#### Transcript Chapter 8

```Chapter 8
Operating Assets:
Property, Plant, and Equipment,
Natural Resources,
and Intangibles
Financial Accounting, Alternate 4e by Porter and Norton
1
Johnson Controls, Inc.
Property, Plant, and Equipment
Buildings and improvement
Machinery and equipment
Construction in progress
At
Cost
Land
Less accumulated depreciation
Property, plant, and equipment (net)
\$ 1,242.9
3,191.1
310.7
\$ 4,744.7
223.8
\$ 4,968.5
(2,588.7)
\$ 2,379.8
Book Value
2
Acquisition Cost of P,P&E

All costs necessary to acquire asset and
prepare for intended use
Purchase
Price
+
Taxes
Transportation Charges
Installation
Costs
3
Group Asset Purchases
Allocate cost of lump-sum purchase based
on fair market values
Cost
\$100,000
Fair Market
Value
Building =
\$90,000
Land =
\$30,000
% of
Market
Value
75%
25%
Allocated
Cost
\$75,000
\$25,000
4
Capitalization of Interest

Interest can be included
as part of the cost of an
asset if:
»
»
company constructs asset
over time, and
borrows money to finance
construction
5
Depreciation of P,P & E
Match
cost of
assets
with periods
benefited
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
29
30
31
via
Straight-Line
Units-ofProduction
Accelerated
Methods
6
Straight-Line Method

Allocates cost of asset evenly over its
useful life
\$9,000
3-year life
\$3,000
Year 1
\$3,000
Year 2
\$3,000
Year 3
7
Units-of-Production Method

Allocate asset cost based on number of
units produced over its useful life
depreciation =
per unit
8
Double-Declining-Balance Method
Double the straight-line rate on a
declining balance (book value)
 Accelerated method - higher amount of
depreciation in early years

Straight-Line
Rate
9
Depreciation Example
On January 1, Kemp Company purchases a
machine for \$20,000. The life of the
machine is estimated at five years, after
which it is expected to be sold for \$2,000.
10
Depreciation Example
Calculate Kemp's depreciation of the
machine for years 1 - 5 using the straightline, units-of-production and doubledeclining-balance depreciation methods.
\$20,000 cost - \$2,000 residual value =
\$18,000 to be depreciated
11
Straight-Line Depreciation
Depreciation
\$18,000
5-year life
\$3,600
Year 1
\$3,600
Year 2
= Cost - Residual Value
Life
= \$20,000 - \$2,000
5 years
= \$3,600
\$3,600
Year 3
\$3,600
Year 4
\$3,600
Year 5
12
Units-of-Production Depreciation

Kemp’s estimated machine production:
Yr. 1
3,600 units
Yr. 2
3,600 units
Yr. 3
3,600 units
Yr. 4
3,600 units
Yr. 5
3,600 units
Total 18,000 units
13
Units-of-Production Depreciation
Depreciation
per unit
= Cost - Residual Value
Life in Units
= \$20,000 - \$2,000
18,000
= \$ 1.00
14
Units-of-Production Depreciation

Kemp’s depreciation in 2004:
4,000 units x \$1/unit = \$ 4,000
15
Double-Declining-Balance
Depreciation
DDB rate = (100% / useful life) x 2
= (100% / 5 years) x 2
= 40%
Initially
ignore
residual value
16
Double-Declining-Balance
Depreciation
Year 1 Depreciation
Year
1
Rate
40%
= Beginning book value x rate
= \$20,000 x 40%
= \$8,000
Beginning
Ending
Book Value Depreciation Book Value
\$20,000
\$8,000
\$12,000
17
Double-Declining-Balance
Depreciation
Year 2 Depreciation
Year
1
2
Rate
40%
40%
= Beginning book value x rate
= \$12,000 x 40%
= \$4,800
Beginning
Ending
Book Value Depreciation Book Value
\$20,000
\$8,000
\$12,000
\$12,000
4,800
7,200
18
Double-Declining-Balance
Depreciation
Year
1
2
3
4
5
Rate
40%
40%
40%
40%
40%
Beginning
Ending
Book Value Depreciation Book Value
\$20,000
\$8,000
\$12,000
12,000
4,800
7,200
7,200
2,880
4,320
4,320
1,728
2,592
2,592
592
2,000
\$18,000
Final year’s depreciation =
amount needed to equate book
value with salvage value
= Residual
Value
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Straight-Line vs. DDB Depreciation
\$8,000
\$7,000
\$6,000
\$5,000
Straight-line
DDB
\$4,000
\$3,000
\$2,000
\$1,000
\$0
Year 1
Year 2
Year 3
Year 4
Year 5
20
Reasons for Choosing
Straight-Line Depreciation
Simplicity
 Reporting to
stockholders
 Comparability
 Bonus plans

21
Reasons for Choosing
Accelerated Methods
Technological rate of change and
competitiveness
 Minimize taxable income
 Comparability

Income Taxes
22
Changes in Depreciation Estimates
Recompute depreciation schedule using
new estimates
 Record prospectively (i.e., change should
affect current and future years only)

Useful life is
7 years vs. 5?
23
Change in Estimate
Example:
\$20,000 machine originally expected to be
depreciated over 5 years. After 2 years,
useful life is increased to 7 years.
\$3,600
\$3,600
planned
\$3,600
Yr. 1
Yr. 2
Yr. 3
Depreciation
revise
estimate
Yr. 4
Yr. 5
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Change in Estimate
Example:

\$12,800 remaining book value allocated
prospectively over remaining life
\$3,600
\$3,600
\$2,160
\$2,160
\$2,160
\$2,160
\$2,160
Yr. 1
Yr. 2
Yr. 3
Yr. 4
Yr. 5
Yr. 6
Yr. 7
revise
estimate
Depreciation
25
Capital vs. Revenue Expenditures
 Capital
»
be depreciated over a
period of time
 Revenue
»
Expenditure
Expenditure
Expense immediately
Balance
Sheet
Income
Statement
26
Capital vs. Revenue Expenditures
General Guidelines:
» Increase asset life
» Increase asset productivity
» Normal maintenance
» Material expenditures
 Capitalize
 Capitalize
 Expense
 Expense
27
Capital Expenditures
Example:
\$20,000 machine originally expected to be
depreciated over 5 years. After 2 years,
overhaul machine at cost of \$3,000. Machine
life is increased by 3 years.
planned
\$3,600 \$3,600
\$3,600
Yr. 1
Yr. 2
Yr. 3
replace
engine
Yr. 4
Yr. 5
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Capital Expenditures
Example:

\$12,800 remaining book value + \$3,000
capital expenditure depreciated
prospectively over remaining life
\$3,600 \$3,600
\$2,300
\$2,300
\$2,300
\$2,300
\$2,300
\$2,300
Yr. 1
Yr. 3
Yr. 4
Yr. 5
Yr. 6
Yr. 7
Yr. 8
Yr. 2
replace
engine
29
Disposal of Operating Assets
Record depreciation up to date of disposal
 Compute gain or loss on disposal

Proceeds > Book Value = Gain
Proceeds < Book Value = Loss
30
Disposal of Operating Assets
Example:

Sell truck (cost \$20,000; accumulated
depreciation \$9,000) for \$12,400
Asset cost
\$20,000
Less: Accumulated depreciation
9,000
Book value
11,000
Sale price
12,400
Gain on sale of asset
\$ 1,400
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Partial Balance Sheet
(in thousands)
Property and Equipment:
Land and land improvements
Buildings and improvements
Machinery and equipment
Less: accumulated depreciation
Timber, timberlands, and
timber deposits
Natural Resources
\$
70,731
709,127
4,678,112
(2,915,940)
2,542,030
328,720
\$2,870,750
32
Natural Resources
Resource consumed as it is used
 Expense called depletion vs. depreciation
 Depletion method similar to units of
production

33
Walt Disney and Co.
Consolidated Balance Sheets (partial)
Operating assets:
Parks, resorts and other property, at cost
Attractions, buildings and equipment
Accumulated depreciation
Projects in process
Land
Intangible assets, net
Goodwill
(In millions)
\$ 18,917
(8,133)
10,784
1,148
848
12,780
2,776
17,083
34
Intangible Assets

Long-term assets with no physical
properties
Patents
Goodwill
35
Intangible Assets

Includes cost to acquire and prepare for
intended use
Purchase Price
+
Acquisition
Costs
(i.e. legal fees,
registration
fees, etc.)
36
Research & Development

Must be expensed in
period incurred

Difficult to identify future
benefits
37
Amortization of Intangibles
Normally recorded using straight-line
method
 Reported net of accumulated
amortization
 Amortized over legal or useful life,
whichever is shorter

38
Amortization of Intangibles
Example:
ML Company developed a patent for
\$10,000. The patent’s legal life is 20
years, but its anticipated useful life is 5
years.
39
Amortization of Intangibles
ML Company’s annual amortization:
Patent approval costs
\$10,000
Divide by:
Lesser of legal or useful life 5 years
Annual amortization
\$ 2,000
40
Amortization of Intangibles
ML Company’s Balance Sheet Presentation:
Upon
End of
acquisition Yr. 1 Yr. 5
Long-term Assets:
Intangible assets,
net of accum.
amortization
\$10,000
\$8,000
\$ 0
41
Long-term Assets and
the Statement of Cash Flows
Operating Activities
Net income
Depreciation and amortization
Gain on sale of asset
Loss on sale of asset
Investing Activities
Purchase of asset
Sale of asset
Financing Activities
xxx
+
–
+
–
+
42
Analyzing Long-term Assets
Average Life = Property, Plant & Equipment
Depreciation Expense
What is the
average
depreciable
period (or life) of
the company’s
assets?
43
Analyzing Long-term Assets
Average Age = Accumulated Depreciation
Depreciation Expense
Are assets old or
new?
44
Analyzing Long-term Assets
Asset Turnover =
Net Sales
Average Total Assets
How productive
are the company’s
assets?
45
End of Chapter 8
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```