Needles Ch09

8/6/2019 Needles Ch09

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Chapter 9

Long-Term

Assets

Skyline College

Lecture Notes


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92Copyright Houghton Mifflin Company. All rights reserved.

Long-Term Assets

Useful life of more than one yearUsed in the operation of a business

Not intended for resale

Long-term assets might include:

Equipment

Vehicles Property

Trademarks


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Carrying Value

The unexpired cost of an asset(also called book value)

Unexpired Cost = Cost Accumulated Depreciation

On the Balance Sheet:


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ClassificationofLong-Term Assets andMethods of Accounting for Them


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Asset Impairment

When is an asset

deemed impaired?

When a long-term

asset loses some or allof its potential to

generate revenue

before the end of its

useful life

Asset Impairment

The carrying value of a

long-term asset exceeds

its fair value


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AcquiringLong-Term Assets

How do companies make the decision toacquire long-term assets?

Capital Budgeting

Methodof Evaluation

Net Present Value Method

Evaluates the purchase based on the net presentvalue of acquisition cost, net annual savings in

cash flows, and disposal price


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Apple Computer is considering the purchase of a $50,000 customerrelations software package. Management estimates that the company will

save $20,000 in net cash flows per year for four years, the usual life of the

software. The software should be worth $10,000 at the end of that period.

The interest rate is 10 percent compounded annually.

20x5 20x6 20x7 20x8Acquisition cost ($50,000)

Net annual savings in cash flows $20,000 $20,000 $20,000 $20,000

Disposal price 10,000

Net cash flows ($30

,000

) $20

,000

$20

,000

$30

,000

Cash flows related to the purchase of the computer would be as follows:

Net Present Value Method

Present value Tables 3 and 4 can now be used to place the

cash flows on a comparable basis.


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Net annual savings in cashflows

Present value factor = 3.170Table 4: 4 periods, 10%3.170 x $20,000

63,400

Disposal price Present value factor = .683Table 3: 4 periods, 10%

.683 x $10,000

6,830

Net present value $20,230

20 5 20 6 20 7 20 8Acquisition cost ($50,000)

et annual savings in cash lo s $20,000 $20,000 $20,000 $20,000isposal price 10,000

et cash lo s ($30,000) $20,000 $20,000 $30,000

Acquisition cost Present value factor = 1.0001.000 x $50,000

($50,000)

As long as the net present value is

positive, Apple will earn a return of

at least 10 percent.

The return is greater than 10 percent on

the investment. Based on this analysis,

Apple should purchase the software.

Example of Net Present Value Method(contd)


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FinancingLong-Term Assets

Financing

alternatives:

Use cash flow from

operationsIssue common stock

Issue long-term notes

Issue bonds

Investors may investigate

whether a company has

free cash flow to finance

long-term assets.

Free cash flow is cash that remains after deducting fundscommitted to operations at current levels


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The Matching Rule andLong-Term Assets

When a company purchases an asset, it may choose tocapitalize it, thus deferring an expense to a later period

Favorably impacts profitability for that current period

Management uses ethical judgments in resolving two issues:

1. How much of the cost of a long-term asset shouldbe allocated to expense in the current period?

2. How much should be retained on the balance sheet

as an asset that will benefit future periods?


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Long-Term AssetAccounting Policies

Each company must determine how it will

treat long-term assets:

1. What is the cost of the long-term asset?

2. How should the expired portion of the cost of theasset be allocated against revenues over time?

3. How should subsequent expenditures, such as

repairs and additions, be treated?4. How should disposal of the long-term asset be

recorded?


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Discussion: Ethics on the Job

Brattman Company purchases a building and theland on which it is located for a lump sum. Theaccountant must allocate the purchase price betweenthe building and the land. The accountant decides to

allocate a larger portion of the price to the landsince this will improve net income. (If he allocatedmore of the price to the building, depreciationexpense would be higher, thus decreasing netincome.)

Q. Is this decision ethical? What must the accountant

base his decision on?


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What Are Expenditures?

Payments or obligations to make a futurepayment for an asset or for a service

CapitalExpenditure

RevenueExpenditure

Expenditure for the

purchase or

expansion of a long-

term asset

Expenditure for the

repair, maintenance,

and operation of a

long-term asset


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Capital Expenditures

Outlays for plant assets, natural resources, and

intangible assets

Additions, which are enlargements to the

physical layout of a plant assetBetterments, which are improvements to a plant

asset but that do not add to the plants physical

layout

Extraordinary repairs, which are repairs thatsignificantly enhance a plant assets estimated

useful life or residual value


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Acquisition Costs

Includes all expenditures reasonable and necessary toget an asset in place and ready for use

Installation costs

FreightInsurance while in transit

Testing and setup

Are these items considered

acquisition costs?Repair costs

Interest charges on purchase

No

No


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AcquiringLand

Costs that should be debited tothe Land account include:

Purchase price

Agent commissions

Legal feesAccrued taxes paid by

purchaser

Grading

Land preparation feesAssessments for local

improvements

Landscaping

Sample

Acquisition of Land

Net purchase price $170,000

Brokerage fees 6,000

Legal fees 2,000Tearing down old building $10,000

Less salvage 4,000 6,000

Grading 1,000

Total cost $185,000

Improvements to real estate like fences,driveways, or parking lots have a limited

life. They should be recorded in an account

called Land Improvements, not the Land

account.


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Leasehold Improvements

Improvements to leased property that become theproperty of the lessor at the end of the lease

Classified as tangible assets in property, plant,

and equipment section of the balance sheet

Costs of leasehold improvements aredepreciated or amortized over the remainingterm of the lease or the useful life of the

improvement, whichever is shorter.


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Acquiring Equipment

Acquisition costs include:

Purchase price (less cash discounts)

All expenditures connected with purchasing the

equipment and preparing it for use Freight

Insurance in transit

Excise taxes and tariffs

Buying expenses Installation costs

Cost of test runs

Equipment is subject

to depreciation

because it has alimited useful life


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Group Purchases

Land and other assets may sometimes be purchasedfor a lump sum

Because buildings are

depreciable and land is not,the purchase price must be

allocated to each asset

Appraisal Percentage Apportionment

L , ( , , ) 8, ( 8 , )B il i 9 , 9 ( 9 , , ) , ( 8 , 9 )T t ls , 8 ,

ABC Co. buys a building and

the land on which it is situated

for a lump sum of $85,000.

Assume that appraisals yield

estimates of $10,000 for the

land and $90,000 for the

building if purchased separately.

Allocate as follows:


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What Is Depreciation?

The periodic allocation of the cost of a tangibleasset (other than land and natural resources)over the assets estimated useful life

All tangible assets except land have a limited useful life(physical deterioration and obsolescence limit useful life)

Depreciation refers to the allocation of the cost of a plant

asset to the periods that benefit from the asset, not to the

assets physical deterioration or decrease in market value

Depreciation is not a process of valuation; it is a process

of allocation


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Four Factors That Affect theComputationofDepreciation

1. Cost Net purchase price of an asset plus allreasonable and necessary expenditures

to get it in place and ready for use

2

. Residualvalue

Estimated scrap, salvage, or trade-in

value on the estimated date of itsdisposal

3. Depreciable

cost

Cost less residual value

4. Estimateduseful life

Total number of service units expectedfrom a long-term asset


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Depreciation Expense, Asset Name xxxAccumulated Depreciation, Asset Name xxx

To record depreciation for the period

Accounting for Depreciation

Depreciation is recorded at the end of theaccounting period by an adjusting entry


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Methods of Accounting forDepreciation

Accelerated method of depreciation

that results in larger amounts ofdepreciation in earlier years of the

assets life and smaller amounts in

later years

Spreads the depreciable cost evenly

over the estimated useful life of the

asset

Based on the assumption that

depreciation is solely the result of use

and that passage of time plays no role

in the depreciation process

Declining-balance

method

Straight-line

method

Production method


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ifeUsefulstimated

alueesidualCostonepreciatiYearly !

yearper$1,800

years5

$1,000$10,000 !!

A delivery truck costs $10,000 and has an estimated

residual value of $1,000 at the end of its estimated

useful life of5 years.

Straight-Line Method Illustrated


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Cost

YearlyDepreciation

AccumulatedDepreciation

CarryingValue

Date of purchase $10,000 $10,000End of first year 10,000 $1,800 $1,800 8,200End of second year 10,000 1,800 3,600 6,400End of third year 10,000 1,800 5,400 4,600End of fourth year 10,000 1,800 7,200 2,800End of fifth year 10,000 1,800 9,000 1,000

Theamountof

depreciationisthesameeachyear

Accumulated

depreciationincreasesuniformly

Thecarryingvalue

decreasesuniformlyuntilitreachestheestimated

residualvalue

DepreciationSchedule,Straight-Line Method


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A delivery truck costs $10,000 and has an estimated residual value of

$1,000 at the end of its estimated useful life of five years. Assume the

truck was driven 20,000 miles during year 1; 30,000 miles during year2;

10,000 miles during year3; 20,000 miles during year4; and 10,000 miles

during year5.

ifeUsefulofUnitsstimated

alueesidualCostCostonepreciati !

mileper$0.10miles90,000$1,

000$1

0,000

!!

The unit of output

or use should be

appropriate for

that asset

Production Method


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Cost Miles

YearlyDepreciation

AccumulatedDepreciation

CarryingValue

Date of purc ase $10,000 $10,000End of first year 10,000 20,000 $2,000 $2,000 8,000End ofsecond year 10,000 30,000 3,000 5,000 5,000End of third year 10,000 10,000 1,000 6,000 4,000

End of fourth year 10,000 20,000 2,000 8,000 2,000End of fifth year 10,000 10,000 1,000 9,000 1,000

Thereisadirectrelation

betweentheamountof

depreciationeachyear

andtheunitsofoutput

oruse.

Accumulated

depreciationincreases

eachyearindirect

relationtounitsof

outputoruse.

Thecarryingvalue

decreaseseachyearin

directrelationtounitsof

outputoruseuntilthe

estimatedresidualvalueis

reached.

DepreciationSchedule,Production Method


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Declining-Balance Method

Based on the passage of time

Assumes that many kinds of plant assetsare most efficient when new

Is consistent with the matching rule

Any fixed rate can be used

Most common rate is twice the straight-line depreciation percentage (calleddouble-declining-balance method)


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Double-Declining-BalanceMethod Illustrated

A delivery truck costs $10,000 and has an estimated residual

value of $1,000. Its estimated useful life is 5 years.

Under the straight-line method, the depreciation rate for each

year is 20 percent:

percent20years5percent100 !z

Under the double-declining-balance method, the depreciation

rate for each year is 40 percent:

percent40percent202 !v

This fixed rate is applied to the remaining carrying value

at the end of each year.


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Graphic ComparisonofThree MethodsofDeterminingDepreciation


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RevisingDepreciation Rates

Sometimes a company must revise its estimateof an assets useful life or its residual value

The periodic depreciation expense will increase or

decrease depending on the adjustment

The remaining depreciable cost of the asset should

be spread over the remaining years of useful life


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Methods ofDisposal

Discard

Sell for cash

Exchange for another asset

When plant

assets are no

longerusefu

1. Record depreciation for the partial year up to the date

of disposal

2. Remove the carrying value of the asset


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MGC Company purchased a machine on January 2, 20x2, for $6,500 and

planned to depreciate it on a straight-line basis over its estimated useful life

(8 years). Its residual value at the end of8 years was estimated to be $500.

On December31, 20x7, the balances of the relevant accounts were:

Machi ry ccumulat r ciati , Machi ry

6,500 4,650

On January 2, 20x8, management disposed of the asset.

Disposal of a Depreciable Asset


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Disposal of a Plant Asset

Remove the carrying value of the asset Carrying value is computed by subtracting accumulated

depreciation from the acquisition cost of the asset If the asset is fully depreciated, the carrying value is zero If the asset is not fully depreciated, a loss is recorded

Jan. 2 Accumulated epreciation, Machiner 4,650

oss on isposal of Machiner 1, 50Machiner 6,500

iscarded machine no longerused in business

Accum. r ciati , Machi ry

4,650

Machi ry

6,500 4,6506,500

al. -0- al. -0-

Gains and losses on disposal of plant assets are classified as other

revenues and expenses on the income statement.


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Selling a Plant Asset for Cash

In addition to removing the carrying value of the

asset, you will also record the cash received

If cash received = carrying value, no gain or loss is

recorded

If cash received < carrying value, loss

is recorded

If cash received > carrying value, gain

is recorded


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Selling an Asset for CashCash Received = Carrying Value

Received $1,850 cash for sale of machinery.

Remove the carrying value of the asset and record receipt of cash:

Jan. Cas ,8Acc lat D r ciati n, ac inery ,

ac inery ,Sale f ac inery f r carryingal e;nogainor loss


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Selling an Asset for CashCash Received < Carrying Value


Jan. Cas ,Acc lated Depreciation, ac inery ,Loss on Saleof ac inery 8

ac inery ,Saleof ac inery at less t an carryingal e; loss of 8 recorded

( ,8 , )



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Selling an Asset for CashCash Received > Carrying Value


Jan. 2 ash 2,000Accumulated epreciation, Machiner 4,650

Gain on ale of Machiner 150Machiner 6,500

ale of machiner at more than carr ingvalue; gain of $150 recorded($2,000 $1, 50)



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Exchanges of Plant Assets

May involvesimilar assets

May involvedissimilar assets

Old

machine

traded in

for newer

model

Cement

mixertraded in

for truck

Purchase price is reduced by the amount of the trade-in allowance

If trade allowance is greater than assets carrying value, gain realized.

If trade allowance is less than assets carrying value, loss realized.


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What Are Natural Resources?

Assets that are converted to inventory bycutting, pumping, mining, or other extractionmethods

Timberlands

Oil and Gas Reserves

Mineral Deposits

Record at acquisition

cost and show on the

balance sheet as

long-term assets


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AvailableUnitsofumberstimated

alueesidual-esourceaturalofCostper UnitCostepletion !

Depletionof Natural Resources

(1) The exhaustion of a natural resource and(2) The proportional allocation of the cost of a

natural resource to the units extracted

Costs are allocated

much like the

production method

of depreciation


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RecordingDepletion Expense

A mine that cost $1,800,000 has an estimated 1,500,000 tons of coal.The estimated residual value of the mine is $300,000. During the first

year, 115,000 tons of coal are mined and sold.

AvailableUnitsofumberstimated

alueesidual-esourceaturalofCostper UnitCostDepletion !

per ton$1tons1,500,000

$300,000-$1,800,000 !!

Dec. 31 Depletion Expense, Coal Deposits 115,000Accumulated Depletion, Coal Deposits 115,000

To record depletion of coal mine: $1per ton, 115,000 tons mined and sold

Natural resources that have been extracted but not sold are considered inventory

and are not recorded as an expense until the year sold.


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Development and Exploration Costsin the Oil andGas Industry

Use one of these two accounting methods:

Successful

efforts method

Cost recorded as an asset and depleted over the

estimated life of the resource. For an unsuccessful

effort, write off immediately as a loss.

Full-costing

method

All costs, including costs of dry wells, are

recorded as assets and depleted over the estimated

life of the producing resources. Improves earnings

performance in the early years.


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What Is an Intangible Asset?

GoodwillTrademarks

Brand names

Copyrights

Patents

Leaseholds

Software

Customer Lists

Long-term, nonphysicalasset whose value comes

from the rights or

advantages afforded its

owner


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Importance of Intangibles

For some companies, intangible assets make up asubstantial portion of total assets


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Accounting for Intangible Assets

Intangibles developed

by a firm for its own

benefit

Intangibles acquired

from others

Record as expense Record as asset; amortizeover the shorter of useful

life or legal life (not to

exceed 40 years)


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Difficult Issues WhenAccounting for Intangibles

How to account for the initial carrying value?

How to account for that amount under normal

business conditions (periodic write-off or

amortization)?

How to account for the amount if the value

declines substantially and permanently?

How to estimate an intangible assets value

and useful life?


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Intangible Assets Illustrated

Soda Bottling Company purchases a patent on a unique bottle cap for$18,000. The patent will last for20 years, but the product using the cap

will be sold only for the next six years.

Patents 8,000ash 8,000

ecord rchaseof ottlecappatent

Recordthepurchaseofthepatent:

Amortization xpense 3,000Patents

3,000orecordamortizationexpensefor

patent ($ 8,000 6 years)

Recordtheannualamortizationexpense:

NoticethatthePatentsaccount isdirectly reduced y theamountofamortizationexpense, whereasdepreciationordepletion isaccumulated inseparatecontraaccountsforotherlong-term assets.


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Intangible Assets Illustrated(contd)

The patent becomes worthless after only 1 year. Record the write-off:

If the patent becomes worthless before it is fully amortized, theremaining carrying value is written off as a loss by removing it from

the Patents account.

Loss on Patent 15,000

Patents 15,000

To record the write -off of aworthless patent($18,000$3,000)


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Research andDevelopment Costs

The FASB requires that all R&D costs be treated as

revenue expenditures and charged to expense in the

period in which they are incurred.

Why? Too difficult to trace specific costs to specific profitable

developments

Costs of R&D are continuous and necessary for thesuccess of a business and are treated as current expenses

Studies show that 30 to 90 percent of all new products fail

and 75 percent of new-product expenses are unsuccessful


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Computer Software Costs

Costs incurred in developingcomputer software for sale or

lease or for a firms internal use

are research and development

costs until the product hasproved technologically feasible

Costs incurred beforetechnologically feasible

should be charged to expense

as incurred

Once a working program is

ready, all costs are recordedas assets

Amortize over theestimated economic life

using the straight-line

method


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954Copyright Houghton Mifflin Company All rights reserved

Goodwill

A companys good reputationCustomer satisfaction

Good management

Manufacturing efficiency

Good location

Goodwill exists when a purchaser pays more for a business

than the fair market value of the businesss net assets

Goodwill should not be recorded unless it is paid for in connection with

the purchase of a whole business

Goodwill = Purchase price FMV of identifiable net assets

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