lots, sidewalks, driveways, landscaping, lighting systems, fences, sprinklers, etc. • Depreciation: the allocation of the cost of a tangible asset over its service life Copyright © 2014 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

7 -9 Buildings • Administrative offices, retail stores, manufacturing facilities, and storage warehouses Copyright © 2014 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

7 -10 Equipment • Machinery used in manufacturing, computers and other office equipment, vehicles, furniture, and fixtures • Recurring costs not part of the cost of equipment Copyright © 2014 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

7 -11 Basket Purchases • Purchase of more than one asset for one purchase price • Allocate total purchase price based on individual fair values Copyright © 2014 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

7 -12 Basket Purchases—Example Copyright © 2014 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

7 -13 Natural Resources • Oil, natural gas, timber, and salt • Physically use up, or deplete • Depletion: allocation of the cost of a natural resource over its service life • Identical to the activity-based method of recording depreciation Copyright © 2014 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

7 -14 Learning Objective 2 Identify the Major Types of Intangible Assets Copyright © 2014 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

7 -15 Intangible Assets • No physical substance • Can be very valuable • Acquired in two ways: • Purchase • Create internally Copyright © 2014 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

7 -16 Patents • Exclusive right to manufacture a product or to use a process • Granted for a period of 20 years • When purchased: • Capitalized for purchase price plus legal and filing fees • When internally developed: • Capitalized for legal and filing fees Copyright © 2014 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

7 -17 Copyrights • Exclusive right of protection given to the creator of a published work • Granted for the life of the creator plus 70 years • Legal action against anyone who attempts to infringe the copyright • Accounting is virtually identical to that of patents Copyright © 2014 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

7 -18 Trademarks • Word, slogan, or symbol that distinctively identifies a company, product, or service • Renewed for an indefinite number of 10 -year periods • Capitalized for legal, registration, and design fees • Advertising costs are recorded as advertising expense Copyright © 2014 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

7 -19 Franchises • Local outlets that pay for the exclusive right to use the franchisor’s name and to sell its products • Within a specified geographical area • May include other benefits • Capitalized for initial fee • Additional periodic payments usually expensed as incurred Copyright © 2014 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

7 -20 Goodwill • Represents the value of a company as a whole, over and above the value of its identifiable net assets • Recorded at: Purchase Price – Fair value of the net assets acquired Copyright © 2014 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Illustration 7. 6—Business Acquisition with Goodwill Copyright © 2014 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education. 7 -21

7 -22 Learning Objective 3 Describe the Accounting Treatment of Expenditures After Acquisition Copyright © 2014 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

7 -23 Expenditures After Acquisition • • Repairs and maintenance Additions Improvements Legal defense of intangible assets Capitalize If it increases future benefits Expense If it benefits only the current period Copyright © 2014 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Illustration 7. 7—Expenditures after Acquisition Copyright © 2014 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education. 7 -24

7 -25 Materiality • An item is said to be material if it is large enough to influence a decision • Immaterial: • Costs expensed under a certain dollar amount Copyright © 2014 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

7 -26 Part B Cost Allocation Copyright © 2014 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

7 -27 Learning Objective 4 Calculate Depreciation of Property, Plant, and Equipment Copyright © 2014 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

7 -28 Depreciation • The process of allocating to an expense the cost of an asset over its service life Copyright © 2014 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

7 -29 Recording Depreciation • A local Starbucks pays $1, 200 for equipment—say, an espresso machine. The machine is expected to have a useful life of four years Copyright © 2014 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

7 -30 Common Terms • Accumulated depreciation: contra asset account to record the total depreciation taken to date • Book value: Original Cost – Current Balance in Accumulated Depreciation • Service life: how long the company expects to receive benefits from the asset before disposing of it • Residual value: salvage value or the amount the company expects to receive from selling the asset at the end of its service life Copyright © 2014 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

7 -31 Depreciation Methods • Straight-line method • Declining-balance method • Activity-based method Copyright © 2014 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Calculating Depreciation Under Straight-line method Copyright © 2014 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education. 7 -32

Calculating Depreciation Under Declining-Balance Method Copyright © 2014 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education. 7 -33

Calculating Depreciation Under Activity-Based Method Copyright © 2014 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education. 7 -34

Illustration 7. 16 and 7. 17—Comparison of Depreciation Methods Copyright © 2014 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education. 7 -35

7 -36 Tax Depreciation • Accelerated methods reduce taxable income more in the earlier years of an asset’s life • Companies use: • Straight-line method for financial reporting • Accelerated method for tax reporting Copyright © 2014 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

7 -37 Learning Objective 5 Calculate Amortization of Intangible Assets Copyright © 2014 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

7 -38 Amortization of Intangible Assets • Allocating the cost of intangible assets to expense is called amortization Copyright © 2014 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

7 -39 Amortization Example Copyright © 2014 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Intangible Assets not Subject to Amortization • Intangible assets with indefinite useful lives • Subjected to impairment rules Copyright © 2014 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education. 7 -40

7 -41 Part C Asset Disposition: Sale, Retirement, or Exchange Copyright © 2014 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

7 -42 Learning Objective 6 Account for the disposal of long-term assets Copyright © 2014 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

7 -43 Three Methods of Asset Disposal of Long-Term Assets Sale Can result in either a gain or a loss Retirement Occurs when a longterm asset is no longer useful but cannot be sold Exchange Occurs when two companies trade assets Copyright © 2014 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Sale of Long-Term Assets— Gain Copyright © 2014 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education. 7 -44

Sale of Long-Term Assets— Loss Copyright © 2014 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education. 7 -45

Retirement of Long-Term Assets— Loss Copyright © 2014 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education. 7 -46

Exchange of Long-Term Assets— Gain Copyright © 2014 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education. 7 -47

7 -48 Learning Objective 7 Describe the Links Among Return on Assets, Profit Margin, and Asset Turnover Copyright © 2014 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

7 -49 Return on Assets • Indicates the amount of net income generated for each dollar invested in assets • Profit margin: indicates the earnings per dollar of sales • Asset turnover: measures the sales per dollar of assets invested Copyright © 2014 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

7 -50 Learning Objective 8 Identify Impairment Situations and Describe the Two -Step Impairment Process Copyright © 2014 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

7 -51 Asset Impairment • Impairment: occurs when the future cash flows (future benefits) generated for a long-term asset fall below its book value • Recording the loss Copyright © 2014 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Illustration 7. 32—Two-Step Impairment Process Copyright © 2014 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education. 7 -52

7 -53 End of Chapter 7 Copyright © 2014 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.