Transcript Libby Chapter 8 - University of Minnesota

Reporting and
Interpreting Property,
Plant, and Equipment;
Natural Resources;
and Intangibles
Chapter 8
Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
8-2
Understanding The Business
Costly excess
capacity reduces
profits.
Insufficient
capacity results
in lost sales.
How much
is enough?
8-3
Learning Objectives
Define, classify, and explain the nature of
long-lived productive assets and interpret
the fixed asset turnover ratio.
8-4
Classifying Long-Lived Assets
Actively Used in Operations
Expected to Benefit Future Periods
Tangible
Intangible
Physical
Substance
No Physical
Substance
8-5
Classifying Long-Lived Assets
Actively Used in Operations
Examples

Land

Assets subject to depreciation
 Buildings and equipment
 Furniture and fixtures

Natural resource
assets
Intangible
subject to depletion
Expected to Benefit Future Periods
Tangible
Physical
Substance

Physical
Mineral No
deposits
and timber
Substance
8-6
Classifying Long-Lived Assets
Actively Used in Operations
Examples

Value represented by rights
Expected
to Benefit Future Periods
that produce
benefits
Patents
Copyrights
Trademarks
Intangible
Tangible
Franchises
Goodwill
No Physical
Physical

Subject
to amortization
Substance
Substance
8-7
Fixed Asset Turnover
Fixed
=
Asset
Turnover
Net Sales Revenue
Average Net Fixed Assets
For the year 2003, Delta Airlines had $13,303 of
revenue. End-of-year fixed assets were $16,752
and beginning-of-year fixed assets were $16,524.
(All numbers in millions.)
This ratio measures a company’s
ability to generate sales given an
investment in fixed assets.
8-8
Fixed Asset Turnover
Fixed
=
Asset
Turnover
Net Sales Revenue
Average Net Fixed Assets
Fixed
=
Asset
Turnover
$13,303
($16,524 + $16,752) ÷ 2
= 0.80
2003 Fixed Asset Turnover Comparisons
Delta
Southwest
United
0.8
0.84
0.85
8-9
Learning Objectives
Apply the cost principle to measure the
acquisition and maintenance of property,
plant, and equipment.
8-10
Measuring and Recording Acquisition Cost
Acquisition cost includes the purchase price
and all expenditures needed to prepare the
asset for its intended use.
Acquisition cost does not include
financing charges and cash discounts.
8-11
Acquisition Cost – Buildings

Purchase price

Renovation and
repair costs

Legal and realty
fees

Title fees
8-12
Acquisition Cost – Equipment

Purchase price

Installation costs

Modification to building
necessary to install
equipment

Transportation costs
8-13
Acquisition Cost – Land






Purchase price
Real estate commissions
Title insurance premiums
Delinquent taxes
Surveying fees
Title search and transfer fees
Land is not depreciable.
8-14
Acquisition for Cash
On January 1, Delta Air Lines purchased
aircraft for $70,000,000 cash.
GENERAL JOURNAL
Date
Jan.
Description
1
Debit
Page 8
Credit
8-15
Acquisition for Cash
On January 1, Delta Air Lines purchased
aircraft for $70,000,000 cash.
GENERAL JOURNAL
Date
Jan.
Description
1 Flight equipment
Cash
Debit
Page 8
Credit
70,000,000
70,000,000
8-16
Acquisition for Debt
On January 14, Delta Air Lines purchased
aircraft for $1,000,000 cash and a
$69,000,000 note payable.
GENERAL JOURNAL
Date
Jan.
Description
14
Debit
Page 9
Credit
8-17
Acquisition for Debt
On January 14, Delta Air Lines purchased
aircraft for $1,000,000 cash and a
$69,000,000 note payable.
GENERAL JOURNAL
Date
Jan.
Description
14 Flight equipment
Cash
Note payable
Debit
Page 9
Credit
70,000,000
1,000,000
69,000,000
8-18
Acquisition for Noncash Consideration
Record at the current market value of
the consideration given, or the current
market value of the asset acquired,
whichever is more clearly evident.
8-19
Acquisition for Noncash Consideration
On July 7, Delta gave Boeing 6,000,000 shares of
$1.50 par value common stock with a market value of
$7 per share plus $28,000,000 in cash for aircraft.
GENERAL JOURNAL
Date
July
Description
7
Debit
Page 10
Credit
8-20
Acquisition for Noncash Consideration
On July 7, Delta gave Boeing 6,000,000 shares of
$1.50 par value common stock with a market value of
$7 per share plus $28,000,000 in cash for aircraft.
GENERAL JOURNAL
Date
July
Description
7 Flight equipment
Cash
Common stock
Additional paid-in capital
Debit
Page 10
Credit
70,000,000
28,000,000
9,000,000
33,000,000
8-21
Acquisition by Construction
Asset cost includes:
All materials and
labor traceable to
the construction.
A reasonable
amount of
overhead.
Interest on debt
incurred during
the construction.
8-22
Repairs, Maintenance, and Additions
Type of
Capital or
Expenditure Revenue
Identifying Characteristics
Ordinary
Revenue 1. Maintains normal operating condition
repairs and
2. Does not increase productivity
maintenance
3. Does not extend life beyond original
estimate
Extraordinary
repairs
Capital
1. Major overhauls or partial
replacements
2. Extends life beyond original estimate
Additions
Capital
1. Increases productivity
2. May extend useful life
3. Improvements or expansions
8-23
Capital and Revenue Expenditures
Financial Statement Effect
Treatment
Statement
Expense
Current Current
Income Taxes
Capital
Expenditure
Balance sheet
account debited
Deferred
Higher
Higher
Revenue Income statement Currently
Expenditure account debited recognized Lower
Lower
Many companies have policies expensing all
expenditures below a certain amount according to the
materiality constraint.
8-24
Learning Objectives
Apply various cost allocation methods as
assets are held and used over time.
8-25
Depreciation
Depreciation is a cost allocation process
that systematically and rationally matches
acquisition costs of operational assets
with periods benefited by their use.
Balance Sheet
Acquisition
Cost
(Unused)
Income Statement
Cost
Allocation
Expense
(Used)
8-26
Depreciation
Depreciation
Expense
Depreciation for
the current year
Accumulated
Depreciation
Total of depreciation
to date on an asset
Income
Statement
Balance
Sheet
8-27
Depreciation on Delta’s 2003 Balance Sheet
Property and Equipment:
Flight equipment
Less: Accumulated depreciation
$ 21,008
6,497
$ 14,511
Equipment under capial lease
Less: Accumulated amortization
463
353
110
Ground property and equipment
Less: Accumulated depreciation
4,477
2,408
2,069
Advance payments for equipment
Total property and equipment
62
$ 16,752
Book Values
Book value =
/ Market value
8-28
Depreciation Concepts
The calculation of depreciation requires
three amounts for each asset:
 Acquisition cost.
 Estimated useful life.
 Estimated residual value.
8-29
Alternative Depreciation Methods
 Straight-line
 Units-of-production
 Accelerated Method:
Declining balance
8-30
Straight-Line Method
Depreciation
Expense per Year
=
Cost - Residual Value
Life in Years
At the beginning of the year, Delta purchased
ground equipment for $62,500 cash. The
equipment has an estimated useful life of 3
years and an estimated residual value of
$2,500.
SL
8-31
Straight-Line Method
Depreciation
Expense per Year
=
Cost - Residual Value
Life in Years
Depreciation
Expense per Year
=
$62,500 - $2,500
3 years
Depreciation
Expense per Year
=
$20,000
SL
8-32
Straight-Line Method
Depreciation Accumulated
Expense
Depreciation
Year
(debit)
(credit)
1
2
3
$ 20,000
20,000
20,000
$ 60,000
$
$
20,000
20,000
20,000
60,000
Accumulated
Depreciation
Balance
$
20,000
40,000
60,000
Undepreciated
Balance
(book value)
$
62,500
42,500
22,500
2,500
Residual Value
SL
More companies use the straight-line
method of depreciation in their financial
reports than all other methods combined.
8-33
Units-of-Production Method
Step 1:
Depreciation =
Rate
Cost - Residual Value
Life in Units of Production
Step 2:
Number of
Depreciation
Depreciation
× Units Produced
=
Expense
Rate
for the Year
8-34
Units-of-Production Method
At the beginning of the year, Delta purchased
ground equipment for $62,500 cash. The
equipment has a 100,000 mile useful life and an
estimated residual value of $2,500.
If the equipment is used 30,000 miles in the first
year, what is the amount of depreciation expense?
8-35
Units-of-Production Method
Step 1:
Depreciation = $62,500 - $2,500 = $.60 per mile
100,000 miles
Rate
Step 2:
Depreciation
= $.60 per mile × 30,000 miles = $18,000
Expense
8-36
Units-of-Production Method
Year
Miles
1
2
3
30,000
50,000
20,000
100,000
Depreciation
Expense
Accumulated
Depreciation
Balance
$
$
18,000
18,000
Undepreciated
Balance
(book value)
$
62,500
44,500
8-37
Units-of-Production Method
Year
Miles
1
2
3
30,000
50,000
20,000
100,000
Depreciation
Expense
Accumulated
Depreciation
Balance
$
$
$
18,000
30,000
12,000
60,000
18,000
48,000
60,000
Undepreciated
Balance
(book value)
$
62,500
44,500
14,500
2,500
Residual Value
8-38
Accelerated Depreciation
Accelerated depreciation matches higher
depreciation expense with higher revenues
in the early years of an asset’s useful life when
the asset is more efficient.
Depreciation
Expense
Early Years
High
Later Years
Low
Repair
Expense
Low
High
8-39
Double-Declining-Balance Method
Declining balance rate of 2 is
double-declining-balance (DDB) rate.
Annual
Depreciation =
expense
Net
Book
Value
×
(
2
Useful Life in Years
Cost – Accumulated Depreciation
Annual computation ignores residual value.
)
8-40
Double-Declining-Balance Method
At the beginning of the year, Delta
purchased equipment for $62,500 cash.
The equipment has an estimated useful
life of 3 years and an estimated residual
value of $2,500.
Calculate the depreciation expense
for the first two years.
8-41
Double-Declining-Balance Method
Annual
Net
Depreciation = Book
expense
Value
×
(
2
Useful Life in Years
)
Year 1 Depreciation:
$62,500 ×
(
2
3 years
) = $41,667
Year 2 Depreciation:
($62,500 – $41,667) ×
(
2
3 years
) = $13,889
8-42
Double-Declining-Balance Method
Year
1
2
3
Depreciation
Expense
(debit)
Accumulated
Depreciation
Balance
$
$
$
41,667
13,889
4,629
60,185
41,667
55,556
60,185
Undepreciated
Balance
(book value)
$
62,500
20,833
6,944
2,315
Below residual value
($62,500 – $55,556) ×
(
2
3 years
) = $4,629
8-43
Double-Declining-Balance Method
Year
1
2
3
Depreciation
Expense
(debit)
Accumulated
Depreciation
Balance
$
$
$
41,667
13,889
4,444
60,000
41,667
55,556
60,000
Undepreciated
Balance
(book value)
$
62,500
20,833
6,944
2,500
Depreciation expense is limited to the amount that
reduces book value to the estimated residual value.
8-44
Depreciation and Federal Income Tax
For tax purposes, most corporations use the
Modified Accelerated Cost Recovery System
(MACRS).
MACRS depreciation provides for rapid writeoff of an asset’s cost in order to stimulate
new investment.
8-45
Depreciation Methods in Other Countries
Many countries, including Australia, Brazil,
England, and Mexico, use other methods
such as depreciation based
on the current fair value of assets.
8-46
Learning Objectives
Explain the effect of asset impairment
on financial statements.
8-47
Asset Impairment
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.
8-48
Learning Objectives
Analyze the disposal of property,
plant, and equipment.
8-49
Disposal of Property, Plant, and Equipment


Voluntary disposals:
 Sale
 Trade-in
 Retirement
Involuntary disposals:
 Fire
 Accident
8-50
Disposal of Property, Plant, and Equipment
 Update depreciation
to the date of disposal.
 Journalize disposal by:
Recording cash
received (debit)
or paid (credit).
Recording a
gain (credit)
or loss (debit).
Writing off accumulated
depreciation (debit).
Writing off the
asset cost (credit).
8-51
Disposal of Property, Plant, and Equipment
If Cash > BV, record a gain (credit).
If Cash < BV, record a loss (debit).
If Cash = BV, no gain or loss.
8-52
Disposal of Property, Plant, and Equipment
Delta Airlines sold flight equipment
for $5,000,000 cash at the end of its
17th year of use. The flight equipment
originally cost $20,000,000, and was
depreciated using the straight-line
method with zero residual value
and a useful life of 20 years.
Let’s answer the following questions.
8-53
Disposal of Property, Plant, and Equipment
The amount of depreciation expense
recorded at the end of the 17th year to
bring depreciation up to date is:
a.
b.
c.
d.
$0.
$1,000,000.
$2,000,000.
$4,000,000.
8-54
Disposal of Property, Plant, and Equipment
The amount of depreciation expense
recorded at the end of the 17th year to
bring depreciation up to date is:
a.
b.
c.
d.
$0.
$1,000,000.
$2,000,000.
$4,000,000.
Annual Depreciation:
($20,000,000 - $0) ÷ 20 Years.
= $1,000,000
8-55
Disposal of Property, Plant, and Equipment
After updating the depreciation,
the equipment’s book value at the
end of the 17th year is:
a.
b.
c.
d.
$3,000,000.
$16,000,000.
$17,000,000.
$4,000,000.
8-56
Disposal of Property, Plant, and Equipment
Accumulated Depreciation =
(17yrs. × the
$1,000,000)
= $17,000,000
After updating
depreciation,
the equipment’s
value at
the
BV = Cost book
- Accumulated
Depreciation
endBV
of=the
17th year
is:
$20,000,000
- $17,000,000
= $3,000,000
a.
b.
c.
d.
$3,000,000.
$16,000,000.
$17,000,000.
$4,000,000.
8-57
Disposal of Property, Plant, and Equipment
The equipment’s sale resulted in:
a.
b.
c.
d.
a gain of $2,000,000.
a gain of $3,000,000.
a gain of $4,000,000.
a loss of $2,000,000.
8-58
Disposal of Property, Plant, and Equipment
The equipment’s sale resulted in:
a.
b.
c.
d.
a gain of $2,000,000.
a gain of $3,000,000.
a gain of $4,000,000.
a loss of $2,000,000.
Gain = Cash Received - Book Value
Gain = $5,000,000 - $3,000,000 = $2,000,000
8-59
Disposal of Property, Plant, and Equipment
Prepare the journal entry to record Delta’s sale
of the equipment at the end of the 17th year.
GENERAL JOURNAL
Date
Description
Debit
Page 8
Credit
8-60
Disposal of Property, Plant, and Equipment
Prepare the journal entry to record Delta’s sale
of the equipment at the end of the 17th year.
GENERAL JOURNAL
Date
Description
Cash
Debit
Page 8
Credit
5,000,000
Accumulated Depreciation
Gain on Sale
Flight Equipment
17,000,000
2,000,000
20,000,000
8-61
Learning Objectives
Apply measurement and reporting concepts
for natural resources and intangible assets.
8-62
Natural Resources
Extracted from
the natural
environment.
A noncurrent
asset presented
at cost less
accumulated
depletion.
Examples: oil, coal, gold
8-63
Natural Resources
Total cost of
asset is the cost
of acquisition,
exploration,
and development.
Total cost is
allocated over
periods benefited
by means of
depletion.
Depletion is like depreciation.
8-64
Depletion of Natural Resources
Depletion is calculated using the
units-of-production method.
Unit depletion rate is calculated as follows:
Acquisition and
Development Cost
–
Residual
Value
Estimated Recoverable Units
8-65
Depletion of Natural Resources
Total depletion cost for a period is:
UNIT DEPLETION
RATE
Total
depletion
cost
×
NUMBER OF UNITS
EXTRACTED IN PERIOD
Cost of
goods sold
Inventory
for sale
Unsold
Inventory
8-66
Natural Resources
Specialized plant assets may be required to extract
the natural resource.
These assets are recorded in a separate account
and depreciated.
8-67
Intangible Assets
Often provide
exclusive rights
or privileges.
Noncurrent assets
without physical
substance.
Intangible
Assets
Useful life is
often difficult
to determine.
Usually acquired
for operational
use.
8-68
Intangible Assets
Record at current
cash equivalent
cost, including
purchase price,
legal fees, and
filing fees.







Goodwill
Trademarks
Patents
Copyrights
Franchises
Licensing Rights
Technology
8-69
Intangible Assets
Definite Life


Amortize over shorter of
economic life or legal life,
subject to rules specified
by GAAP.
Use straight-line method.
Indefinite Life

Not amortized.

Tested at least annually
for possible impairment,
and book value is reduced
to fair value if impaired.
Amortization is a cost allocation process
similar to depreciation and depletion.
8-70
Intangible Assets – Goodwill
Goodwill
Occurs when one
company buys
another company.
Only purchased
goodwill is an
intangible asset.
The amount by which the
purchase price exceeds the fair
market value of net assets acquired.
8-71
Intangible Assets – Goodwill
Goodwill
Indefinite Life
Not amortized.
Value must be reviewed
at least annually for
possible impairment, and
book value is reduced
to fair value if impaired.
8-72
Intangible Assets – Goodwill
Arpec Company paid $2,000,000 to purchase
all of Utek Company’s assets and assumed
liabilities of $400,000. The acquired assets were
appraised at a fair value of $1,800,000.
8-73
Intangible Assets – Goodwill
What amount of goodwill should be
recorded on Arpec Company books?
a.
b.
c.
d.
$200,000
$400,000
$600,000
$800,000
8-74
Intangible Assets – Goodwill
What amount of goodwill should be
recorded on Arpec Company books?
a.
b.
c.
d.
$200,000
$400,000
$600,000
$800,000
FMV of Assets
Debt Assumed
FMV of Net Assets
Purchase Price
Goodwill
$
$
1,800,000
400,000
1,400,000
2,000,000
600,000
8-75
Intangible Assets – Trademarks
A symbol, design, or logo
associated with a business.
Internally
developed
trademarks
have no
recorded
asset cost.
Purchased
trademarks
are recorded
at cost.
8-76
Intangible Assets – Patents
Exclusive right granted by 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.
Research and development costs that might result
in a patent are normally expensed as incurred.
8-77
Intangible Assets – Copyrights
Exclusive right granted by the federal
government to protect artistic or
intellectual properties.
Legal life is
life of creator
plus 70 years.
Amortize cost
over the period
benefited.
8-78
Intangible Assets – Franchises
Legally protected right to sell products or
provide services purchased by franchisee
from franchisor.
Purchase price is an intangible
asset that is amortized.
8-79
Intangible Assets – Licensing Rights
Limited permissions 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.
8-80
Intangible Assets - Technology
A category of intangible
assets that includes a
company’s website and
any computer programs
written by its employees.
8-81
Learning Objectives
Explain the impact on cash flows of acquiring,
using, and disposing of long-lived assets.
8-82
Focus on Cash Flows
8-83
Chapter Supplement A
Changes in Depreciation Estimates
8-84
Changes in Estimates
Depreciation Expense is based on . . .
ESTIMATED
useful life
ESTIMATED
residual value
If the estimates change, the book value less
any residual value at the date of change is
depreciated over the remaining useful life.
8-85
Changes in Estimates
Delta purchased an aircraft for $60,000,000. The
aircraft is depreciated using the straight-line method
with a useful life of 20 years and an estimated
residual value of $3,000,000. In year 5, Delta
changed the estimated useful life to 25 years and
lowered the residual value to $2,400,000
Calculate depreciation expense for the
fifth year using the straight-line method.
8-86
Changes in Estimates
Asset cost
Accumulated depreciation
($2,850,000 per year × 4 years)
Remaining book value
Less estimated residual value
Depreciable base
Divide by remaining life
Revised annual depreciation
$ 60,000,000
11,400,000
48,600,000
2,400,000
46,200,000
÷ 21
$ 2,200,000
8-87
End of Chapter 8