8-1 PowerPoint Authors: Susan Coomer Galbreath, Ph.D., CPA Charles W. Caldwell, D.B.A., CMA Jon A. Booker, Ph.D., CPA, CIA Cynthia J. Rooney, Ph.D., CPA.

8-1

PowerPoint Authors:Susan Coomer Galbreath, Ph.D., CPACharles W. Caldwell, D.B.A., CMAJon A. Booker, Ph.D., CPA, CIACynthia J. Rooney, Ph.D., CPA

Reporting and InterpretingProperty, Plant, and Equipment;

Natural Resources;and Intangibles

Chapter 08

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

8-2

Understanding The Business

How much is enough?

Insufficient capacity results

in lost sales.

Costly excesscapacity reduces

profits.

8-3

Tangible

PhysicalSubstance

Intangible

No PhysicalSubstance

Expected to Benefit Future Periods

Classifying Long-Lived Assets

8-4

Tangible

PhysicalSubstance

Intangible

No PhysicalSubstance

Classifying Long-Lived Assets

Land Assets subject to depreciation

Buildings and equipment Furniture and fixtures

Natural resource assets subject to depletion

Mineral deposits and timber

Definite life Patents Copyrights Franchises

Indefinite life Trademarks Goodwill

8-5

Fixed Asset TurnoverFixedAsset

Turnover

Net Sales Revenue

Average Net Fixed Assets=

This ratio measures a company’s ability to generateThis ratio measures a company’s ability to generatesales given an investment in fixed assets.sales given an investment in fixed assets.

This ratio measures a company’s ability to generateThis ratio measures a company’s ability to generatesales given an investment in fixed assets.sales given an investment in fixed assets.

During 2009, Southwest Airlines had $10,350 of revenue. End-of-year fixed assets were $10,634 and beginning-of-year fixed

assets were $11,040. (All numbers in millions.)

During 2009, Southwest Airlines had $10,350 of revenue. End-of-year fixed assets were $10,634 and beginning-of-year fixed

assets were $11,040. (All numbers in millions.)

FixedAsset

Turnover

$10,350

($10,634 + $11,040) ÷ 2= = 0.96

Southwest Delta United1.01 1.40 1.86

2008 Fixed Asset Turnover Comparisons

8-6

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 includefinancing charges and cash discounts.

Acquisition cost includes the purchase price and all expenditures needed to prepare the asset for its intended use.

Acquisition cost does not includefinancing charges and cash discounts.

Buildings• Purchase price• Renovation and repair costs• Legal and realty fees• Title fees

Buildings• Purchase price• Renovation and repair costs• Legal and realty fees• Title fees

8-7

Measuring and RecordingAcquisition Cost

Equipment

• Purchase price

• Installation costs

• Modification to buildingnecessary to install equipment

• Transportation costs

Equipment

• Purchase price

• Installation costs

• Modification to buildingnecessary to install equipment

• Transportation costs

Land• Purchase price• Real estate commissions• Title insurance premiums• Delinquent taxes• Surveying fees• Title search and transfer fees

Land• Purchase price• Real estate commissions• Title insurance premiums• Delinquent taxes• Surveying fees• Title search and transfer fees

Land is not depreciatedLand is not depreciated

8-8

On January 1, Southwest Air Linespurchased aircraft for $75,000,000 cash.

GENERAL JOURNAL Page 8

Date Description Debit Credit

Jan. 1 Flight equipment (+A) 75,000,000

Cash (-A) 75,000,000

Measuring and Recording Acquisition Cost

Acquisitionfor Cash

On January 14, Southwest Air Linespurchased aircraft for $1,000,000 cash

and a $74,000,000 note payable.

Acquisition for Debt



Jan. 14 Flight equipment (+A) 75,000,000

Cash (-A) 1,000,000

Note payable (+L) 74,000,000

8-9

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.

Record at the current market value of the consideration given, or the current market value of the asset acquired,

whichever is more clearly evident.

On July 7, Southwest gave Boeing 1,000,000 shares of $1.00 par value common stock with a market value of

$50 per share plus $25,000,000 in cash for aircraft.

On July 7, Southwest gave Boeing 1,000,000 shares of $1.00 par value common stock with a market value of

$50 per share plus $25,000,000 in cash for aircraft.



July 7 Flight Equipment (+A) 75,000,000

Common Stock (+SE) 1,000,000

Additional Paid-in Capital (+SE) 49,000,000

Cash (-A) 25,000,000

8-10

Acquisition by Construction

Asset cost includes:Asset cost includes:

All materials andlabor traceable tothe construction.

A reasonableamount ofoverhead.

Interest on debtincurred during

the construction.

8-11

Repairs, Maintenance, and Additions

Type of Capital orExpenditure Revenue Identifying Characteristics

Ordinary Revenue 1. Maintains normal operating conditionrepairs and 2. Does not increase productivity

maintenance 3. Does not extend life beyond original estimate4. Recurring in nature and involve small amounts of money at each occurence

Additions and Capital 1. Major overhauls or partialImprovements replacements

2. Usually occur infrequently3. Increases efficiency4. May extend useful life5. Involve large amounts of money

8-12

Financial Statement Effect

Current Current Treatment Statement Expense Income Taxes

Capital Balance sheetExpenditure account debited Deferred Higher Higher

Revenue Income statement CurrentlyExpenditure account debited recognized Lower Lower

Repairs, Maintenance, and Additions

To solve this problem, many companies have policies regarding the expensing of all expenditures below a

certain amount according to the materiality constraint.

8-13

Depreciation is a cost allocation process that systematically and rationally matches acquisition costs

of operational assets with periods benefited by their use.

Depreciation is a cost allocation process that systematically and rationally matches acquisition costs

of operational assets with periods benefited by their use.

Cost

Allocation(Unused)

Balance Sheet

(Used)

Income Statement

Expense

Depreciation Concepts

AcquisitionCost

DepreciationExpense

IncomeStatement

BalanceSheet

AccumulatedDepreciation

Depreciation for

the current year

Total of depreciation

to date on an asset

8-14

Depreciation Concepts

The calculation of depreciation requiresthree amounts for each asset: Acquisition cost. Estimated useful life. Estimated residual value.

The calculation of depreciation requiresthree amounts for each asset: Acquisition cost. Estimated useful life. Estimated residual value.

Alternative depreciation methods: Straight-line Units-of-production Accelerated Method: Declining balance

Alternative depreciation methods: Straight-line Units-of-production Accelerated Method: Declining balance

8-15

Straight-Line Method

Cost - Residual Value

Useful Life in Years

Cost - Residual Value

Useful Life in Years

Depreciation

Expense per Year

Depreciation

Expense per Year==

At the beginning of the year, Southwest 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.

Depreciation

Expense per Year=

Depreciation

Expense per Year= $20,000

$62,500 - $2,500

3 years

8-16

Depreciation Accumulated Accumulated UndepreciatedExpense Depreciation Depreciation Balance

Year (debit) (credit) Balance (book value)62,500$

1 20,000$ 20,000$ 20,000$ 42,500 2 20,000 20,000 40,000 22,500 3 20,000 20,000 60,000 2,500

60,000$ 60,000$

Residual Value

SL More companies use the straight-line method of depreciation in their financial

reports than all other methods combined.

Straight-Line Method

8-17

Units-of-Production Method

Depreciation Rate

= Cost - Residual Value Life in Units of Production

Step 1:

Step 2:

Depreciation Expense =

Depreciation Rate

×Number of

Units Producedfor the Year

At the beginning of the year, Southwest 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?

8-18

Units-of-Production Method

$62,500 - $2,500 100,000 miles

= $.60 per mileDepreciation Rate

=

Step 1:

Step 2:

$.60 per mile × 30,000 miles = $18,000

Depreciation Expense =

Accumulated UndepreciatedDepreciation Depreciation Balance

Year Miles Expense Balance (book value)62,500$

1 30,000 18,000$ 18,000$ 44,500 2 50,000 30,000 48,000 14,500 3 20,000 12,000 60,000 2,500

100,000 60,000$ Residual Value

8-19

Accelerated Depreciation

DepreciationDepreciation RepairRepairExpenseExpense ExpenseExpense

Early YearsEarly Years HighHigh LowLow

Later YearsLater Years LowLow HighHigh

Accelerated depreciation matches higher depreciation expense with higher revenuesin the early years of an asset’s useful life

when the asset is more efficient.

8-20

Declining-Balance Method

AnnualDepreciation

expense

NetBookValue

( )Useful Life in Years 2

= ×

Cost – Accumulated Depreciation

Declining balance rateof 2 is double-declining-

balance (DDB) rate.

Annual computation ignores residual value.Annual computation ignores residual value.

At the beginning of the year, Southwest 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.

8-21

AnnualDepreciation

expense

NetBookValue

( )Useful Life in Years 2

= ×

( ) $62,500 × 3 years 2

= $41,667

( ) ($62,500 – $41,667) ×

3 years 2

= $13,889


Year 1 Depreciation:

Year 2 Depreciation:

8-22

Depreciation Accumulated UndepreciatedExpense Depreciation Balance

Year (debit) Balance (book value)62,500$

1 41,667$ 41,667$ 20,833 2 13,889 55,556 6,944 3 4,629 60,185 2,315

60,185$

( ) ($62,500 – $55,556) × 3 years 2

= $4,629

Below residual value


8-23

Depreciation expense is limited to the amount thatreduces book value to the estimated residual value.

Depreciation Accumulated UndepreciatedExpense Depreciation Balance

Year (debit) Balance (book value)62,500$

1 41,667$ 41,667$ 20,833 2 13,889 55,556 6,944 3 4,444 60,000 2,500

60,000$


8-24

International Perspective—IFRSMeasurement Basis for Property, Plantand Equipment

IFRS permit companies to value property, plant, and

equipment at historical cost or to revalue them to their fair value as of the balance

sheet date.

Under GAAP, revaluation of property, plant, and

equipment to fair value is prohibited.

US GAAP and IFRS differ with respect to the measurement basis for property, plant and equipment on the balance sheet.

8-25

Measuring Asset ImpairmentImpairment is the loss of a significant portion

of the utility of an asset through . . .• Casualty.• Obsolescence.• Lack of demand for the asset’s services.

Recognize aloss whenan assetsuffers a

permanentimpairment.

8-26

Journalize disposal by:

Writing off accumulateddepreciation (debit).

Writing off the asset cost (credit).

Recording cashreceived (debit)or paid (credit).

Recording again (credit)

or loss (debit).

Update depreciation to the date of disposal.

Disposal of Property, Plantand Equipment

8-27


Southwest Airlines sold flight equipmentfor $11,000,000 cash at the end of its

17th year of use. The flight equipment originally cost $30,000,000, and was depreciated using the

straight-line method with zero residual valueand a useful life of 25 years.

Let’s answer the following questions.

Southwest Airlines sold flight equipmentfor $11,000,000 cash at the end of its

17th year of use. The flight equipment originally cost $30,000,000, and was depreciated using the

straight-line method with zero residual valueand a useful life of 25 years.

Let’s answer the following questions.

8-28

The amount of depreciation expense recorded at the end of the 17th year to

bring depreciation up to date is:

a. $0.

b. $1,200,000.

c. $1,500,000.

d. $2,000,000.

The amount of depreciation expense recorded at the end of the 17th year to

bring depreciation up to date is:

a. $0.

b. $1,200,000.

c. $1,500,000.

d. $2,000,000.

Annual Depreciation: ($30,000,000 – $0) ÷ 25 Years. = $1,200,000


8-29

After updating the depreciation,the equipment’s book value at the end of

the 17th year is:

a. $9,600,000.

b. $20,400,000.

c. $12,800,000.

d. $6,600,000.

After updating the depreciation,the equipment’s book value at the end of

the 17th year is:

a. $9,600,000.

b. $20,400,000.

c. $12,800,000.

d. $6,600,000.

Accumulated Depreciation =

(17yrs. × $1,200,000) = $20,400,000

BV = Cost – Accumulated Depreciation

BV = $30,000,000 – $20,400,000 = $9,600,000


8-30

The equipment’s sale resulted in:

a. a gain of $1,400,000.

b. a gain of $6,200,000.

c. a gain of $3,800,000.

d. a loss of $1,700,000.

The equipment’s sale resulted in:

a. a gain of $1,400,000.

b. a gain of $6,200,000.

c. a gain of $3,800,000.

d. a loss of $1,700,000.

Gain = Cash Received – Book ValueGain = $11,000,000 – $9,600,000 = $1,400,000


8-31

Prepare the journal entry to record Southwest’s sale of the equipment at the end of the 17th year.



Cash (+A) 11,000,000

Accumulated Depreciation (+XA) 20,400,000

Gain on Sale (+Gain, +SE) 1,400,000

Flight Equipment (-A) 30,000,000


8-32

Acquisition and Depletion of Natural Resources

Examples: oil, coal, goldExamples: oil, coal, gold

Extracted fromthe natural

environment.

A noncurrentasset presented

at cost lessaccumulated

depletion.

Total cost of asset is the cost

of acquisition, exploration,

and development.

Total cost isallocated over

periods benefitedby means of

depletion.

Depletion is like units-of-production depreciation.

8-33

The unit depletion rate is calculated as follows:

Estimated Recoverable Units

Acquisition and ResidualDevelopment Cost Value–

Depletioncost

Inventoryfor sale Unsold

Inventory

Cost ofgoods sold

Depletion cost for a period is:

UNIT DEPLETIONRATE

NUMBER OF UNITSEXTRACTED IN PERIOD×

Acquisition and Depletion of Natural Resources

8-34

Acquisition and Amortization of Intangible Assets

Noncurrent assetswithout physical

substance.

Noncurrent assetswithout physical

substance.

Useful life isoften difficultto determine.

Useful life isoften difficultto determine.

Usually acquired for operational

use.

Usually acquired for operational

use.

Often provideexclusive rights

or privileges.

Often provideexclusive rights

or privileges.Intangible

Assets

Record at current cash equivalent cost, including purchase price, legal fees, and filing fees.

8-35


Definite Life

• Amortize over shorter of economic life or legal life, subject to rules specified by GAAP.

• Use straight-line method.

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.

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.

Amortization is a cost allocation process similar to depreciation and depletion.

8-36

Occurs when onecompany buys

another company.

The amount by which the purchase price exceedsthe fair market value of net assets acquired.

Only purchased goodwill is an

intangible asset.

Goodwill


Goodwill is not amortized. Its value must be reviewedat least annually for possible impairment, and the

book value is reduced to fair value if impaired.

Goodwill is not amortized. Its value must be reviewedat least annually for possible impairment, and the

book value is reduced to fair value if impaired.

8-37

Arpec Company paid $2,000,000 to purchaseall of Utek Company’s assets and assumed liabilities of $400,000. The acquired assets were appraised at a fair value of $1,800,000.

What amount of goodwill should be recorded on Arpec Company books?

a. $200,000

b. $400,000

c. $600,000

d. $800,000

What amount of goodwill should be recorded on Arpec Company books?

a. $200,000

b. $400,000

c. $600,000

d. $800,000

FMV of Assets 1,800,000$ Debt Assumed 400,000

FMV of Net Assets 1,400,000 Purchase Price 2,000,000

Goodwill 600,000$


8-38

Acquisition and Amortization of Intangible AssetsTrademarks

• A symbol, design, orlogo associated witha business.

• An exclusive legal rightto use a name, imageor slogan.

• Purchased trademarksare recorded at cost.

Trademarks

• A symbol, design, orlogo associated witha business.

• An exclusive legal rightto use a name, imageor slogan.

• Purchased trademarksare recorded at cost.

Copyrights

• The exclusive right to publish, use, and sell a literary, musical, or artistic work.

• Legal life is life of creator plus 70 years.

• Amortize cost over the period benefited.

Copyrights

• The exclusive right to publish, use, and sell a literary, musical, or artistic work.

• Legal life is life of creator plus 70 years.

• Amortize cost over the period benefited.

8-39


Patents

• 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.

• Research and development costs that might result in a patent are normally expensed as incurred.

Patents

• 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.

• Research and development costs that might result in a patent are normally expensed as incurred.

Technology

• A category of intangible assets that includes a company’s website and any computer programs written by its employees.

Technology

• A category of intangible assets that includes a company’s website and any computer programs written by its employees.

8-40

Franchises

• Legally protected right purchased by a franchisee to sell products or provide services for a specified period and purpose.

• Purchase price is an intangible asset that is amortized.

Franchises

• Legally protected right purchased by a franchisee to sell products or provide services for a specified period and purpose.

• Purchase price is an intangible asset that is amortized.


Licenses and Operating 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.

Licenses and Operating 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.

8-41

International Perspective—IFRSMeasurement Basis for Property, Plantand Equipment

IFRS require that research expenditures be reported

as an expense, but development costs be

capitalized as an asset after technical and commercial feasibility of the resulting product or service have

been established.

Under GAAP, all research and development costs must be reported as an

expense.

US GAAP and IFRS differ with respect to the treatment of development costs.

8-42

Focus on Cash Flows

8-43

Chapter Supplement A – Changes in Depreciation Estimates

Depreciation Expense is based on . . .

ESTIMATED useful life

ESTIMATED useful life

ESTIMATED residual valueESTIMATED 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.

If the estimates change, the book value less any residual value at the date of change is depreciated

over the remaining useful life.

Southwest 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,

Southwest 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.

Southwest 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,

Southwest 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.

8-44

Chapter Supplement A – Changes in Depreciation Estimates

Acquisition cost 60,000,000$ Accumulated depreciation (years 1-5) ($2,850,000 per year × 4 years) 11,400,000 Remaining book value 48,600,000 Less: New residual value 2,400,000 New depreciable amount 46,200,000 Divide by remaining life ÷ 21Revised annual depreciation 2,200,000$

8-45

End of Chapter 08

8-1 PowerPoint Authors: Susan Coomer Galbreath, Ph.D., CPA Charles W. Caldwell, D.B.A., CMA Jon A. Booker, Ph.D., CPA, CIA Cynthia J. Rooney, Ph.D., CPA.

Documents

asset slide

year depreciation expense

depreciation buildings

calculation of depreciation

longlived assets slide

debt slide

construction asset cost

years depreciation expense