College Accounting Heintz & Parry 20 th Edition. Chapter 18 Accounting for Long-Term Assets.

College AccountingCollege Accounting

Heintz & ParryHeintz & Parry2020thth Edition Edition

Heintz & ParryHeintz & Parry2020thth Edition Edition

ChapterChapter 1818

Accounting for Long-Term AssetsAccounting for

Long-Term Assets

1

Determine the cost of

property, plant, and

equipment.

LONG-TERM ASSETSLONG-TERM ASSETS

• Property, plant, and equipment– Tangible and used in the operations of the

business– Also called plant assets or fixed assets– Examples: Land, buildings, furniture and

equipment• Wasting assets

– Natural resources consumed in the operation of the business

• Intangible assets– Long-term assets that have no physical

substance– Examples: Patents, copyrights, trademarks

LONG-TERM ASSETSLONG-TERM ASSETS

• Long-term assets (except land) gradually wear out or are used up as time passes– The portion that has been used up or

worn out is recognized as an expense• Plant asset – “depreciation”• Natural resources – “depletion”• Intangible assets – “amortization”

– Process of cost allocation• Not a process of valuation• Not intended to make the assets reflect

their market values on the balance sheet

LANDLAND

• Cost includes:– All amounts spent to purchase the land

and prepare it for its intended use, including costs for:

• Legal and real estate fees• Cost of removing old

buildings• Grading the land• Special tax assessments

LAND IMPROVEMENTSLAND IMPROVEMENTS

• Costs related to land that are notpermanent in nature– Cost includes:

• Planting trees andshrubs

• Installing fences• Paving parking areas

– Depreciated overtheir expected usefullives

BUILDINGSBUILDINGS

• Cost includes:– Purchase price

• If purchase price includes land, the cost ofland and building must be determined andaccounted for separately

– Legal fees and related taxes• If the building is constructed, the cost

includes material, labor, architectural, and engineering fees– Insurance premiums and interest on

loans during construction

Interest on loans DURING CONSTRUCTION is debitedto the asset account, but interest AFTER the asset is

put into service is debited to an expense account.

EQUIPMENTEQUIPMENT

• Cost includes:– Purchase price– Transportation charges– Insurance while in transit– Installation costs– Any other costs that are incurred up to

the point of placing the asset in service

2

Explain the nature and

purpose of depreciation.

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DATE DESCRIPTION PR DEBIT CREDIT

Depr. Expense—Delivery Equip.1

2

3

4

5

6

7

8

9

10

11

100 00

DEPRECIATIONDEPRECIATION

Reported on theincome statement

Dec. 3120--



Depr. Expense—Delivery Equip.1

2

3

4

5

6

7

8

9

10

11

100 00

Accum. Depr.—Delivery Equip. 100 00


Deducted from the asset account“Delivery Equipment” on the balance sheet

Dec. 3120--


• Two major types:

• Physical depreciation – The loss of usefulness because of

deterioration

• Functional depreciation – The loss of usefulness because of

inadequacy or obsolescence

3

Compute depreciation using

the straight-line, declining-

balance, sum-of-the-years’-

digits, and units-of-

production methods.


• Cost – The sum of all amounts spent to acquire an asset and prepare it for its intended use

The new asset had a cost of $10,000.

What did we pay for the new asset?


Useful life – The amount of service expected to be obtained from an asset

Be careful! We only want toknow how long our

company will use the asset, not how long the asset could last.

How long will the asset be used?


Useful life – The amount of service expected to be obtained from an asset

We plan on usingit for 4 years.

How long will the asset be used?


• Salvage value – The estimated scrap, or market, value for the asset on its expected disposal date

We feel we can sell itfor $1,000 after using

it for 4 years.

What can we get for it when we’re through with it?

FOUR COMMON DEPRECIATION METHODS

FOUR COMMON DEPRECIATION METHODS

• The most commonly used depreciation methods for financial reporting purposes are:– Straight-line method– Declining-balance method– Sum-of-the-years’-digits method– Units-of-production method

STRAIGHT-LINE METHODSTRAIGHT-LINE METHOD

Depreciation is recognized evenly over the years of the asset’s life.

FORMULA:

(Cost – Salvage Value) ($10,000 – $1,000)

Cost minus salvage valueis also called

“depreciable cost.”


Depreciation is recognized evenly over the years of the asset’s life.

FORMULA:

(Cost – Salvage Value)Est. Useful Life

($10,000 – $1,000)4 Years

$2,250per year



YEARDEPR.

EXPENSEACCUM.

DEPR.BOOK VALUE

Book Value = Cost – Accumulated Depreciation



YEARDEPR.

EXPENSEACCUM.

DEPR.BOOK VALUE

$10,000

BOOK VALUE = COSTat time of purchase



YEARDEPR.

EXPENSEACCUM.

DEPR.BOOK VALUE

$10,000

Same depreciationeach year

1 $2,250 $2,250 7,750

2 2,250



YEARDEPR.

EXPENSEACCUM.

DEPR.BOOK VALUE

$10,000

First year’s depreciation + Second year’s depreciation($2,250 + $2,250)

1 $2,250 $2,250 7,750

2 2,250 4,500



YEARDEPR.

EXPENSEACCUM.

DEPR.BOOK VALUE

$10,000

Cost – Accumulated Depreciation($10,000 – $4,500)

1 $2,250 $2,250 7,750

2 2,250 4,500 5,500



YEARDEPR.

EXPENSEACCUM.

DEPR.BOOK VALUE

$10,000

First year’s depreciation + Second year’s depreciation + Third year’s depreciation

($2,250 + $2,250 + $2,250)

1 $2,250 $2,250 7,750

2 2,250 4,500 5,500

3 2,250 6,750



YEARDEPR.

EXPENSEACCUM.

DEPR.BOOK VALUE

$10,000

1 $2,250 $2,250 7,750

2 2,250 4,500 5,500

3 2,250 6,750 3,250

4 2,250 9,000

The entire depreciable cost has beenexpensed by the end of the fourth year.



YEARDEPR.

EXPENSEACCUM.

DEPR.BOOK VALUE

$10,000

1 $2,250 $2,250 7,750

2 2,250 4,500 5,500

3 2,250 6,750 3,250

4 2,250 9,000 1,000

Book value is now equal to the salvage value.

DECLINING-BALANCE METHODDECLINING-BALANCE METHOD

• Higher depreciation expense in the first year of an asset’s life and gradually decreasing expense in subsequent years.

FORMULA:

Depreciation Rate

DEPRECIATION RATEDEPRECIATION RATE

• Commonly, the depreciation rate is twice the straight-line rate.

STRAIGHT-LINE RATE FORMULA:

100%Useful Life

100%4 Years

Straight-linerate is 25%



FORMULA:

Twice the straight-line rate2 25%

Depreciation Rate50%



FORMULA:

In year 1, Book Value = Cost

Depreciation RateBook Value at Beg. of Year

50% $10,000



$5,000First year’s depreciation =

FORMULA:


50% $10,000



Let’s compute thesecond year’s depreciation.

FORMULA:




The rate stays the same.

FORMULA:


50%



Cost Accumulated Depreciation

–$10,00

0– $5,000

FORMULA:


50% $5,000



Second year’s depreciation = $2,500

Let’s look at thethird year’s depreciation.

FORMULA:


50% $5,000



$2,500

Cost – Accumulated Depreciation$10,000– ($5,000 +

$2,500)

FORMULA:


50%



$2,500

Third year’s depreciation = $1,250

Let’s look at thefourth and final year.

FORMULA:


50%



$1,250

Book value is down to $1,250.The goal is to reduce it to the salvage

value by the end of fourth year.That means only $250 of depreciation to go!

FORMULA:


50%



FORMULA:


50% $1,250

$625 is too much! Book value would fallbelow the salvage value. The fourth

year’s depreciation is limited to $250.

$625



YEARDEPR.

EXPENSEACCUM.

DEPR.BOOK VALUE

$10,000

1 $5,000 $5,000 5,000

2 2,500 7,500 2,500

3 1,250 8,750 1,250

4 250 9,000 1,000

Just like the straight-line method,total depreciation is $9,000.



YEARDEPR.

EXPENSEACCUM.

DEPR.BOOK VALUE

$10,000

1

2

3

4

What if the asset had beenbought on April 1 of year 1?



YEARDEPR.

EXPENSEACCUM.

DEPR.BOOK VALUE

$10,000

1

2

3

4

Year 1: $10,000 50% = $5,000;$5,000 9/12 = $3,750

$3,750 $3,750 6,250



YEARDEPR.

EXPENSEACCUM.

DEPR.BOOK VALUE

$10,000

1

2

3

4 Year 2: $6,250 50% = $3,125

$3,750 $3,750 6,250

3,125 6,875 3,125



YEARDEPR.

EXPENSEACCUM.

DEPR.BOOK VALUE

$10,000

1

2

3

4Year 3:

$3,125 50% = $1,563

$3,750 $3,750 6,250

3,125 6,875 3,125

1,563 8,438 1,562



YEARDEPR.

EXPENSEACCUM.

DEPR.BOOK VALUE

$10,000

1

2

3

4Only $562 of depreciation to go beforebook value reaches the salvage value.

$3,750 $3,750 6,250

3,125 6,875 3,125

1,563 8,438 1,562


1,5628,438

3,1256,875

1,0009,000 562


YEARDEPR.

EXPENSEACCUM.

DEPR.BOOK VALUE

$10,000

1

2

3

4

$3,750 $3,750 6,250

3,125

1,563

Year 4: $1,562 × 50% = $781

Too much! Limited to only $562

SUM-OF-THE-YEARS’ DIGITS METHOD


• Higher depreciation expense in the first year of an asset’s life and gradually decreasing expense in subsequent years. An accelerated depreciation method, but not as accelerated as declining-balance method.

FORMULA:(Cost – Salvage Value)Remaining Useful Life

($10,000 – $1,000) 4

Year 1 = 4 years remaining

FORMULA:(Cost – Salvage Value) Remaining Useful Life

Sum-of-the-Years’ Digits

($10,000 – $1,000)

4 + 3 + 2 + 1 = 10

410







FORMULA:(Cost – Salvage Value) Remaining Useful Life

Sum-of-the-Years’ Digits

($10,000 – $1,000)

Year 1 depreciation is $3,600.

410


SUM-OF-THE-YEARS’-DIGITS METHODSUM-OF-THE-YEARS’-DIGITS METHOD

YearDepreciable

Cost RateAnnualDepr.

$10,000

Accum.Depr.

Book Value

1 $9,000234 Cost – Salvage Value



YearDepreciable


$10,000

Accum.Depr.

Book Value

1 $9,000234

4/10 $3,600 $3,600 6,400 9,000

Depreciable costdoes not change.



YearDepreciable


$10,000

Accum.Depr.

Book Value

1 $9,000234

4/10 $3,600 $3,600 6,400 9,000 3/10

It is the rate thatdecreases over time.



YearDepreciable


$10,000

Accum.Depr.

Book Value

1 $9,000234

4/10 $3,600 $3,600 6,400 9,000 3/10

900 9,000 1/102/10 9,000 8,100

6,300 3,700 1,900 1,000 9,000

2,700 1,800

No adjustment is neededin the fourth year.



YearDepreciable


$10,000

Accum.Depr.

Book Value

1234

9,000

9,000 9,000

$9,000

5 9,000

What if this assethad been bought April 1st?



YearDepreciable


$10,000

Accum.Depr.

Book Value

1234

9,000

9,000 9,000

$9,000

5 9,000

4/10 $2,700 $2,700 7,300

$9,000 4/10 9/12



YearDepreciable


$10,000

Accum.Depr.

Book Value

1234

9,000

9,000 9,000

$9,000

5 9,000

$2,700 $2,700 7,3004/103/10 2,925 5,625 4,375

$9,000 4/10 3/12 = $900;$9,000 3/10 9/12 = $2,025;

$900 + $2,025 = $2,925

4/10



YearDepreciable


$10,000

Accum.Depr.

Book Value

1234

9,000

9,000 9,000

$9,000

5 9,000

4/10 $2,700 $2,700 7,3004/103/10 2,925 5,625 4,3753/102/10 2,025 7,650 2,350

The remaining years are computed in the same manner: 3 months at one

rate and 9 months at another.



YearDepreciable


$10,000

Accum.Depr.

Book Value

1234

9,000

9,000 9,000

$9,000

5 9,000

4/10 $2,700 $2,700 7,3004/103/10 2,925 5,625 4,3753/102/10 2,025 7,650 2,3502/101/10

1/10 1,125 8,775 1,225 225 9,000 1,000

Year 5 is only 3 months.

UNITS-OF-PRODUCTION METHODUNITS-OF-PRODUCTION METHOD

• Depreciation is based on the extent to which the asset was used during the year.

FORMULA:


The asset (a vehicle) is expectedto be driven 90,000 miles in its

useful life.

Step #1 Compute depreciation per unit.

Estimated Useful Life in Units

90,000=



FORMULA:


Step #1 Compute depreciation per unit.

Estimated Useful Life in Units

90,000

Depreciation per Mile = $.10

=


Depreciation is based on the extent to which the asset was used during the year.

FORMULA:

Step #2 Multiply depreciation per unit by the number of units produced or consumed this year.

24,000 miles $.10/mile

Year 1 depreciation is $2,400.



FORMULA:

Step #2 Multiply depreciation per unit by the number of units produced or consumed this year.

24,000 miles $.10/mile

All years are computedin the same manner.

DEPRECIATION METHODS FOR FEDERAL INCOME TAX

DEPRECIATION METHODS FOR FEDERAL INCOME TAX

• The method used depends on when the asset was purchased:– Before 1981

• Straight-line, declining-balance, sum-of-the-years’-digits, or units-of-production methods

– 1981–1986• Accelerated cost recovery system (ACRS)

– After 1986• Modified accelerated cost recovery

(MACRS)

4Account for repairs,

maintenance, additions,

improvements, and

replacements to plant and

equipment.

REPAIRS AND MAINTENANCEREPAIRS AND MAINTENANCE

• If the repairs do not extend the life of the asset or improve its usefulness:– Record as an expense– Examples:

• Replacement of minor parts• Lubrication• Cleaning

ADDITIONS AND IMPROVEMENTSADDITIONS AND IMPROVEMENTS

• Accounted for in two ways:

– If it increases the usefulness of the asset and will provide benefits in future periods:

• Debit the asset account, increasing book value• Depreciate over the remaining life of the asset

– If it extends the useful life of the asset, but does not increase its usefulness or efficiency:

• Debit Accumulated Depreciation, increasing book value


• If at the beginning of 20-2, the company replaced a disk drive on computer A at a cost of $400.

EXAMPLE: A business purchased two computers on January 1, 20-1. Both computers were purchased for $6,500, are estimated to be used for 3 years, and have salvage values of $500. The business uses the straight-line

method in computing depreciation.

The replacement extends the life of the computer but doesn’t increase its

usefulness.


Computer A6,500

Accum. Depr.—Computer A

2,000 12/31/-1

4001/1/-2

1,600

The replacement is debited

to Accumulated Depreciation.


Computer A6,500


2,000 12/31/-1

4001/1/-2

1,600

Book value is now $4,900

($6,500 – $1,600).


Computer A6,500


2,000 12/31/-1

4001/1/-2

1,600Depreciation for the remaining two years:

(Book value – Salvage value)/Remaining life

($4,900 – $500)/2 years = $2,200 per year


• On January 1, 20-2, the company added a new tape drive backup unit to computer B at a cost of $400.

Example: A business purchased two computers on January 1, 20-1. Both

computers were purchased for $6,500, are estimated to be used for 3 years, and have

salvage values of $500. The business uses the straight-line method in computing

depreciation.

Adding new components increases

the usefulness of the computer.


Computer B6,500

Accum. Depr.—Computer B

2,000

1/1/-2

Debited directlyto the asset account

400


Computer B6,500


2,000

1/1/-2

Book value is now $4,900($6,900 – $2,000).

400

6,900


Computer B6,500


2,000

1/1/-2 400

6,900Depreciation for the remaining two years:

(Book value – Salvage value)/Remaining life

($4,900 – $500)/2 years = $2,200 per year

5

Account for the

disposition of property,

plant, and equipment.

PLANT ASSET DISPOSALSPLANT ASSET DISPOSALS

• A plant asset can be disposed of in several ways:

– Discarded or retired– Sold– Exchanged or traded in for another

asset

DISCARDING OR RETIRING PLANT ASSETS


EXAMPLE: A printer with a cost of $800 and accumulated

depreciation of $800 is discarded.

There is no gain or losssince the book value is

$0.



Accum. Depr.—Office Equip.1

2

3

4

5

6

7

8

9

10

11

800 00



Since the company no longer has the

printer, its cost and related depreciation

are removed from the books.

Office Equipment 800 00

Discarded printer



1

2

3

4

5

6

7

8

9

10

11



What if the accumulated

depreciation had been$720 instead?



Accum. Depr.—Office Equip.1

2

3

4

5

6

7

8

9

10

11

720 00



Loss of $80

Office Equipment

80 00

Discarded printer

Loss on Discarded Office Equip.

800 00

SELLING PLANT ASSETSSELLING PLANT ASSETS

EXAMPLE: A printer with a cost of $800 and accumulated

depreciation of $720 is sold for $80.

We’re giving up an asset

with a value of $80to get $80 cash.



Accum. Depr.—Office Equip.

1

2

3

4

5

6

7

8

9

10

11

720 00


No gain or loss

Office Equipment

80 00

Sold printer

800 00

Cash




1

2

3

4

5

6

7

8

9

10

11

720 00


If we sold the printer for $120:Gain of $40

($120 cash – $80 book value)

Office Equipment

120 00

Sold printer

800 00

Cash

Gain on Sale of Printer 40 00




1

2

3

4

5

6

7

8

9

10

11

720 00


If we sold the printer for $50:Loss of $30

($80 book value – $50 cash)

Office Equipment

50 00

Sold printer

800 00

Cash

30 00Loss on Sale of Printer

EXCHANGE OR TRADE-IN OF PLANT ASSETS


Book value of $1,100($8,000 – $6,900)

Old Delivery Truck

8,000Cost

Accum. Depr.—Old Truck

6,900

EXAMPLE: An old delivery truck is traded-in for a new delivery truck with a

fair market value of $30,000.



Example: An old delivery truck is traded-in for a new delivery truck with

a fair market value of $30,000.

Old Delivery Truck

8,000Cost

Accum. Depr.—Old Truck

6,900

If a $1,000 trade-in isgranted on the old truck:

$100 loss



1

2

3

4

5

6

7

8

9

10

11



The new delivery truck is entered

on the books at its market value.

30,000 00Delivery Equipment (New)



Accum. Depr.—Delivery Equip.

1

2

3

4

5

6

7

8

9

10

11

6,900 00



Accumulated Depreciation on theold truck is removed from the

books.

30,000 00Delivery Equipment (New)




1

2

3

4

5

6

7

8

9

10

11

6,900 00



The loss is recognized.It will be shown on the income

statement.

Loss on Exchange of Equipment

30,000 00

100 00

Delivery Equipment (New)




1

2

3

4

5

6

7

8

9

10

11

6,900 00



The cost of the old delivery truck

is removed from the books.


30,000 00

100 00


Delivery Equipment (Old) 8,000 00




1

2

3

4

5

6

7

8

9

10

11

6,900 00



Cash is credited for the amount paid, $29,000

($30,000 price – $1,000 trade-in).


30,000 00

100 00



Cash 29,000 00




1

2

3

4

5

6

7

8

9

10

11

6,900 00



What if the trade-in hadbeen $1,500 instead?


30,000 00

Purchased a new truck

100 00



Cash 29,000 00



• $1,500 trade-in – $1,100 book value $400 gain




1

2

3

4

5

6

7

8

9

10

11

6,900 00



Note that for TAX purposes, the new equipment would be

valued at $29,600 and NO gain would

be recognized on the exchange.

Purchased a new truck



Cash 28,500 00

30,000 00

Gain on Exchange 400 00

6

Explain the nature of,

purpose of, and

accounting for depletion.

NATURAL RESOURCESNATURAL RESOURCES

EXAMPLE: A coal mine is acquired at a cost of $1,000,000. No salvage value. Approximately 1,000,000 tons of coal

are expected to be mined.

Natural resources are“depleted” over time

using units-of-productionmethod.


EXAMPLE: A coal mine is acquired at a cost of $1,000,000. No salvage value. Approximately 1,000,000 tons of coal

are expected to be mined.(Cost – Salvage Value)/Tons

$1,000,000

1,000,000 tons

Depletion is

$1.00/ton


EXAMPLE: During the current year, 180,000 tons of coal were mined and

sold.

180,000 $1.00

tonsper ton

$180,000 depletion



1

2

3

4

5

6

7

8

9

10

11


180,000Depletion Expense—Mine

Accum. Depletion—Mine 180,000

Very similar todepreciation adjusting entries

7

Explain the nature of

and accounting for

intangible assets.

INTANGIBLE ASSETSINTANGIBLE ASSETS

• Patents– Give the inventor the exclusive right to

produce, use, and sell an invention for a period of 20 years

• If a company purchases a patent, the amount paid equals the cost of the patent

• If it develops its own patent, only the fees paid to the government and patent attorneys equals the cost

• Cost is “amortized” over the patent’s useful life using the straight-line method


• Copyrights– Give the exclusive right to the reproduction

and sale of a literary, artistic, or musical composition for the life of the holder plus 50 years

• If a company purchases a copyright, the amount paid equals the cost of the copyright

• If it develops its own copyrighted content, the cost of obtaining the copyright, itself, is an ordinary expense

• Cost is “amortized” over a copyright’s useful life using the straight-line method or in proportion of actual sales


• Trademarks– Trade names to identify a firm’s merchandise

are protected by registering them with the United States Patent Office

• If a company purchases a trademark, the amount paid equals the cost of the trademark

• If it develops its own trademark, only the cost to register it is recorded as an asset.

• Cost is then “amortized” over the trademark’s useful life using the straight-line method

College Accounting Heintz & Parry 20 th Edition. Chapter 18 Accounting for Long-Term Assets.

Documents

cost of land

plant assets

intended usethe new

physical depreciation

cost of property

purpose of depreciation

loss of usefulness

balance sheetdec