Mc GrawHillIrwin Copyright 2011 by The Mc GrawHill

Mc. Graw-Hill/Irwin Copyright © 2011 by The Mc. Graw-Hill Companies, Inc. All rights reserved.

Chapter 9 Reporting and Interpreting Long-Lived Tangible and Intangible Assets Power. Point Authors: Susan Coomer Galbreath, Ph. D. , CPA Charles W. Caldwell, D. B. A. , CMA Jon A. Booker, Ph. D. , CPA, CIA Fred Phillips, Ph. D. , CA

Learning Objective 1 Define, classify, and explain the nature of long-lived assets. 9 -3

Definition and Classification Actively Used in Operations l l l 9 -4 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 2 Apply the cost principle to the acquisition of long-lived assets. 9 -5

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 -6

Acquisition of Tangible Assets l Purchase cost Legal fees Surveying fees Broker’s commissions l Purchase/construction cost l Legal fees l Appraisal fees l Architectural fees l Land l l Buildings 9 -7

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 charged to the building and land accounts? 9 -8

Cash Purchase 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 paid cash for the new ride. 1 Analyze 2 Record 9 -9

Credit Purchase Instead of paying cash, assume that Cedar Fair issued a note for the new ride, but paid cash for the transportation and installation of the ride. Prepare the journal entry for the acquisition. 1 Analyze 2 Record 9 -10

Maintenance Costs Incurred during Use 9 -11

Depreciation Expense Depreciation is a cost allocation process that matches costs of operational assets with periods benefited by their use. Acquisition Cost Allocaton Balance Sheet 9 -12 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 2 Record Depreciation calculations require three amounts for each asset: Acquisition cost. Estimated useful life. Estimated residual value. 9 -13

Depreciation Expense 2008 Depreciation Includes $130 for 2008 Book value 2008 9 -14

Learning Objective 3 Apply various depreciation methods as economic benefits are used up over time. 9 -15

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-Cart Ride for $62, 500 cash. The ride has an estimated useful life of 3 years and an estimated residual value of $2, 500. 9 -16

Straight-Line Method ($62, 500 - $2, 500) × 9 -17 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 -18 30, 000 100, 000 = $18, 000

Units-of-Production Method 9 -19

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 -20

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

Summary of Depreciation Methods 9 -23

Tax Depreciation For tax purposes, most corporations use the Modified Accelerated Cost Recovery System (MACRS). MACRS depreciation provides for rapid write-off of an asset’s cost in order to stimulate new investment. 9 -24

Learning Objective 4 Explain the effect of asset impairment on the financial statements. 9 -25

Asset Impairment Losses Impairment is the loss of a significant portion of the utility of an asset through. . . § Casualty. § Obsolescence. § Lack of demand for the asset’s services. A loss should be recognized when an asset suffers a permanent impairment. Cedar Fair recorded a write-down of $3, 200, 000 on equipment. 1 Analyze 2 Record 9 -26

Learning Objective 5 Analyze the disposal of longlived tangible assets. 9 -27

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 -28 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 -29 Book value

Disposal of Tangible Assets Cedar Fair sold a hotel for $3, 000 cash at the end of its 16 th year of use. The hotel originally cost $20, 000, and was depreciated using the straight-line method with zero residual value and a useful life of 20 years. The amount of depreciation per year is: a. b. c. d. 9 -30 $0. $500, 000. $1, 000. $2, 000. Annual Depreciation: ($20, 000 - $0) ÷ 20 Years = $1, 000 per year

Disposal of Tangible Assets Cedar Fair sold a hotel for $3, 000 cash at the end of its 16 th year of use. The hotel originally cost $20, 000, and was depreciated. Accumulated using the straight-line method Depreciation = with zero residual value and a useful life of 20 years. (16 yrs. × $1, 000) = $16, 000 The equipment’s value at date BV = Cost -book Accumulated Depreciation of sale is: - $16, 000 BV = $20, 000 = $4, 000 a. b. c. d. 9 -31 $4, 000. $3, 000. $17, 000. $16, 500, 000.

Disposal of Tangible Assets Cedar Fair sold a hotel for $3, 000 cash at the end of its 16 th year of use. The hotel originally cost $20, 000, and was depreciated using the straight-line method with zero residual value and a useful life of 20 years. The equipment’s sale resulted in: a. b. c. d. 9 -32 a loss of $1, 000. a gain of $3, 000. a gain of $1, 000. a loss of $5, 000. Loss = Cash Received - Book Value Loss = $3, 000 - $4, 000 = $1, 000

Disposal of Tangible Assets Analyze and prepare the journal entry to record Cedar Fair’s sale of the hotel. 1 Analyze 2 Record 9 -33

Learning Objective 6 Analyze the acquisition, use, and disposal of long-lived intangible assets. 9 -34

Intangible Assets Often provide exclusive rights or privileges. Noncurrent assets without physical substance. Intangible Assets Useful life is often difficult to determine. 9 -35 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 -36

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 -37 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 -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 2 9 -41 Record

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

Learning Objective 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 2008, Cedar Fair had $1, 000 of revenue. End-of-year fixed assets were $1, 800, 000 and beginning-of-year fixed assets were $1, 940, 000. (All numbers in millions. ) 9 -44

Turnover Analysis 9 -45 Fixed = Asset Turnover Net Sales Revenue Average Net Fixed Assets Fixed = Asset Turnover $1, 000 ($1, 800, 000 + $1, 940, 000) ÷ 2 = 0. 53

Learning Objective 8 Describe the 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

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 -49 Inventory for sale Cost of goods sold Unsold Inventory

Supplement 9 B Changes in Depreciation Estimates

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 -51

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. During year 5, Cedar Fair changed the 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 -52

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 -53

Chapter 9 Solved Exercises M 9 -4, M 9 -5, M 9 -6, E 9 -7, E 9 -11

M 9 -4 Computing Book Value (Straight-Line Depreciation) Calculate the book value of a two-year-old machine that cost $200, 000, has an estimated residual value of $40, 000, and has an estimated useful life of four years. The company uses straight-line depreciation. ($200, 000 - $40, 000) × 9 -55 1 4 = $40, 000 per year

M 9 -5 Computing Book Value (Units-of-Production Depreciation) Calculate the book value of a two-year-old machine that cost $200, 000, has an estimated residual value of $40, 000, and has an estimated useful life of 20, 000 machine hours. The company uses units-of-production depreciation and ran the machine 3, 000 hours in year 1 and 8, 000 hours in year 2. 1 st Year Depreciation ($200, 000 - $40, 000) × 2 nd Year Depreciation ($200, 000 - $40, 000) × 9 -56 3, 000 20, 000 = $24, 000 8, 000 20, 000 = $64, 000

M 9 -5 Computing Book Value (Units-of-Production Depreciation) Calculate the book value of a two-year-old machine that cost $200, 000, has an estimated residual value of $40, 000, and has an estimated useful life of 20, 000 machine hours. The company uses units-of-production depreciation and ran the machine 3, 000 hours in year 1 and 8, 000 hours in year 2. 9 -57

M 9 -6 Computing Book Value (Double-Declining-Balance Depreciation) Calculate the book value of a two-year-old machine that cost $200, 000, has an estimated residual value of $40, 000, and has an estimated useful life of four years. The company uses double-declining-balance depreciation. Round to the nearest dollar. 1 st Year Depreciation × 2 4 = $100, 000 ($200, 000 - $100, 000) × 2 4 = $50, 000 ($200, 000 - $0) 2 nd Year Depreciation 9 -58

M 9 -6 Computing Book Value (Double-Declining-Balance Depreciation) Calculate the book value of a two-year-old machine that cost $200, 000, has an estimated residual value of $40, 000, and has an estimated useful life of four years. The company uses double-declining-balance depreciation. Round to the nearest dollar. 9 -59

E 9 -6 Computing Depreciation under Alternative Methods Plastic. Works Corporation bought a machine at the beginning of the year at a cost of $12, 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, 3, 000 units; year 2, 3, 000 units; year 3, 2, 000 units; year 4, 1, 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 9 -60

E 9 -6 Computing Depreciation under Alternative Methods 1 b. Units-of-production 1 c. Double-declining-balance 9 -61

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 ($2, 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 -62

E 9 -7 Computing Depreciation under Alternative Methods Sonic Corporation purchased and installed electronic payment equipment at its drive-inn 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 -63 1 3 = $8, 500 per year

E 9 -7 Computing Depreciation under Alternative Methods 1. Straight-line 9 -64

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 -65

E 9 -7 Computing Depreciation under Alternative Methods 2. Units-of-production 9 -66

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 -67 2 3 = $18, 000 2 3 = $6, 000 2 3 = $2, 000

E 9 -7 Computing Depreciation under Alternative Methods 3. Double-declining-balance Below residual value Depreciation expense is limited to the amount that reduces book value to the estimated residual value. 9 -68

E 9 -11 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 53, 700 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. 9 -69

E 9 -11 Demonstrating the Effect of Book Value on Reporting an Asset Disposal Case (b) Book Value = $18, 000 Case (c) Book Value = $13, 000 9 -70

E 9 -11 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 Case (a) Book Value = $16, 000 9 -71 + Stockholders’ Equity

E 9 -11 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 -72

E 9 -11 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 Case (b) Book value = $18, 000 9 -73

E 9 -11 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 9 -74

End of Chapter 9