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Principles of AccountingPrinciples of Accounting•• Kimmel Kimmel •• Weygandt Weygandt •• Kieso Kieso

Chapter 9Chapter 9

Reporting and Analyzing Reporting and Analyzing Long-Lived AssetsLong-Lived Assets

Prepared by Barbara MullerPrepared by Barbara MullerArizona State University WestArizona State University West

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Chapter 9Reporting and Analyzing

Long-Lived Assets

After studying this chapter, you should be able to:

Describe how the cost principle applies to plant assets.

Explain the concept of depreciation.Compute periodic depreciation using the straight-

line method, and contrast its expense pattern with those of other methods.

Describe the procedure for revising periodic depreciation.

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After studying this chapter, you should be able to:

Explain how to account for the disposal of plant assets.

Describe methods for evaluating the use of plant assets.

Identify the basic issues related to reporting intangible assets.

Indicate how long-lived assets are reported on the balance sheet.

Chapter 9Reporting and Analyzing

Long-Lived Assets

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Cost of Plant Assets STUDY OBJECTIVE 1

Plant assets are resources that• have physical substance• are used in the operations of a business• are not intended for sale to customers• deliver service potential over their useful lives

(except land) Plant assets are recorded at cost

• cost consists of all expenditures necessary to acquire the asset and make it ready for its intended use

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Types of Expenditures Revenue Expenditure -

immediately charged against revenue as an expense

Capital Expenditure - increase the company’s investment in productive activity

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Cost is measured by• the cash paid in a cash transaction, or • the cash equivalent price paid when noncash

assets are used in payment. The cash equivalent price is equal to

• the fair market value of the asset given up, or • the fair market value of the asset received,

whichever is more clearly determinable.

Plant Assets

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Cost of land includes• Cash price, closing costs, brokers’

commissions, accrued property taxes, etc.

• Can also include costs to raze a building, drain and fill the land

• Proceeds from sale of salvaged materials are deducted from the cost

Plant AssetsLand

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Cost of Land Improvements

All expenditures necessary to make the improvements ready for their intended use• Drive ways• Parking lots• Fences• Underground sprinklers

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Buildings

All necessary expenditures relating to the purchase or construction of a building.

When a building is purchased such costs include the• purchase price• closing costs (attorney's fees title

insurance)• real estate broker's commissions

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Buildings

If a building is purchased, but needs to be readied for its intended use, cost includes• expenditures for remodeling rooms or

offices• replacing or repairing

o roofo floorso electrical wiringo plumbing

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Buildings

When a building is constructed, its cost consists of• the contract price • architect's fees• building permits• excavation cost• interest costs during during

construction

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Equipment

Cost of equipment includes• purchase price• sales tax• freight charges and insurance during

transit paid by the purchaser• expenditures required in assembling• installing and testing the unit

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Equipment

Two criteria apply in determining the cost of equipment• the frequency of cost - one time or recurring • the benefit period - the life of the asset or 1 year

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Leasing Versus Purchasing an Asset

Advantages of leasing include• Reduced risk of obsolescence

• Little or no down payment

• Shared tax advantages

• Assets and liabilities may not be recorded

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Depreciation STUDY OBJECTIVE 2

The process of allocating to expense the cost of a plant asset over its useful life in a rational and systematic manner.

• Depreciation is not a process of asset valuation.

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Depreciation

Three classes of plant assets are depreciated• Land improvements• Buildings• Equipment

Land is NOT depreciated

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The revenue-producing ability of an asset declines during its useful life because of wear and tear.

Depreciable Assets

A decline in revenue- producing ability may

also occur because of obsolescence.

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Land

Does not depreciate since its usefulness and revenue producing ability generally remain intact, or increase.

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CA

SH

Accumulated Depreciation

• The balance in Accumulated Depreciation is not a cash fund.

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Factors in Computing Depreciation

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Let’s ReviewLet’s Review

Depreciation is a process of:Depreciation is a process of:

a.a. valuation.valuation.

d.d. appraisal. appraisal.

c.c. cash accumulation. cash accumulation.

b.b. cost allocation. cost allocation.

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Let’s ReviewLet’s Review

Depreciation is a process of:Depreciation is a process of:

a.a. valuation.valuation.

d.d. appraisal. appraisal.

c.c. cash accumulation. cash accumulation.

b.b. cost allocation.cost allocation.

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Depreciation Methods STUDY OBJECTIVE 3

Straight-line Declining-balance Units-of-activity

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Straight-line Method

Depreciable Cost*________________________________________________________________________________________________________

The asset's useful life measured in years

*(cost of the asset less its salvage value)

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Straight-Line Depreciation Formula

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Straight-line Method

Is the most widely used method of depreciation.

Depreciation is the same for each year of the asset's useful life.

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Partial Year Depreciation

If an asset is purchased during the year rather than on January 1, the annual depreciation is prorated for the proportion of a year it is used.

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Declining-Balance Method Is an accelerated

method. Accelerated methods

of depreciation result in more depreciation in the early years of an asset's life and less depreciation in the later years.

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Units-of-Activity Method

The life of an asset is expressed in terms of the total units of production or the use expected from the asset.

The amount of depreciation is proportional to the activity that took place during the period.

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Patterns of Depreciation

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Depreciation and Income Taxes

• The IRS allows corporate taxpayers to deduct depreciation when computing taxable income.

• The IRS does not require the taxpayer to use the same depreciation method on the tax return that is used in preparing financial statements.

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Depreciation and Income Taxes

Many large corporations use straight-line depreciation in their financial statements to maximize net income.

At the same time they use a special accelerated-depreciation method on their tax returns to minimize their income taxes.

The choice of depreciation method must be disclosed in the notes to financial statements.

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Revising Periodic Depreciation STUDY OBJECTIVE 4

A change in estimate (estimated useful life, estimated salvage value, etc.) affects current and future years but not prior periods.

Significant changes in estimate must be disclosed in the financial statements.

Extending an asset's estimated life reduces depreciation expense and increases net income for the period.

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EXPENDITURES DURING USEFUL LIFE

Ordinary Repairs • are expenditures to maintain the

operating efficiency and expected productive life of the asset.

• are usually small in amount that occur frequently throughout the service life.

• examples include oil changes on vehicles and painting of buildings.

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EXPENDITURES DURING USEFUL LIFE

Additions and Improvements

• are expenditures incurred to increase the operating efficiency, productive capacity, or expected useful life of the plant asset.

• are usually material in amount and occur infrequently during the period of ownership.

• are capital expenditures.

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Impairments

A permanent decline in the market value of an asset.

The asset is written down to the new market value during the year in which the decline occurs.

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Plant Asset Disposals STUDY OBJECTIVE 5

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Sale of Plant Assets

In the sale of an asset, the book value of the asset is compared with the proceeds from the sale.

• If the proceeds exceed the book value a gain on disposal occurs.

• If proceeds from the sale are less than the book value a loss on disposal occurs.

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Retirement of Plant Assets

A retirement is recorded by • decreasing Accumulated Depreciation for the full

amount of depreciation taken over the life of the asset, and

• decreasing the asset account for the original cost of the asset.

The loss is equal to the asset's book value at the time of retirement (a gain is not possible).

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Analyzing Plant Assets STUDY OBJECTIVE 6

The two measures by which plant assets are evaluated are

• Return on Assets Ratio

• Asset Turnover Ratio

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Return on Assets Ratio

Indicates the amount of net income generated by each dollar invested in assets

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Asset Turnover Ratio

Indicates (1) how efficiently a company uses its assets, and (2) how many dollars of sales are generated by each dollar invested in assets?

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Analyzing Plant Assets

A company can increase its return on assets by (1) increasing profit per sale as measured by profit margin ratio, or (2) increasing its volume of sales as measured by the asset turnover ratio

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Intangible Assets STUDY OBJECTIVE 7

Intangible assets are rights, privileges, or competitive advantages

Intangible assets result from ownership of long-lived assets that do not possess physical substance

Intangible assets are often a company’s most valuable assets

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Types of Intangible Assets

Patents Copyrights Trademark or Trade Names Franchises and Licenses Goodwill

PATENT

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Intangible Assets

Intangible assets are recorded at cost If the intangible has a limited useful life, its

cost is allocated (amortized) over the useful life.

If the intangible has an indefinite life, it is not amortized.

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Patents are an exclusive right that enables the recipient to manufacture, sell, or control a patent for 20 years from the date of grant.The initial cost of a patent is cash or cash equivalent price paid to acquire the patent. Legal costs of protecting a patent are added to the Patent account and amortized over the remaining life of the patent.

Patents

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R&D costs are expenditures that may lead to a patent, copyright, or other intangible asset

R&D costs are not intangible assets R&D costs are usually expensed as

incurred

Research and Development Costs

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Copyrights

Copyrights are granted by the federal government giving the owner the exclusive right to reproduce and sell artistic or published work.

Copyrights extend for the life of the creator plus 70 years.

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Trademarks/ Trade Names

A word, phrase, jingle,or symbol that distinguishes or identifies a particular enterprise or product.

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Franchises and Licenses A franchise is a contractual agreement under

which the franchiser grants the franchisee the right (within a designated geographic area)

• to sell certain products• to render specific services, or • to use certain trademarks or trade names When costs can be identified with the

acquisition of the franchise or license, an intangible asset should be recognized

Annual payments made under a franchise agreement should be recorded as operating expenses

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Goodwill Goodwill represents the value of all favorable

attributes that relate to a business enterprise, including• exceptional management• desirable location• good customer relations• skilled employees

Goodwill cannot be sold individually, it is associated with the business as a whole

Goodwill is only recorded when an entire business is purchased

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Presentation Of Long-lived Assets

STUDY OBJECTIVE 8

Plant assets are shown in the financial statements under Property, Plant, and Equipment.

Intangibles are shown separately under Intangible Assets

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Presentation Of Long-lived Assets

Contra accounts• Plant assets make use of a contra account “Accumulated

Depreciation”

• Amortization of intangible assets is recorded directly to the asset account, bypassing the use of a contra account

Disclosures include major classes of assets

and methods of depreciation

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