Beruflich Dokumente
Kultur Dokumente
ondUse Assefs
Operolionol
| | / \ A tl \/ | n
iere s VVnereYouve Seen
InChopter3, you leorned:
. Accruols in whichtheexchonge
ore tronsoctions
of therelotedqoodsond services
. Deferrols of coshcomesbeforetheexchonge
in whlchtheexchonge
oretronsoctions
of therelctedgoodsond services.
Bothore portof occruolbosisoccounting.
Here'sWhereYou'reGoino
. Youwillleornto occount
forthepurchose mcnufocturing
onduseof bulldings, plonts,
equipment, noturol ond intongible
resources, ossetsl
. Youwlll leornhow tronsoctions on thefl-
ossetsore presented
relotedto long-term
nonciolstotemenls.
ffieruw"{ryW$laefives
When you are finished studying this chapter' you should be able to:
1- Explain how long-term assetsare classified and how their cost is computed.
2" Explain and compute how tangible assetsare written off over their useful lives and
reported on the financial statements.
3. Explain and compute how intangible assetsare written off over their useful lives
and reported on the financial statements.
5. Explain how the disposal ofan assetis reflected in the financial statements.
{r. Recognize and explain how long-term assetsare reported on the financial state-
ments, and preparefinancial statementsthat include long-term assets.
7, Use return on assets(ROA) and the assetturnover ratio to help evaluatea firm's
performance.
€fAtesJdaffers
The bankruptcyof WorldComin 2002was the culminationof an
$11 billionaccountingfraud,the largeston record.ScottSullivan,
the former chief financialofficer (CFO)receiveda 5-yearprison
sentencefor his part in the fraud. Sentencingguidelinessuggest
25 yearsfor his crimes,but he was rewardedfor his cooperation
with government prosecutorsin the case against former CEO
BernardEbbers.Ebberswas sentencedto 25 yearsbut is appeal-
ing both the convictionand the sentence,
Besides Sullivanand Ebbers,who will pay for the $11 billionfraud? Eleven
former membersof the WorldCom board of directorsagreed to pay investors
$20 millionas partialcompensationfor the investors'losses. The directorswill
pay this money from their own pockets,in addition to any amountspaid by
the insurance companiesthat providedliabilityinsurance for the directors.The
resultof this type of settlement,similarto the agreementby the Enrondirec-
torsto pay $13 million to investors,could be harmful to all investorsin pub-
licfy traded companies.Accordingto Daniel Akst, a writer for The New york
Times,"it's hard to imaginea better systemfor driving away the kind of expe-
rienced,carefulpeopleyou would want most to serveon any board."
So,who paysfor fraudssuchasthoseat WorldComand Enron?Employees,
shareholders, and membersof the board are just a few of the groups.ALL in-
vestorssharethe costsof the unethicalbehaviorof corporatecriminalsin ways
we are just beginningto recognize.
L"{}.1 AcquiringPlantAssets
Ex plainhow long- te rm
assetsare classifiedand So far, you have studied the accounting cycle and know how transactionsmake their way
how their cost is computed. to the financial statements.In this chapter,we will look at the purchaseof long-term assets
that are used in the operation of a business.Long-term assetspurchasedas investmentsor
to resell are not consideredoperational assets,so the information in this chapter does not
apply to them.
All businessespurchase long-term operational assetssuch as computers, copy ma-
chines, and furniture as well as short-term assetssuch as folders, paper, and pens. Acquir-
ing long-term assets,often called fixed assets,is usually more complicated than acquiring
short-term assets.Purchasinglong-term assetsis complex for severalreasons.With long-
term assets,a firm must put a great deal ofcare in selectingthe vendor becausethe relation-
ship could last for a significant amount of time. The monetary investment in long-term
assetsis typically much greaterthan the investmentin short-term assets,and it is more dif-
ficult to disposeof long-term assetsif the company makes a bad decision. For example, a
new computer system for tracking inventory would cost a firm like Staples thousandsof
dollars more than the purchaseof a new telephonefor the employeelounge. If Staples'man-
ager did not like the kind of phone that was purchased,it would be simple to give it away
or donate it to the local Goodwill and buy another.What happensif the manager decides
the wrong computerized inventory system was purchased?It is significantly harder to get
rid of the long-term asset,and it could reflect poorly on the managerwho made the deci-
sion to purchasethe system in the first place.
Before a firm purchasesa long-term asset,it must determine how much revenuethat
assetwill generateand how much the assetwill cost. The cost of a long-term assetmust in-
clude all of the coststo get the assetready for use.Long-term assetsoften require extensive
setup and preparationbefore they become operational,and employeesneed to be trained to
use them. If Staplespurchasesa new computerized inventory system, it may require new
C H A P T E 4R . A C Q U I R I N GP L A N TA S S E T S 155
hardware and software, and employeeswill need to be trained to use the new system.All
of these costs will be recorded as part of the cost of the asset.
Consideringall of thesecostsis part of the processof acquiring a long-term asset.Ac-
countantsthen use thesecoststo accountfor the purchaseand useof the asset.What assetsto
buy and how to pay for them are decisionsthat do not affect the income statementat the time
of the purchase.Recordingthe purchaseof a long-term assetaffectsthe balancesheetand po-
tentially the statementof cashflows. As you saw in Chapter3, a businessdefersrecognizing
the expenseof a long-term assetuntil the assetis actually usedin the business.When the as-
setis usedand the expenseis recognized,the expenseis called depreciationexpense.This de-
ferral is an exampleof a timing difference.We havepurchaseda long-term assetat one point
in time in the past, and we will use that assetover a subsequentperiod of time.
EXHIBIT4.1
From the Balance Sheet of Staples, Inc.
( in tho us ands ) Fromthe Balance
Sheetof Staples
January
28, January
29, You won't know the meanins
2006 2005 of some terms Stapleshas
used, but you will learn about
Property and equipment:
ffi"."J]
tangnbte
Land and buildings . .
Leasehold improvements
$ 705,978$ 649,175
884,953 762,946
them in this chaoter.
N l-'
1,330,1911,140,234
I r-::l1 | Equipment
Fumiture and fixtures 672,931 597,293
Totalpropertyandequipment ..... 3,593,9433,149,648
Less accumulated depreciation and amortization 1,835,549t,548,774
Net property and equipment 1,758,3941,600,874
ruffit
I intangible ff,
Lease acquisition costs net of accumulated
amortization
Intangible assetsnet of accumulated amortization . .
34,885 38,400
240,395 222,520
lryq I Goodwill
Other assets
r,378,752 1,321,464
119,619 106,578
Total long-term assets $3,532,045$3,289,836
156 CHAPTER4 . ACQ UI SI TI O NAND USEO F L O N G - T E R MO P E R A T I O N A A
L SSETS
Your Turn4-l For eachof the following costs,tell whether it should be recordedas an asset
'W-mww.w'wor recordedas an expenseat the time of the transaction.
-h$muww 1. Paymentfor employee salaries
2. Purchaseof new delivery truck
3. Rent paid in advance
4. Rent paid in arrears(after use of the building)
Relativefair market value
method is a way to allocate BasketPurchase
Allocation
the total costfor several
assetspurchasedtogether to Calculating the acquisition cost of certain assetscan be diffrcult. Buying a building with the
eachof the individualassets. land it occupiesis an example of a "basket purchase"becausetwo assetsare acquired for a
Thismethod is basedon the single price. For the accountingrecords,the firm must calculatea separatecost for each as-
assets'individualmarket set.Why? The f,rrmwill depreciatethe building but it will not depreciatethe land. The firm
varues.
divides the purchaseprice betweenthe building and land by using the relative fair market
C H A P T E R 4. A C Q U I R I N GP L A N TA S S E T S 157
il\i
ilF
$- -E
Li rud-h.u
$"T. #$il*#usine ss
Leaseor Buy? preciated, just likeanyotherdepreciable assetowned
by the company.
Generally accepted accounting principles (GAAP) try to The accounting standards haveveryspecificrules
makesurethe financialstatements reflectthe sub-
abouthowto account for long-term leases. Thecriteria
stanceof a companys transactions instead of the form if a leasequalifies
for deciding asa capitalleasearevery
of thetransaction. Because a company's financial state- numerous,
technical, andhighlydebated anddiscussed
mentsaresoimportant to investors, creditors, andany-
by standards-setting boardssuchas the Financial Ac-
onewho wantsto evaluate a company's performance,
countingStandards Board(FASB) andtheSecurities and
how a transaction is reflected on thosestatements is (SEC).
Exchange Commission An accountant comesin
veryimportant to the company. Sometimes recording a
handywhenthisissue comesup.
transactionbasedon itssubstance maynot beveryap- In the long-term assets sectionof a company's bal-
pealing. A classic example is buyingor leasing long-
ancesheet,you will oftenseeitemscalledcapitalized
termassets. Whena company buysan asset, it isshown
leasesor leasehold improvements. Capitalized leases
on the balance sheet,andanyamountthat the com- represent assets a companyhas,in substance, bought
panyowesfor thepurchase of theassetmustbeshown but the form of the purchase is a lease.Leasehold im-
on the balance sheetasa liability. provements are long-termassetsin the form of addi-
Suppose a company doesnotwantto put anyaddi- tions and improvements to leasedproperty.For
tionalliabilities
on itsbalance sheet. Thenwoulda com-
example, if a company remodels the interiorof a leased
panyleasean assetinsteadof buyingit? Couldthe
officebuilding, thecostof the remodeling will becalled
company simplyrecordthe expense of leasing the asset leasehold improvements.
as the leasepayments are made?lf the form of the A companydecides whetherto leasean assetor to
transaction is a leasebut the substance is morelikea purchase anasset based on business factorssuchas(1) the
purchase, the leaseis calleda capitallease,and GAAP (2)the interest
typeof assetandthe riskof obsolescence,
saysthe transaction mustbe recorded likea purchase.
rateof theleasepayments compared withtheinterest rate
Inotherwords,a company cannot"hide"futurefinan- purchase, (3) purchase
of a the lease's renewaland op-
cialcommitments related to long-term leases by calling
tions,(4)the acceptable alterations to leasedassets, and
the transaction a leaseand simplyrecognizing the ex- (5)theestimated usefullifeof theleased assetto the busi-
pensewhenthe payments aremade.Thatmeansthe ness.Howeve6 theaccounting treatment shouldnotinflu-
companymustrecordthe asseton the balancesheet goes
encethe economic decision. lt the otherway-the
andalsorecordthe relatedlong-term obligation of the
economic decision influences theaccountinq treatment.
futureleasepayments asa liability.
Thenthe assetisde-
value method. Supposea company purchaseda building and its land togetherfor one price
of $ 100,000.The company would obtain a market price, usually in the form of an appraisal,
for each item separately.Then, the company usesthe relative amountsof the individual ap-
praisalsto divide the purchaseprice of $ 100,000betweenthe two assets.Supposethe build-
ing appraisedat $90,000 and the land appraisedat $30,000. The total appraisedvalue is
($90,000
$120,000 + $30,000).
Thebuildingaccountsfor three-quarters
of thetotal appraised
value.
$90,000+$120,000:3/4
So,theaccountant ofthe totalcostofthebasketpurchase.
recordsthebuildingatthree-fourths
3/4x$100,000:$7 5 , 0 0 0
158 CHAPTER4 . ACQ UI SI TI oNAND Us E oF L o N G - T E R MO P E R A T I O N A A
L SSETS
1/4x$100,000:$25,000
Your Turn 4-2 BargainCompany paid $480,000for a building and the land on which it is lo-
cated. Independentappraisalsvalued the building at $400,000and the land
Wffimpm'
Wmpwwru at $100,000.How much should Bargain €ompany record as the cost of the
building and how much as the cost of the land?Why does the company need
to record the costs separately?
[,.o.2 Tangible
UsingLong-Term Assets:
Ex plainand c om p u teh o w
tangible assetsare written
andDepletion
Depreciation
off over their useful lives Now that you are familiar with the types of assetsa firm may have and the costs associated
and reported on the with their acquisition, we are ready to talk about using the assets.Until property, plant, and
financialstatements. equipment are put into use,their costsremain as assetson the balancesheet.As soon as the
firm uses the asset to help generate revenue, the financial statementswill show some
amount of expense on the income statement.Recording a cost as an asset, rather than
To capitalize is to record a recording it as an expense,is called capitalizing the cost. That cost will be recognized as
cost as an assetrather than to an expenseduring the periods in which the assetis used. Recall from Chapter 3 that depre-
recordit as an expense.
ciation is a systematicand rational allocation processto recognizethe expenseoflong-term
assetsover the periods in which the assetsare used. Depreciation is an example of the
matching principle-matching the cost of an assetwith the revenueit helps generate.For
each year a company plans to use an asset,the company will recognize depreciation ex-
penseon the income statement.
If you hear or read, "The assetis worth $10,000 on our books," that does not mean
the assetis actually worth that amount if it were sold. Instead,it meansthat $10,000 is
the carrying value or book value of the assetin the accountingrecords-it is the amount
not yet depreciated.It is called the carrying value becausethat is the amount at which we
carry our assetson the balancesheet.The amount not yet depreciatedis also known as
the book value becauseit is the value of the asseton the accountingrecords.As you read
about the specific methodsof depreciatingassets,refer to the vocabularyof depreciation
inBxhlbrt 4.2.
Accountants primarily use three terms to describe how a cost is written off over sev-
Amortization meansto write eral accounting periods. Amortization is the most general expressionfor writing off the
off the cost of a long-term cost of a long-term asset.Depreciation is the specific word that describesthe amortization
assetover more than one
of certain kinds of property, plant, or equipment. Depletion is the specific term that de-
accountingperiod.
scribes the amortization of a natural resource.There is no specific term for writing off in-
Depreciationis a systematic tangible assets,so accountantsuse the generaltermamortizationto describewriting off the
and rationalallocation cost of intangibleassets.
processto recognizethe All of theseterms-amortization, depreciation,and depletion-refer to allocating the
expenseof long-term assets cost of an assetto more than one accountingperiod.
over the periodsin which the
Accountants use severalmethods of depreciationfor the financial statements.We will
assetsare used.
discussthree of the most common:
Depletionis the amortization 1. Straight-line depreciation
of a natural resource.
2. Activity (units-of-production) depreciation
3. Declining balance depreciation
CHAPTER4. USI NGLO N G - T E R MT A N G I B L EA S S E T SD
: E P R E C I A T I OANN D D E P L E T I O N 159
EXHIBIT4.2
DepreciationTerminology
The amount paid for the asset, Staples purchases computer cash
including all amounts registers for its new store for
to get the asset up
necessa:tr1 $21.000.
Cost or acquisition cost and runninq
How long the company plans Staples plans to use these cash
to use the asset; may be registers for 10 years.
measured in years or in units
Estimated useful life
that the asset will produce
Estimated value the asset will When Staples is done using the
have when the company is cash registers, the company plans
Salvage value or done with it-the salvage value to seII them for $1,000.
residual value is the estimated market value
on the anticipated disposal
date
Foreachof the following,givethe term for writing off the costof the asset. YOUf TUfn 4-3
1. Equipment Wqmw-wN'.
.fum"w:$
2. Building
3 . Oilwe ll
Straight-tineDepreciation
StraightJine depreciation is the simplestway to allocatethe cost of an assetto the peri- Straight-line
depreciation
isa
ods in which the assetis used.This is the methodwe usedin Chapter3. Using this method, depreciationmethodin which
the depreciationexpenseis the sameevery period. To calculatethe appropriateamountof the depreciation
expenseis
the sameeachperiod'
depreciationexpensefbr eachaccountingperiod,you fbllow severalsteps.
First, you must estimatethe useful life of the asset.The firm should consider this esti-
mate when purchasing an assetand use the estimateafter the purchaseto properly account
for the cost of that asset.
Second,you estimatethe salvagevalue, the amountyou believethe assetwill be worth Salvagevalue(alsoknownas
when the company is finished using it. Salvagevalue is the amount you think someonewill residualvalue)isthe
pay you for the usedasset.Someonewho knows a lot about the assetand the relationship estimatedvalueof an assetat
the end of its usefullife'
betweenthe use of the assetand its market value will estimatethe salvagevalue. Salvag"
value is an estimatethat vou mav need to revise more than once durins the life of the asset.
150 CHAPTER4 . ACQ UI SI TI O NAND USEO F L O N G - T E R MO P E R A T I O N A A
L S5ETs
The useful life and the salvagevalue are related, and the hrm should have made theseesti-
mates as part of the acquisition decision.
Third, you calculatethe depreciablebase-the amount you want to depreciate-by de-
ducting the salvagevalue from the acquisition cost of the asset.This calculation gives the
depreciablebase.
Fourth, you divide the depreciablebase-the difference between the asset'scost and
its estimatedsalvagevalue-by the estimateof the number of yearsof the asset'suseful life.
This gives you the annual depreciationexpense.
EXHIBIT4.3
HolidayHotel'sOrange
J ui ceM ach in e
$11,500invoice price
Cost + 1,000delivery and installation costs
$12,500
Then, Holiday divides the depreciablebaseby the number of years of useful life.
The equipmentaccountwill have a balanceof $12,500during the entire life of the asset.The
accumulateddepreciationaccountwill have a balanceof $2,000 after the 2006 depreciation
is recorded.Here is how the assetis reoortedon the balancesheetat December31.2006:
December
31,2006
Equipment $12,soo
Lessaccumulated
depreciation (2,000)
Net bookvalue $10,s00
In the following year, 2007, the income statementfor the year would again include
$2,000 depreciationexpense.The straight-line method gets its name from the fact that
the sameamount is depreciatedeachyear, so the depreciationexpensecould be graphed
as a straighthorizontal line acrossthe life ofthe asset.The adjustmentat the end of 2007
will be identical to the adjustmentat the end of 2006.It will add $2,000 to the accumu-
lated depreciationaccount,so the new balanceis $4,000.Becausethe income statement
is only for a single year, the depreciationexpensewill again be $2,000. The balance
sheetat December 31,2007 , would show how the carrying value of our assetis declin-
ing, becauseon that date Holiday has used it for 2 years.
December31,2007
E quip me n t $12,s00
Lessaccumulateddepreciation (4,000)
Net book value $ 8,soo
Depreciation
Expense
o
$2,000
2009
Year
Activity (Units-of-Production)
Depreciation
Another way a firm determinesdepreciationexpenseis by estimatingthe productivity of the
asset-how much the assetwill produceduring its useful life. How many units will the asset
produce,or how much work will the assetdo during its useful life? This way of determining
Activity method depreciation depreciationexpenseis called the activity method, also known as the units-of-production
is the method of deoreciation method.Examplesof activitiesare miles driven or units produced.If a companybuys a car, it
in which usefullife is
may decide to use it for 100,000miles before trading it in. The activity method is similar to
expressedin terms of the total
units of activityor production the straighrline method.The differenceis that an estimateof the number of units of activity
expectedfrom the asset,and over the asset'slife is usedasthe allocationbaseinsteadof an estimateof the numberof years
the assetis written off in of useful life.
proportionto its activity
during the accountingperiod. Acquisition cost - Salvagevalue
Rate per activity unit
Estimate useful life in activity units
To use the activity method, Holiday needsto estimatehow many units the machine will
be able to produce during its useful life. SupposeHoliday estimatesthe machine will be
able to produce 240,000 glassesofjuice during its useful life. You calculate the deprecia-
ble basein exactly the sameway when using activity depreciationas when using straight-
line depreciation-subtract the expectedsalvagevalue from the cost. In this example, the
depreciablebaseis $12,000($12,500- $500).You then divide the depreciablebaseby the
total number of units you expect to produce with the machine during its useful life.
C H A PT E R. 4U S IN GL O N G-TE RTA
M N GIB LE
A S S E TS
D:E P R E C IA TION
A N D D E P LE TION 153
Holiday will use this rate of 90.05 per glassto depreciatethe machine for eachglassof juice
it produces.Supposethe machinehas a built-in counterthat showed36,000glassesofjuice
were squeezedduring the first year. The depreciationexpenseshown on the income state-
ment for that year would be $1,800.
That is the depreciationexpensefor the year, and the book value ofthe assetwould decline
by that amount during the year. It is important to keep a record of the book value of the
assetso that Holiday Hotels doesnot depreciatethe assetlower than its $500 estimatedsal-
vage value. The salvagevalue will equal the carrying value when the assethas reachedthe
end of Holiday's estimateof the useful life.
Exhibit 4.5 shows the depreciation schedulefor the orange juice machine, given the
production levels for each year as shown.
EXH I B I T 4. 5
ActivityDepreciation
Production Accumulated Book Value of
Each Year- Depreciation Depreciation Depreciation the Asset
Number of Rate x Number Expense (BalanceSheet (BalanceSheet
Glassesof of Glassesof Juice (lncome at the End of at the End of
Year Orange Juice *Rate:$0.05per Glass Statementl the Yearl the Year)
2006 36,000 x 36,000
$0.05 $1,800 $ 1,800 $10,700
2007 41,000 x 41,000
$0.05 $2,050 $ 3,850 $ 8,650
2008 39,000 x 39,000
$0.05 $1,950 s s,800 $ 6,700
2009 46,000 x 46,000
$0.05 $2,300 $ 8,100 $ 4,400
2010 43,000 x 43,000
$0.05 50
$2,1 $10,250 $ 2,250
2011 35,000 x 35,000
$0.05 $1,750 $12,000 $ 500
Costof machine
of $12,500
minussalvage givesa depreciable
valueof$500, baseof$12,000.
production
Totalestimated glasses.
is 240,000
"Rate= $12,000 = $0.05perglass.
+ 240,000
Withtheactivity
depreciationmethod,thedepreciation
expenseeachyeardependsonhowmanyunitstheassetproduces eachyear.Thismethod
matchestheexpense to theamountof workperformed
bytheasset. thebookvalueis decreasing
Although eachyear,theamountof depreciation
expensewilllikelyvaryfromyear-to-year,
asshownin boththetableandgraph.
As always,accumulated depreciation
isworking
itswayupuntilit
reachesthedepreciable base-costminussalvagevalue.
Thatmeans thebookvaluewillbeequalto theestimated
salvagevalueattheendof itsuseful
life.
Year
CHAPTER4 . ACQ UI SI TI O NAND USEO F L O N G - T E R MO P E R A T I O N A A
L SSETS
DecliningBalanceDepreciation
You have learned about the straight-line depreciationmethod and the activity depreciation
Decliningbalance method. The third method is declining balance depreciation. This method is considered
depreciation is an accelerated an accelerated depreciation method, one that allows more depreciationin the early years
depreciationmethod in which of an asset'slife and less in the later years. The higher depreciation chargeswill occur in
depreciationexpenseis based
on th e de clin ingb ook v alue
the early, more productive yeilrs when the equipment is generatingmore revenue.Depreci-
of the asset. ating more ofthe assetin the first few years also helps even out the total expensesrelated
to an asset.In later years, the depreciation expenseis lower but repair expensesare likely
Accelerateddepreciation is a to be increasing.
depreciationmethod in which The declining balancemethod speedsup an asset'sdepreciationby applying a constant
more depreciationexpenseis
rate to the declining book value of an asset.Frequently,f,rrmsuse a version of the declining
taken in the earlyyearsof the
asset'slife and lessin the later
balancemethod called double-declining balance.The firm takes200Voof the straight-line
years. rate to use as the annual depreciationrate. For example, if the useful life of an assetwere
5 years,the straight-line rate would be one-fifth, or 2OVo.That is because20Voof the asset
would be depreciatedeach year for 5 years using straight-line depreciation.The rate used
for double-declining balance depreciation would be 40Vo, which is 20OVo,or twice, the
straight-line rate. Here is how this method works and why it is called double-declining bal-
ance.Every year, the accountantdepreciatesthe carrying value, or book value, of the asset
by an amount equal to two divided by the useful life in years.
An example will help you seehow this method works. Supposethe useful life of an asset
is 4 years.The double-declining rate would be
2+ 4years= l /2
Alternatively, you could calculate the straight-line rate and then double it.
l00%o+ 4 years = 25Voper year : Straight-line rate
Double it: 50Vo: Double-declining balancerate
Using this depreciation method for Holiday Hotel's orangejuice machine, the book value
at the beginning of the first year is $12,500-its acquisition cost. Notice that the calcula-
tion of the annual depreciation expense ignores any salvage value becausebook value
equalscost minus accumulateddepreciation.Recall that the useful life of the juice machine
is 6 years. So the depreciationrate is
2+ 6years:I/3
EXH I B I T 4. 5
Double-Declining-Balance
Depreciation
Book Value Book Value at
Before Accumulated the End of the
Depreciation Depreciating Depreciation Depreciation Year:$12,500-
Rate = 1/3 the Asset for Expense (At the End Accumulated
Year or 33.333% the Year for the Year of the Year) Depreciation
2006 $12,500 67
$4,1 $ 4,167 $8,333
2007 ?e???
$ 8,333 $2,778 $ 6,94s $5,555
2008 ?e??? ( EqFE $1,852 $ 8,797 $3,703
2009 .33333 $ 3,703 $1,234 $10,031 $2,469
2010 .33333 $ 2,469 $ 823 $10,8s4 $1,646
2011 .33333 $ 1,646 46*
$1,1 $12,000 $ 500**
of (0.33333
"Thecalculation x $1,646)
indicates
depreciation
expenseof $549.
Because thisisthelastyearof itsusefullifeandthebookvalueafter
thisyear'sdepreciation
shouldbe$500,thedepreciation
expensemustbe$1,146to bringthetotalaccumulated depreciationto $12,000.
**Thedepreciationexpense forYear6 mustbecalculated
to makethisthebookvalueattheendof theusefullife-because thebookvalueshould
betheestimatedsalvage value.
Withdouble-declining
depreciation,
depreciationexpense is largerin theearlyyearsof theasset'slifeandsmallerin thelateryears.
Thebookvalueis
decreasing
at a decreasing
rate.Still,the balance
in AccumulatedDepreciation is workingitswayupuntilit reachesthecostminussalvagevalue.A firm
alwayswantsthebookvalueoftheassetto beequalto theestimated salvagevalueat theendof itsusefullife.
20tl
Year
16 6 CHAPTER4 . ACQ UI SI TI O NAND Us E O F L O N G - T E R MO P E R A T I O N A L
AssETS
cost- Salvage
Acquisition value =
Activity Unitdeoreciation
rate
Estimated
usefullifein activitvunits
Ratex Actualactivitylevelfor theyear= Yearlydepreciation
expense
D o u b l e -d e c l ibal
ni ng bookvaluex (2/Estimated
ance Beginning-of-the-year usefullifein years)=
Yearlydepreciation
expense
EXHIBIT4.8 Double-Declinirg
Year StraightLine Activity Balance
Comparison of 2006 2,000 1,800 $ 4,167
$ $
Depreciation Expense 2007 $ 2,000 $ 2,050 $ 2,778
by Yearover the Life 2008 $ 2,000 $ 1,950 $ 1,852
of the OrangeJuice 2009 $ 2,000 $ 2,300 $ 1,234
M ach in efo r 2010 $ 2,000 $ 2,150 $ 823
HolidayHotels 2011 $ 2,000 $ 1,750 $ 1,146
Totaldepreciation
Notice that the annual
expense the
during
depreciation expensediffers
lifeoftheasset $12,000 $12,000 $12,000
among the three methods,but the
total depreciation expensetaken
over the life of assetis the same
Exhibit 4.7 summarizesthe calculationsfor the three depreciationmethods.
for all methods.
Over the useful life of the asset,the sametotal depreciationexpensewill be recognized
no matter which method is used. Exhibit 4.8 comparesthe depreciationexpenseof the or-
angejuice machine with the three different depreciationmethods.
Depletion. Now that you know how equipment and similar kinds of fixed assetsare
written off using various depreciation methods, we turn our attention to the way natural
resourcesare written off. When a company uses a natural resource to obtain benefits for
the operationof its business,the write-off of the assetis called depletion.For example,
Cleveland-Cliffs, the largest producer of iron ore pellets in North America, uses deple-
tion to expenseiron ore. The company shows depreciation and depletion together on the
balance sheet. Exhibit 4.9 shows the fixed asset portion of the firm's balance sheet.
EXHIBIT4.9
FixedAssets Cleveland-Cliffs
from Cleveland-Cliffs FYomthe Balance Sheet
BalanceSheet December31, 2005
( i n m i l l i ons )
at December31,2005
Properties
Plant and equipment $557.50
Minerals 42t.80
979.30
Allowances* for depreciation and depletion (176.50)
Total properties .. . .. $802.80
Often, all amounts of depreciation, depletion, and amortization are captured in a single
total on the balance sheet.
Depletion is similar to the activity depreciationmethod, but it applies only to writing
off the cost of natural resources.Examples of suchnatural resourcesare land being usedfor
oil wells and mines. A depletion cost per unit is calculated by dividing the cost of the nat-
ural resource less any salvagevalue by the estimated units of activity or output available
from that natural resource. The depletion cost per unit is then multiplied by the units
pumped,mined, or cut per period to determinethe total depletion related to the activity dur-
ing the period.
Supposethat, on Januaryl,2005, a companypurchasesthe rights to an oil well in Texas
for $100,000,estimatingthe well will produce200,000barrelsof oil during its life. The deple-
tion rate per barrel is:
If 50,000 banels are producedin the year 2005, then the depletion related to the 50,000 bar-
rels produced in 2005 will be:
On the December 3I,2005, balaace sheet,the book value of the oil rights will be:
- $25,000= $75.000
$100,000
UsingIntangibleAssets:
Amortization L"{"}.3
E xpl ai nand computehow
In addition to tangible assets,most firms have intangible assets,which are rights, privi- i ntangi bl eassetsare
leges,or benefitsthat result from owning long-lived assets.Intangible assetshave long- written off over their useful
term value to the firm, but they are not visible or touchable.Their value residesin the rights livesand reported on the
and privilegesgiven to the ownersofthe asset.Theserights are often representedby con- fi nanci alstatements.
tracts.Like tangibleassets,they are recordedat cost,which includesall ofthe costsa firm
incurs to obtain the asset.
If an intangible assethas an indefinite useful life, the assetis not amortized. However,
the firm will periodically evaluate the assetfor any permanent decline in value and then
write it down if necessily. The idea here is that the balance sheetshould include any asset
that has future value to produce revenuefor the firm, but the assetshould never be valued
at more than its fair value. Writing down an assetbecauseof a permanentdecline in value
means reducing the amount of the assetand recording a loss that will go on the income
statement,
Intangible assetsthat have a limited life are written off over their useful life or legal
life, whichever is shorter,using straight-line amortization. That means an equal amount is
expensedeachyear.Firms use an accumulatedamortization accountfor eachintangible as-
set becausethe accumulatedamortization must be reported.Accumulated depreciationand
accumulated amortization are often added together for the balance sheet presentation.
Firms often have one or more intansible assets.
Copyrights
Copyright is a form of legal protection for authorsof "original works of authorship,"pro- A copyrightis a form of legal
vided by U.S. law. When you hear the term copyright, you probably think of written works protection for authors of
such as books and magaztnearticles. Copyright protection extendsbeyond written works "original works of
to musical and artistic works and is availableto both published and unpublishedworks. Ac- authorship,"providedby U.S.
taw.
cording to the 1976 Copyright Act, the owner of the copyright can
. copy the work
. use the work to prepa.rerelated material
. distribute copies of the work to the public by sale,rental, or lending
. perform the work publicly, in the case of literary, musical, dramatic, and choreo-
graphic works
168 CHAPTER4 . ACQ UI SI TI O NAND USEO F L O N G - T E R MO P E R A T I O N A L
ASSETS
. perform the work publicly by means of a digital audio transmission, in the case of
sound recordings
All costs to obtain and defend copyrights are part of the cost of the asset.Copyrights
arc amortized using straight-line amortization over their legal life or their useful life,
whichever is shorter.
Patents
A patent is a propertyright A patent is a property right that the U.S. governmentgrantsto an inventor "to exclude oth-
that the U.S.government ers from making, using, offering for sale, or selling the invention throughout the United
grantsto an inventor "to
Statesor importing the invention into the United Statesfor a specifiedperiod of time in ex-
excludeothersfrom making,
change for public disclosure of the invention when the patent is granted." For example,
using,offering for sale,or
sellin gthe in ve ntio n Micron Technology filed for a patentfor a computermemory device in February 2004. IBM
throughout the United States obtained a patent for a vibration-driven wireless network in April 2000. Did you know that
or importingthe invention universities apply for hundredsof patentseach year for their inventions?In20O4, the Uni-
into the United Statesfor a versity of California applied for 424 patents-more patentsthan any other university.
specifiedperiod of time."
As with copyrights, coststo defend patents arecapitalized as part of the cost of the as-
set.Patentsarc amortizedusing straight-line amortization over their useful life or legal life,
whichever is shorter.For example, most patentshave a legal life of 20 years. However, a
company may believe the useful life of a patent is less than that. If the company believes
the patent will provide value for only 10 years,the company should use the shortertime pe-
riod for amortizing the asset.
Trademarks
A trademark isa symbol, A trademark is a symbol,word, phrase,or logo that legally distinguishesone company's
word,phrase, or logothat product from any others, One of the most recognizedtrademarksis Nike's swooshsymbol.
legallydistinguishesone In many cases,trademarksare not amortized becausetheir useful lives are indefinite. Reg-
company's productfrom any
others. istering a trademark with the U.S. Patent and Trademark Office provides 10 years of pro-
tection, renewableas long as the trademark is in use.
Franchises
A franchiseis an agreement A franchise is an agreementthat authorizes someone to sell or distribute a company's
that authorizessomeoneto goods or servicesin a certain area.The initial cost of buying a franchiseis the franchisefee,
sell or distributea company's and this is the intangible assetthat is capitalized.It is amortized over the life of the fran-
goodsor servicesin a certain
area.
chise if there is a limited life. If the life of the franchise is indefinite, it will not be amor-
tized. In addition to the initial fee, franchiseowners pay an ongoing fee to the company that
is usually a percentageof sales.You might be surprised at some of the top franchisesfor
2005.They include Subway,Curves,and Quiznos.
Goodwill
Goodwill is the excessof cost Goodwitl is the excessof cost over market value of the net assetswhen one company pur-
over market value of the net chasesanothercompany.When theterm goodwill is usedin everydayconversation,it refers
assetswhen one company to favorable qualities. However, when you seegoodwill on a company's balancesheet,you
purchases another company.
know that it is a result of purchasing anothercompany for more than the fair market value
of its net assets.Goodwill is an advancedtopic for intermediate or advancedaccounting
courses.However, you should have a generalunderstandingof goodwill becauseit appears
on the balance sheetof many firms.
Supposethat The Home Depot purchasedPop's Hardware store for $950,000.The in-
ventory and building-all of Pop's assets-were appraisedat $750,000;and the small hard-
ware store had no debt. Why would The Home Depot pay more than the market value for
the net tangible assetsof Pop's Hardware? Pop's Hardware store had been in businessfor
many years, and the store had a terrific location and a loyal customer base. All of this is
goodwill that Pop's had developedover years of business.GAAP doesnot allow a company
to recognize its internally developedgoodwill, so Pop's financial statementsdo not include
goodwill. Now that The Home Depot has decided to purchasePop's Hardware, however,
CH A P TE4R. C H A N GEASFTE R
TH EP U R C H A SOF
E TH EA S S E T 159
the goodwill will be recorded. Here is how the transactionaffects the accounting equation
for Home Depot:
What happensto the intangible assetgoodwill? Goodwill is not amortized becauseit is as-
sumed to have an indefinite life. Even though goodwill is not amortized, companiesmust
evaluategoodwill to make sure it is not overvaluedon the balancesheet.Goodwill that has
lost some of its value must be written down-that is, the asset is reduced and a loss is
recorded.You can read about a frm's goodwill in the notes to the financial statements.
Research
and DevelopmentCosts
Researchand development (R&D) costs have benefits to the firm-at least that is the goal
of R&D. However, R&D costs are expensedand are not capitalized as part of the cost of
an assetbecauseit is not clear that thesecostsrepresentsomethingofvalue. Softwarede-
velopment costs are consideredresearchcosts until they result in a product that is techno-
logically feasible, so these costs must also be expensed as they are incurred. However,
once the software is consideredtechnologically feasible, the costs incurred from that point
on are capitalized as part of the cost of the software. Deciding when a piece of software is
technologically feasible is anotherexample of how firms needto usejudgment when mak-
ing accounting decisions. The firm's developers and computer experts would make this
judgment.
Changes
after the Purchase
of the Asset L"O-4
Exolainhow decreases in
We startedthe chapter with a discussionof the types and costs of long-term assets.Then, val ue,repai rs,changesi n
we discussedhow the accountingrecordsshow the firm's use of thoseassets.Now we dis- productivecapacity,and
cuss how to adjust financial statementsto record three things that may take place after an changesin estimatesof
assethas beenin use. First, the assetmay lose value due to circumstancesoutside the firm's usefull i fe and sal vage
control. Second,the firm may make expendituresto maintain or improve the assetduring value of assetsare reoorted
its useful life. And third, the firm may need to revise its prior estimatesof an asset'sesti- on the fi nanci alstateme nt s.
mated life and salvagevalue.
Assetlmpairment
By now you know that accountantswant to avoid overstatingassetson the balance sheetor
revenueon the income statement.A firm that is getting ready to prepareits financial state-
ments must evaluateits long-term assets,including goodwill and other intangible assets,for
impairment-a permanent reduction in the fair market value of an assetbelow its book lmpairmentis a permanent
value-if certain changeshave occurred. Such changesinclude d e c l i n ei n t h e f a i r m a r k e t
value of an assetsuchthat its
1.. A downturn in the economy that causesa significant decreasein the market value of a book value exceedsits fair
long-lived asset market value.
2. A changein how the company usesan asset
3. A changein the businessclimate that could affect the asset'svalue
An assetis consideredimpaired when the book value of the assetor group of assetsis greater
than its fair market value. Impairment is not easy to measure,but you will read about it in the
notesto almost every set of financial statements.Becausetesting an assetfor impairment can
be quite diff,cult, it is a topic reseryedfor more advancedcourses.However, you should be
familiar with the terminology becauseyou will seeit in almost every annual report.
17O CHAPTER4 . ACQ UI SI TI O NAND USEO F L O N G - T E R MO P E R A T I O N A A
L SSETS
E XHtBtT4 .10
FYomthe Notes to the Financial Statements
DisclosureAbout Asset of Darden Restaurants,Inc.
lmpairment in Darden
Restaurants'Notes to
the Financial In the fourth quarter of fiscal 2004,we recognized asset impairment charges of $37 million
Statements ($23 million after-tax) for the closing of six Bahama Breeze restaurants and the write-down of four
other Bahama Breeze restaurarts, one Olive Garden restaurant and one Red Lobster restauant
The Notes to the Financial
based on an evaluation of expected cash flows. During flscal 2005,we recognizedassetimpairment
Statementsprovide important
charges of $6 million ($4 million after-tax) for the write-down of two Olive Garden restaurants, one
information about the amounts in Red Lobster restauant and one Smokey Bones restaura.ntbased on an evaluation of expected cash
the financial statements. flows. The Smokey Bones restaurant was closed subsequentto frscal 2005while the two Olive
Garden restaurants and one Red Lobster restaurant continued to operate.
Ordinary repairs are recognizedas current expensesbecausethey are routine and do not in-
creasethe useful life ofthe assetor its efficiency. Ordinary repairs, such as painting, tune-
ups for vehicles, or cleaning and lubricating equipment are expendituresthat are necessary
to maintain an assetin good operating condition and are expensedas incurred'
Supposethe computer terminals at Staples' corporate offices need a monthly tune-up
and cleaning.The cost of this maintenancewould be an expense-recognized in the period
the work was done. But suppose Staples upgraded its computer hardware to expand its
capability or its useful life. This cost would be considered a capital expenditure and
capitalized-recorded as part of the cost of the assetand depreciatedalong with the asset
over its remaining useful life.
Sellinglong-TermAssets L.O.5
E xpl ai nhow the di spo salof
We have bought the long-term assetand used it-depreciating, depleting, or amortizing it
an assetis reflectedin the
over its useful life. Now, we deal with getting rid of an asset.Disposing of an assetmeans financialstatements.
to sell it, trade it in, or simply toss it in the trash. When would a company sell an asset?
Sometimesan assetis sold becauseit is no longer useful to the company.Other times an as-
set is replaced with a newer model, even though there is remaining productive capacity in
the current asset.You calculate the gain or loss on the disposalof an assetby comparing the
172 CHAPTER4 . ACQ UI SI TI O NAND USEO F L O N G - T E R MO P E R A T I O N A A
L SSETS
Perry PlantsCompanyowned an assetthat originally cost $24,000.The com- Your Turn 4-8
pany sold the asseton January 1,2005, for $8,000cash.Accumulateddepre-
ciation on the day of sale was $18,000.Determine whether Perry should
Y*asr Wesvm
recognizea gain or a losson the sale.lf so, how much?
Presentationof Long-Term
Assets H,.{J.6
R ecogni zeand expl ai nh ow
on the Financial
Statements long-termassetsare
ReportingLong-Term
Assets reported on the financial
statements,and prepare
In this chapteryou have seenthat both tangible and intangible long-term assetsale recorded
financialstatementsthat
at the amount the firm paid for them. The assetsare shown on the balance sheetin the last include long-termassets.
halfofthe assetsection, after current assets.Becausethe carrying value ofproperty, plant,
and equipment (PPE) is the difference betweenthe cost of the assetand its accumulatedde-
preciation, accountantssay that PPE is reported atits amortized cost or its depreciatedcost.
The notes to the financial statementsare a good place to learn the types of assets,approxi-
mate age of the assets,and depreciationmethod(s) used.
The use of long-term assetsis shown on the income statement with depreciation,
depletion, aad amortization expense.Often, the amount is included in the total of several
accountsfor presentationon the income statement.
The statementof cash flows will indicate any cash expendituresfor PPE as cash used
for investing activities. Any cash received from the sale of long-term assetswill be shown
as an inflow in the samesection-cash from investing activities-of the statement.Remem-
ber that the gain or loss on the sale of a long-term asset,reported on the income statement,
is not the cashrelated to the sale.The cash collected from the sale will appearon the state-
ment of cashflows.
Exhibit 4.11 showsthe assetsectionof Best Buy's balancesheet.The firm showsthe
various categoriesof fixed assetsat their cost and then shows the deduction for accumu-
lated depreciation.This is all the depreciationthat the firm has taken on its property, plant,
and equipment since their purchase.Some firms show only the net amount, leaving the de-
tails for the notes to the financial statements.In anv case.vou should be able to find or cal-
culatethe cost of a firm's long-termassets.
Preparing
Statements
for Tom'sWear
Since beginning in January2006, Tom's Wear Company has now finished 3 months of busi-
ness.Refresh your memory by reviewing Tom's March 31 balance sheet in Exhibit 4.12,
before Tom's Wear begins the month of April. Tom's Wear has been struggling along, but
Tom believesthat he can make a big profit breakthroughif he can expandhis business.His
researchindicates a large demand for his T-shirts, so he plans a major expansionin April.
Read through eachofthe transactionsand study how they havebeenenteredin the account-
ing equation worksheet in Exhibit 4.13. Then, we will make the end-of-the-month adjust-
ments and preparethe four financial statements.
Transaction 1 In April, Tom's Wear purchaseda van for $25,000. The company paid
an additional $5,000 to have it equipped with the racks for T-shirrs. Tom's Wear fi-
nancedthe $30,000at I}Vo per year for 5 yearswith a local bank. On March 31 of
each year beginning in2007, Tom's Wear will pay the bank the interest it owes for
the year plus $6,000 of the $30,000 principal. Tom's Wear expects the van to be
driven for approximately 200,000 miles and have a residual value of $1,000 at the
end of its useful life. The company decided to depreciatethe van using the activity
method,basedon miles.
Transaction 2 Tom's Wear hired an employee, Sam Cubby, for 20 hours per week to
fold, sort, and deliver the shirts. Sam will earn $1,000 per month, payable on the
ftfth of the following month. Sam will not begin work until May.
Transaction 3 Tom's Wear received cash for the prior month of saleson account, set-
tling the $2,000 accountsreceivableon the March 3I,2006, balance sheet.
174 ASSETS
CHAPTER4 . ACQ UI SI TI O NAND USEO F L O N G - T E R MO P E R A T I O N A L
EXH|S|T4.11
EXHIBIT4,12
BalanceSheetfor Tom's Tom's Wear, Inc.
Wearat March31,2006 Balance Sheet
At March 31, 2006
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176 CHAPTER4 . ACQ UI SI TI oNAND USEoF L o N G - T E R Mo P E R A T I o N A LA S S E T S
Transaction6 Tom's Wear arrangedthe salesof its shirts to a number of sporting good
stores in the area. Each month Tom's Wear will deliver 800 shirts for $10 each to
six different shops.The delivery will be made on the 15th of each month, and the
customer will pay by the 10th of the subsequentmonth. The first deliveries are on
April 15.
Transaction 7 Tom's Wear paid cash for $300 worth of operating expenses.
After you understandeach of the transactionsshown in Exhibit 4.13, you are ready to
make the needed adjustmentsbefore the April financial statementscan be prepared. As
you read each of the explanations for the adjustments,follow along on the worksheet in
Exhibit 4.14.
Adjustment 1 Tom's Wear needsto adjust prepaid insurance.On April 1, there was $75
worth of prepaid insurance on the balance sheet.Recall, Tom's Wear purchased3
months of insuranceon February 15 for a total cost of $ 150,which is $50 per month.
Adjustment 2 Another item that needsto be adjustedis prepaid rent. Tom's Wear paid
$2,400 for 2 months of rent, beginning on April 15. On April 30, half a month's rent
should be expensed.
Adjustment 3 Depreciation expensefor the computer needsto be recorded.Recall, it is
being depreciatedat $100 per month.
Adjustment 4 Depreciation expense for the new van needs to be recorded, It cost
$30,000 and has an estimatedresidual value of $ 1,000. It is being depreciatedusing
the activity method basedon an estimated200,000 miles. During April, the van was
driven 5,000 miles. The rate is $0.145per mile ($29,000depreciablebasedivided
by 200,000miles). The depreciationexpensefor April is $0.145per mile X 5,000
miles : $725.
Adjustment 5 Interest expenseon the note for the computer needsto be accrued.The
3-month,$3,000note at l2%awas signedon March 1. Interestfor April will be $30
($3,000x 0 . 1 2 x U1 2 ).
Adjustment 6lnterest expenseon the note for the van needsto be accrued.The $30,000
note at lj%o was signed on April 1. Interest for April will be $250 ($30,000 X 0. 10
x I/12).
Using the accounting equation worksheet in Exhibit 4.14, yol can see how the financial
statementsare derived. Study each of them by tracing the numbers from the worksheet to
the appropriatefinancial statement,shown in Exhibit 4.15.
L"{t;l ApplyingYourKnowledge-RatioAnalysis
Usereturnon assets (ROA)
andthe assetturnoverratio You know how a firm recordsthe purchaseoflong-term assetsand how it accountsfor the
to helpevaluatea firm's use of the assets.Now we will look at how you can use the information about long-term as-
performance. setsto help evaluatethe performance of the firm.
Returnon Assets
A company purchasesassetsto help generatefuture revenue. Recall the definition of an
asset-something of value used by a businessto generaterevenue.A ratio that measures
how well a company is using its assetsto generaterevenueis return on assets(ROA). ROA
is an overall measureof a company'sprohtability. Like much of the terminology in account-
ing, the name of this ratio is descriptive.A company's return is what the company is get-
ting back. We want to measurethat return as a percentageof assets.So return on assetsis
literally return-net income--divided by assets.
This ratio measuresa company's successin using its assetsto earn income for the
people financing the business-both owners and creditors.Becauseinterest expenseis
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EXHTB|T4.15
FinancialStatementsfor Tom'sWear
The arrows should help you seethe relationships between the financial statements.
lom'swGal
174
CH A P T E R 4. A P P L Y I N GY O U R K N O WL E D G E - R A T I OA N A L Y S I S 179
EXHIBIT4.16
Apple Computer,Inc. Dell,Inc. Returnon Assets
For the year ended For the year ended for AppleComputer
September 24,2005 February 3, 2006 a n d De ll
(dnllus
Net income
inmi,lliore)
part of what has been earned to pay creditors, it is added back to the numerator. Net in-
come is the return to the owners, and interest expenseis the return to the creditors. So
you add interestexpenseback to net income for the numerator.The denominatoris av-
eragetotal assets.
Using a ratio such as ROA gives financial statementusersa way to standardizenet in-
come acrosscompanies.Exhibit 4.16 provides an example. For the fiscal year ended Sep-
tember24,2005, Apple Computershad a net income $1,335and averageassetsof $9,800
(both in millions). The firm had no interest expenseduring the year. For the fiscal year
endedFebruary3,2006,Dellhadnetincome of $3,572andinterestexpenseof $28, with
averageassetsof $23,162 (all dollars in millions). Clearly, Dell is outperforming Apple
Computers in total net income. But that comparison does not tell us how well each com-
pany is using its assetsto make that net income. If we divide net income plus interest ex-
penseby averagetotal assets,we will get the return on assetsfor the year.
It is clear in this comparisonthat Dell is earning a better return with its total assetsthan
Apple Computer is earning with its assets.The industry averagefor firms in this industry
for return on assetsis 12.6%o. Apple's ROA is 13.62Voand Dell's ROA is 15.54Vousing the
results from the fiscal years shown in Exhibit 4.16. You can find up-to-dateinformation on
the firms' ROA at www.moneycentral.msn.com.
AssetTurnoverRatio
Another ratio that helps us evaluatea frrm's use of its assetsis the assetturnover ratio. This
ratio indicateshow effrciently a company is using its assets.The ratio is defined as net sales
divided by averagetotal assets.The ratio answersthe question: How many dollars of sales
are generatedby each dollar investedin assets?
Net sales
Asset turnover ratio :
Averagetotal assets
Look at Apple Computer and Dell again. Sales for Apple Computer for the fiscal year
ended September24,2005, were $13,931 million, and salesfor Dell for the fiscal year
endedFebruary3,2006, totaled $55,908million. The assetturnoverratio for eachis:
(dollars
in millions) AppleComputer D el l
I".f).8 Business
Risk,Control,and Ethics
l dent if yand des c ri b eth e
businessrisksassociated A firm risks losing long-term assetsdue to theft. This risk is not a problem with some large
with long-term assetsand assets,such as a factory, but it is a very seriousproblem with smaller, mobile, fixed assets,
the controlsthat can such as cars,computers,and furniture and fixtures. Even large assets,such as buildings and
minim iz et hos e r is k s . factories, are at risk for damagedue to vandalism,hurricanes,or terrorist activities. One of
the major functions of any company's internal control systemis to safeguardall assetsfrom
theft and damage-whether intentional or unintentional. The cost of safeguardingassets
can be tremendous,as can the cost of replacing them if they are destroyed.The damage
done to long-term assetsby Hurricane Katrina in August 2005 to the Gulf Coast has
amountedto billions of dollars.
Physical controls to safeguardassetsmay be as simple as a lock on a warehouse
door, a video camerain a retail store,or a security guard who remains in an office com-
plex overnight. Even when assetsare protectedin a securefacility with guards,fences,
or alarms,the company must be sure that only the appropriatepeople have accessto the
assets.
Complete and reliable record keeping for the assetsis also part of safeguardingas-
sets. With assetssuch as cash and inventory, the people who are responsible for the
record keeping for long-term assetsshould be different than the people who have phys-
Segregationof duties means ical custody of the assets.This is called segregation of duties and is a very common
that the person who has control.
physicalcustody of an assetis
Monitoring is another control to safeguardassets.This means that someoneneedsto
not the samepersonwho has
record-keepirrg make sure the other controls-physical controls, segregationof duties, and any other poli-
responsibilities
for.that asset. cies and proceduresrelated to protecting assets-are operating properly. Often, firms have
internal auditors-their own employees-who perform this function as part of their job re-
sponsibilities.You may recall that it was an internal auditor who first blew the whistle on
the Enron fraud.
Intangible assetspresent special risks to a firm. Google's attempt to digitize all the
books in the libraries of severalmajor universitieshas brought new concernsover copyright
laws. The value of these intangible assetson a frrm's balance sheetand the potential costs
of defending theserights can amount to signifrcant sums of money. Technology and ethics
have collided, resulting in many questionsabout the legal and ethical dimensionsof current
copyright laws.
'hawefhsA
Googleisscanning of booksin an effortto advance
millions its missionto organize all
knowledge; but in 2005,someauthorsand publishing companies suedGooglefor
copyright infringement. Theargumentis not overthe bookspublishers currently keep
in print;it isoverthe25 millionbooksconsidered "orphans."
lt isverydifficult
to track
downtheownerof thecopyright JaneFriedman, theCEOof HarperCollins Publishers,
doesnot expectthislawsuitto be settledin herlifetime. ButKevinKelly, in a NewYork
Irmesarticle(May14,2006),feelssurethat the technology willwin out. He predicts
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C H A P T E R 4. C H A P T E RS U M M A R Y P R O B L E M S 181
Points
ChapterSummary
. Assetsthat last longer than a year are classified as noncuffent (or long term) on the bal-
ance sheet.They are recordedat cost, including all of the costsnecessaryto get the as-
set ready for use.
. Long-term assetsare written off over their useful lives. For plant and equipment,an as-
set may be written off using either straight-line, activity, or double-declining balance
depreciation methods. Intangible assetswith a definite life are written off, or amor-
tized, using the straighrline method.
. Routine repair and maintenancecostsare expensedas incurred, whereasimprovements
to the productive capacity or the useful life of an assetare capitaTizedas part of the cost
of the asset.
. Any revisions in the useful life or the estimated salvagevalue of an assetare imple-
mented at the time of the revision and in the future periods. Any past depreciationex-
penseis rot revised.
. When an assetis sold, the gain or loss is calculated as the difference between the
proceeds(salesamount) and the book value (cost - accumulateddepreciation)of
the asset.
ChapterSummary
Problems
SupposePencilsOffice Supply startedthe fiscal yearwith the following accountsandbalances:
1. The company purchasednew equipment at the beginning of the fiscal year. The in-
voice price was $158,500, but the manufacturer of the equipment gave Pencils a
37odiscount for paying cash for the equipment on delivery. Pencils paid shipping
costs of $1,500 and paid $700 for a special insurance policy to cover the equip-
ment while in transit. Installation cost was $3,000, and Pencils spent $6,000 train-
ing employees to use the new equipment. Additionally, Pencils hired a new
supervisorat an annual salary of $40,000to be responsiblefor the printing services
area where the new equipment will be used. All payments were made in cash as
the costs were incurred.
2. The company sold some old equipment with an original cost of $12,300 and related
accumulateddepreciationof $11,100.Proceedsfrom the saleamountedto $1,500.
3. The comDanvcollectedcashof $134.200on accountsreceivable.
142 CHAPTER4 . ACQ UI SI TI O NAND USEO F L O N G - T E R MO P E R A T I O N A A
L SSETS
4. The company purchased $365,500 worth of inventory during the year, paying
$200,000 cash, with the remainder purchasedon account.
The company paid insurancepremiums of $12,000.
6. The companypaid $170,000on accountspayable.
7. The company paid employees total cash for salaries of $72,250. (This includes the
amountowed at the beginning of the year and the salaryexpensefor the new supervisor.)
8. The company made sales to customers in the amount of $354,570. They collected
$200,000in cash,and the remainderwas on account.(Inventorysold cost $110,000.)
The company usesonly one revenueaccount: Salesand service revenue.
9. The company paid $50,000 to reduce principal of the long-term note and paid interest
of $10,400.
10. Thecompanypaidoperating
expenses
in theamountof $30,000in cash.
Otherlnformation
A-1. The company owed salariesof $10,250 to employees at year-end (earnedbut not
paid).
A-2, Insuranceleft unused at year-endamountedto $2,000.
A-3. The company estimatesthat the new equipmentwill last for 20 years and have a sal-
vage value of $2,945 at the end of its useful life.
A-4. Previously purchasedfixed assetsare being depreciatedat a rate of lOVoper year.
A-5. Unearned service revenueof $21.000 has been earnedat vear-end.
lnstructions
Set up an accounting equation worksheet. Enter the beginning balances,the transactions,
and any neededadjustmentsat year-end.Then, preparean income statement,statementof
changesin shareholders'equity, the statementof cashflows-all for the fiscal year, and the
balancesheetat December31, 2008.
C H A P T E 4R . C H A P T E RS U M M A R Y P R O B L E M S 183
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C H A P T E4R . A N S WE R ST O Y O U R T U R N Q U E S T I O N S 185
KeyTermsfor Chapter4
Accelerateddepreciation Declining balance Relative fair market value
(p.rca) depreciation(p. 164) method(p. 156)
Activity method Depletion(p. 158) Salvagevalue (p. 159)
depreciation(p.162) Depreciation(p. 158) Segregationof duties
Amortization (p. 158) Franchise(p. 168) (p. 180)
Capital expenditure Goodwill (p. 168) Straight-line depreciation
(p. 170) Impairment(p. 169) (p.1se)
Capitalize (p. 158) lntangibleassets(p. 155) Tangibleassets(p. 155)
Copyright(p.16l) Patent(p. 168) Trademark (p. 168)
Answersto YOUR
TURNQuestions
Chapter4
Your Turn 4-I
1. Expense
2. Asset
3. Asset
4. Expense
Your Turn 4-2
Four-fifthsofthe costs(400,000/500,000 X $480,000): $384,000shouldbe recordedas
thecostof thebuilding,andone-fifthof thecost( I 00,000/500,000 : $96,000
X $480,000)
shouldberecordedasthecostof theland.Thesetwo costsneedto be separatedbecausethe
companywill depreciate thebuildingbut not the land.
Your Turn 4-3
1. Depreciation
2. Depreciation
3. Depletion
Your Turn 4-4
Eachyear'sdepreciation is $2,400[($15,000- $3,000y5years]peryear,sothatamount
will be on the incomestatement for the yearendedDecember31, 2001. At December31,
2007, thecompanywill havetaken2 years'worth of depreciation, so the book valuewill
be$10,200 ($15,000- $4,800).
Your Turn 4-S
Rate: ($44,000- $4,000)+ 100,000: $0.40perunit
2005:3,000unitsx $0.40: $1,200
2006:14,000unitsx $0.40= $5,600
Your Turn 4-6
$50,000x 215: $20,000for thefirst year
Newbookvalue: $50,000- $20,000: $30,000
$30,000x 215: $12,000for thesecondyear
Your Turn 4-7
$6,000+ $2,400: $8,400newdepreciable amount
$8,400/8yearsremaininglife : $1,050peryear
Your Turn 4-8
Thereis a $2,000gainon the sale.Theproceedsof $8,000aregreaterthanthe bookvalue
of $6.000.
186 CHAPTER4 o ACQ UI SI TI oNAND Us E oF L o N G - T E R Mo P E R A T I o N A LA S S E T S
Questions
1. Describe the difference between tangible and intangible assets.
2. What is the difference between capitalizing and expensinga cost?
3. What is depreciation?
4. What does amortization mean?
5. Explain the difference between depreciationand depletion.
6. How do firms determine the cost of property, plant, and equipment?
7. What is a basket purchase?What accounting problem does this type of purchasecre-
ate, and how do firms remedy the accounting problem?
8. What is the carrying value, or book value, of an asset?Is this value equal to the mar-
ket value of the asset?Explain your answer.
9. What is the residual value, or salvagevalue, of an asset?
10. What is the difference between depreciation expenseand accumulateddepreciation?
On which financial statement(s)do depreciation expenseand accumulateddeprecia-
tion appear?
11. How does depreciationapply the matching principle?
12. Explain the difference between the three depreciationmethods allowed by GAAP.
13. What is a copyright and how is it accountedfor?
14. What is a patent and how is it accountedfort
15. What does it mean for an assetto be impaired?
16. What types of costs related to long-term operational assetsare capitalized and what
types are expensed?
17. How is a gain or loss on the disposalof an assetcalculated?On which financial state-
ment(s) would the gain or loss appear?
18. How doesgoodwill arise?
19. How is the return on assets(ROA) ratio calculated and what does this ratio measure?
20. How is the assetturnover ratio calculated and what does this ratio measure?
21. List two typesofcontrols that safeguardassets.
Multiple-Choice
Questions
1. Which of the following is an intangibleasset?
a. Franchise
b. Oil reserves
c. Land
d. Repairs
2, Depreciation is the systematicallocation of the cost of an asset
a. Over the periods during which the assetis paid for
b. Over the periods during which the market value of the assetdecreases
c. Over the periodsduring which the companyusesthe asset
d. Over the life of the company
3. Writing off a cost means
a. Putting the cost on the balance sheetas an asset
b. Evaluating the useful life ofthe asset
c. Recording the cost as an expense
d. Deferring the expense
4. Supposea firm purchasesa new building for $500,000 and spendsan additional
$50,000 making alterationsto it before it can be used. How much will the firm record
as the cost ofthe asset?
a. $500,000
b. $s50,000
c. $450,000
d. It dependson who performed the alterations.
5. Supposea firm buys a piece of land with a building for $100,000.The firm's accoun-
tant wants to divide the cost between the land and building for the firm's financial
records.Why?
a. Land is always more expensivethan buildings.
4 R. S H OR T
C H A P TE E X E R C IS E S 187
ShortExercises
SE4-1. Calculatethe cost of an asset.(LO 1)
Gruber Window Fashionsbought a new wood-cutting machine as a part of its venture into
manufacturing interior shutters.The invoice price of the machine was $90,000.Gruber also
had the following expensesassociatedwith purchasingthis machtne.
What amount should Gruber record on the books for this machine?
AND USEO F L O N G - T E R MO P E R A T I O N A A
L SSETS
What amount should Settler Company record on the books for its new building?
SE4-3.Accountfor basketpurchase.(LO 1)
Tylo Corporation obtained a building, its surrounding land, and a delivery truck in a lump-
sum purchasefor $230,000.An appraisalsetthe value of land at $180,000,the building at
$145,000,and the truck at $25,000.At what amountshouldTylo record eachnew asseton
its books?
SE4-4.Accountfor basketpurchase.(LO 1)
Villa Corporation purchasedthree buildings at a total cost of $960,000.The appraisedval-
ues of the individual buildings were as follows:
Building I $600,000
Building 2 400,000
Building 3 200,000
What amounts should be recorded as the cost for each of the buildings in Villa Corpora-
tion's accounts?
Year 1 12,000
Year 2 10,500
Year 3 9,100
Year4 9,100
Year 5 8,700
SE4-7. Calculatedepreciationexpense:double-decliningbalance.(LO 2)
Using the double-declining balancemethod, calculatethe annual depreciationexpensethat
will be recordedeachyear for an assetthat cost $12,000,has a useful life of 5 years,and
has an estimated salvagevalue of $2,000. Explain what accounting issue arises,if any, in
the fourth and fifth years.
SE4-9. Calculatedepreciationexpense:straight-line.(LO 2)
A machine is purchasedon January2,2006, for $50,000,and it has an expectedlife of
4 years and no estimated salvagevalue. If the machine is still in use 5 years later, what
amount of depreciationexpensewill be reported for the fifth year?
4 . S H O R TE X E R C I S E S 1 8 9
CHAPTER
SE4-11. Calculatedepletion.(LO 2)
CNA Enterprisespurchasesan oil field and expectsit to produce 1,000,000barrels of oil.
The oil field, acquiredin January2006, cost CNA $1.5 million. In20O6,280,000 barrels
were produced. In 2001, the oil field produced 350,000 barrels. What is the depletion for
each of theseyears?
SE4-12. Calculatedepletion.(LO 2)
Earthlink Mining purchaseda copper mine for $12,000,000.The company expectsthe mine
to produce 6,000,000 tons of copper over its 5-year useful life. During the first year of op-
erations,the company extracts750,000 tons of copper.How much depletion should Earth-
link Mining record for the first year?
SE4-13.Amortizationof intangibleassets.(LO 3)
Edgewood Company obtained a patent for a new invention. The costs associatedwith the
patent totaled $35,000.With the rapid developmentof new technology, Edgewood's engi-
neershave estimatedthe invention will not have any value after 10 years.The patent has a
legal life of 20 years. How will Edgewood amofiize the cost of the patent?
SE4-14.Amortizationof intangibleassets.(LO 3)
Barclay Companypurchaseda patentfor $50,000on JanuaryI,2007 . The estimateduse-
ful life is 10 years.The legal life is 20 years.What is the amortization expensefor the fis-
cal year endedDecember31,2007?
SE4-18.Accountfor assetimpairment.(LO 4)
Delta Airlines has determinedthat severalof its planesare impaired. The book value of the
planesis $10 million, but the fair market value of the planesis $9 million. How should Delta
treat this decline?
I ]: 190 CHAPTER4 . ACQ UI SI TI O NAND USEO F L O N G - T E R MO P E R A T I O N A A
L SSETS
truck's salvagevalue to be $5,000.The truck was driven 21,000miles in 2006 and 31,500
miles in 2007.
a. Compute the depreciationexpensefor 2006 and 2007, first using the straight-line
method, then the activity method.
b. Which method portrays more accuratelythe actual use of this asset?Explain
your answer.
record for its annual amortization expense?Show how it would be recordedin the account-
ing equation.
E4-11A. Evaluateassetimpairment.(LO 4)
During its most recent hscal year, Bargain Airlines grounded 10 of its '147s dte to a poten-
tial problem with the wing flaps. Although the planes had been repaired by the end of the
fiscal year, the company believed the problems indicated the need for an evaluation of po-
tential impairment of theseplanes.The results of the analysisindicated that the planes had
petmanently declined in fair value by $120 million below their book value. What effect
would this decline in value have on Bargain Airlines' net income for the year?
Equipment $115,000
Accumulated depreciation 20,000
4 R. E X E R C IS E S 193
C H A P TE :"
The companyusesthe straightJine method, and it now estimatesthe equipmentwill last for
a total of 11 yearswith $5,000estimatedsalvagevalue.The company'sfiscal year endson
December31.
a. How much depreciationdid ShaperCompany record on the equipment at the end
of 2005?
b. After the overhaul at the beginning of 2006, what is the remaining estimatedlife
of the equipment?
c. What is the amount of depreciationexpensethe company will record for 2006?
Calculate the gain or loss on the disposalof the truck for each of the following independent
situations:
a. Dave'sDelivery sold the truck to PapaJohn'sPizzafor $12,000.
b. Dave's Delivery sold the truck to CornerstoneGrocery for $15'000.
c. Dave'sDelivery sold the truck to John'sPlumbing for $16,000.
d. The truck was stolen out of Dave's parking lot, and the company had no
insurance.
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194 CHA P T E4R . A C QU ISIT IoAN
N D U s Eo F L o N G-TE R M
oP E R A TIoN AALssE Ts
the sale?On which financial statementwould that amount be shown?How much would be
shown on the statementof cash flows and in which section?
been repaired by the end of the fiscal year, the company determinedthe problems required
an evaluation of potential impairment of thesetrucks. The results of the analysisindicated
that the trucks had permanently declined in fair value by $7.5 million below their book
value. What effect would this decline have on Super Shippers' net income for the year?
Equipment $94,000
Accumulated depreciation 54,000
During 2008, the following cash costs were incurred for repairs and maintenanceon the
equipment:
b. After the overhaul, at the beginning of 2008, what is the remaining estimatedlife?
c. What is the amount of depreciationexpensethe company will record for 2008?
High-pressuretanningbed $39,000
Accumulateddepreciation 18,000
Calculate the gain or loss on the disposalof the tanning bed for each of the following inde-
pendentsituations:
a. Kat & Jen'ssold the tanningbed to Dark Bodies for $21,000.
b. Kat & Jen'ssold the tanningbed to a customerfor $22,550'
c. Kat & Jen'ssold the tanningbed to Angela's FitnessCenterfor $18,000.
d. The tanningsalonwas broken into and the tanningbed was stolen;Kat & Jen's
had no insurance.
Problem Set A
P4-lA. Calculatecapitalizedcost and depreciationexpense.(LO 1,2)
Acme Print Shop purchaseda new printing pressin 200'7.The invoice price was $158,500,
but the manufacturerof the pressgaveAcme a2%odiscountfor paying cashfor the machine
on delivery. Delivery costs amounted to $1,500, and Acme paid $500 for a special insur-
ancepolicy to coverthe presswhile in transit.Installationcostwas $1,350,andAcme spent
$3,000 training the employeesto use the new press.Additionally, Acme hired a new super-
visor at an annual salary of $65,000 to be responsiblefor keeping the press online during
businesshours.
Required
a. What amount should be capitalized for this new asset?
b. To calculate the depreciationexpensefor 2007, what other information do you
need?Do you think the company should gather this information before
purchasingthe asset?Why or why not?
Year Units
200'7 100,800
2008 130,080
2009 139,200
20to r09,920
Required
a. Calculate the depreciationexpensefor each year ofthe 4-year life ofthe
equipment using
1. StraighGlinemethod
2. Double-decliningbalancemethod
3. Activity method (Round your answersto the nearestdollar.)
b. How does the choice of depreciationmethods affect net income in each of the
years?How does the choice ofdepreciation methods affect the balancesheetin
each of the years?
Required
a. Preparetwo different depreciation schedulesfor the truck-one using the
straightJine method, and the other using the double-declining balancemethod.
(Round to the nearestdollar.)
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C H A P T E R 4. P R O B L E M S 199
b. Determine which method would result in the greatestnet income for the year 2001.
c. (Appendix) How would taxes affect management'schoice between thesetwo
methods for the financial statements?
Required
a. Calculatethe depreciationexpensefor eachyear ofthe 5-yearlife ofthe machine
uslng
1. Straight-line method
2. Double-declining balancemethod (Round to the nearestdollar.)
3. Activity method using units
b. For each method, give the amount of accumulateddepreciationthat would be
shown on the balance sheetat the end of each year.
c. Calculate the book value of the machine at the end of each year for each method.
Patents $35,000
Copyright 21,000
Goodwill 40.000
Required
Show each of the transactionsin the accounting equation, including any adjustmentsthat
would need to be made for the year-endfinancial statements.Then, preparethe intangible
assetssectionof the balancesheetat year-end.
Required
Calculatethe amountof depreciationexpenserelatedto the computersystemHarvey's Hoola
Hoop Company would report on its income statementfor the year ended December 31,
2006, for eachscenario.
Required
For each scenario,calculatethe gain or loss, if any, that would result upon disposal.
Required
a. Calculate the depreciationexpensefor the fiscal years 2007 and2008 using each
of the following methods:
1. Straight-linemethod
2. Double-decliningbalancemethod
b. Assume that Bella Interiors decided to use the straight-line method and that the
sewing machine was sold at the end of December 2009, for $27,000.what was
the gain or loss on the sale?On which financial statementwould the gain or loss
appear?What information does this accounting calculation provide for future
decisions?
Required
a. Assume that the company usesstraight-line depreciation.If the truck is sold for
$25,000, will there be a gain or loss on the sale?If so, how much? How will the
sale affect the financial statementsfor the year?
C H A P T E R 4. P R O B L E M S 201
P4-10A. (Appendix) Analyze and correct accounting errors related to long-term assets.
(Lo 9)
Due to an umpire strike early in 2006, Umpire's Empire had sometrouble with its informa-
tion processingand some effors were made in accountingfor certain transactions.Evaluate
the following independentsituations that occurred during the year:
a. At the beginning of 2006, a building and land were purchasedtogether for
$100,000.Even though the appraisersdeterminedthat9}Vo of the price shouldbe
allocated to the building, Umpire's decided to allocate the entire purchaseprice
to the building. The building is being depreciatedusing the straight-line method
over 40 years,with an estimatedsalvagevalue of $10,000.
b. During the year, Umpire did some R&D on a new gadget to keep track of balls
and strikes. The R&D cost $20,000, and Umpire capitalizedit. The company
intends to write it off over 5 years,using straight-line depreciationwith no
salvagevalue.
c. Near the beginning of the year, Umpire spent$ 10,000on routine maintenance
for its equipment, and the accountant decided to capitalize these costs as part
of the equipment.(Equipmentis depreciatedover 5 yearswith no salvage
value.)
d. Umpire spent $5,000 to extend the useful life of some of its equipment.The
accountantcapitalizedthe cost.
Required
a. For each, describethe error made and list the effect, if any, that the uncorrected
error would have on the following items for Umpire's 2006 financial statements:
net income,long-termassets,and retainedearnings.If thereis no error, simply
write N/A next to the item.
b. Describethe adjustmentsthat would correctthe company'saccountingrecords
and make the 2006 financial statementsaccurate.If there is no error, write N/A
next to the item.
Problem Set B
P4-18. Calculatecapitalizedcost and depreciationexpense.(LO 1,2)
The executivesfor SeaWorld bought a piece of property adjacentto the park with an old,
run-downmotel. The cost of the land with the old motel was $1,500,000.Real estatecom-
missions and fees including the title searchwere $317,850.SeaWorld paid its attorney
$15,000to review the contractand completethe purchaseofthe land on July 1, 2008.The
resortpaid $25,750for the old motel to be demolishedand an additional$17,850for sugar
white sandto be hauled in to preparethe land for use.The company paid $80,000 for some
palm trees for the new area.SeaWorld hired three new employeesat a salary of $35,000 a
year each to maintain the landscapingfor the new area.
Required
a. What amount should be capitalized for this new asset?
b. Would there be any depreciationexpensefor land at the end of 2008? Explain
your answer.
of its useful life of 4 years.A machine like this is supposedto deliver 160,000hours of ser-
vice. The actual number of hours that the machine was used per year was:
Year Hours
2005 40,000
2006 60,800
2001 39,200
2008 20,000
Required
a. Calculatethe depreciationexpensefor eachyear ofthe 4-yearlife ofthe ball
machine using
1. Straighrline method
2. Activity method
3. Double-decliningmethod
b. How does the choice of depreciationmethods affect income in each of the years?
c. How does the choice of depreciationmethods affect the balancesheetin each of
the years?
Required
a. Preparetwo different depreciation schedulesfor the display rack-one using the
straight-line method and the other using the double-declining balancemethod.
(Round to the nearestdollar.)
b. Determine which method would result in the greaternet income for the year 2010.
c. How would taxes affect management'schoice between thesetwo methods for the
financial statements?
Required
a. Calculate the depreciationfor each year using each ofthese depreciation
methods:
1. Straight-linemethod
2. Activity method basedon units
3. Double-declining balance method (round to the nearestdollar)
b. For each method, give the amount of accumulateddepreciationthat would be
shown on the balance sheetat the end of each year.
Calculate the book value of the water filter at the end of each year for each
method.
Trademarks $85,000
Copyright 50,000
Goodwill 80.000
C H A P T E R 4. P R O B L E M S 203
1. At the beginning of the year, Larkin filed for a new trademark. The costs totaled
$40,000. Its useful life is estimatedat 5 years.
2. Larkin incurred R&D costs of $30,000, related to new product development.No new
products have been identified.
3. Larkin evaluatedthe goodwill for impairment and reducesits book value by $20,000.
4. Larkin successfullydefendedits copyrights in court. Feestotaled $10,000.
Required
Show each of the transactionsin the accounting equation, including any adjustmentsthat
would need to be made for the year-endfinancial statements.Then, preparethe intangible
assetssectionof the balancesheetat year-end.
Required
Calculatethe amount of depreciationexpenserelated to the computer systemHallmark
will report on its income statementfor the fiscal year ended June 30,2009, for each
scenarl0.
Required
For each scenario,calculate the gain or loss, if any, that would result upon disposal.
204 CHAPTER4 . ACQ UI SI TI O NAND USEO F L O N G - T E R MO P E R A T I O N A L
ASSETS
Required
a. Calculate the depreciationexpensefor the frscal years 2008 and 2009 using each
of the following methods:
1. Straight-line method
2. Double-declining balancemethod
b. Assume that the company decided to use the double-declining balancemethod
and that the brewery equipment was sold at the end of December 2009, for
$42,000.What was the gain or loss on the sale?On which financial statement
would the gain or loss appear?What information does this accounting calculation
provide for future decisions?
Required
a. Assume that Queen GrandeView uses straight-line depreciation.If the van is
sold for $20,000, will there be a gain or loss on the sale?If so, how much? How
will it affect Queen GrandeView's financial statementsfor the year?
b. Assume that Queen GrandeView usesdouble-declining balancedepreciation.If
the van is sold for $9,750, will there be a gain or loss on the sale?If so, how
much? How will it affect Queen GrandeView's financial statementsfor the year?
c. Assume Queen GrandeView usesdouble-declining balancedepreciationand
sells the van for $23,000.Would there be a gain or loss on the sale?How would
that changeif Queen GrandeView had been using straight-line depreciation?
P4-108. (Appendix) Analyze and correct accounting errors related to long-term assets.
(L0 9)
During 2007, Jule's Gym had some trouble with its information processingdue to several
hurricanes,and someeffors were made in accountingfor certain transactions.The firm uses
straight-line depreciationfor a1lof its long-term assets.Evaluatethe following independent
situationsthat occurred during the year:
a. At the beginning of the year, a basketpurchaseof a building and land was made
for $350,000.The appraisersindicated that the market value of the land was
$135,000and the market value of the building was $250,000.So, Jule's Gym
allocated $135,000 of the purchaseprice to the land and the remainder of the
purchaseprice to the building. The building has an estimateduseful life of
20 years and an estimatedsalvagevalue of $25,000.
b. The plumber spent a great deal of time repairing broken toilets in one of the
gym's buildings this year. Total cost, which Jule's Gym capitalizedowas $5,000.
Jule's Gym decided it was best to leave it on the books as an assetand not write
it off, becausethe toilets will be used for quite a few more years. (Use 20 years
as the estimatedremaining useful life of the toilets.)
c. Jule's Gym purchaseda new van. It cost $20,000 and is expectedto last 3 years.
It has a salvagevalue of $2,000. To properly equip it for transporting gym
equipment between locations, the inside was customized at a cost of $6,000. The
cost of the van was capitalized,and the cost of the customization was expensed.
d. Jule's Gym spent $5,500 on routine maintenanceof its exerciseequipment.The
cost was expensed.
C H A P T E4R . F I N A N C I A LS T A T E M E N T
ANALYSIS 205
Required
a. For each, describethe error made and list the effect, if any, that the uncorrected
ertor would have on the following items for Jule's Gym's 200'7financial
statements:net income, long-term assets,and retained earnings.If there is no
error, simply write N/A next to the item.
b. Use the accounting equation to show the adjustmentsthat would correct the
company's accountingrecords and make the 2001 financial statementsaccurate.
If there is no error, write N/A next to the problem.
Financial
Statement
Analysis
FSA4-1. Analyzelong-termassetson the balancesheet.(LO 6)
Information from The Home Depot Annual Report is shown here.
Required
a. Can you tell how much The Home Depot paid for the buildings it owns? If so,
how do you know?
b. Can you tell how much the buildings are worth (the market value)?
c. Explain what you think is included in each category of Property and Equipment.
(Hint: To explain Capital Leases,be sure to read the UnderstandingBusiness
feature in the chapter.)
d. The Home Depot saysit is modernizing its storesand building many new stores.
Is this supportedby any of the information?
Fromthe BalanceSheetof The Home Depot, at
( dollar sin m ill i o n s ) January 29 January
30
2006 2005
Propertyand Equipmentat cost:
Land 7,924 6,932
B uildings 14,056 12,325
F ur nit ur e,F ix tu re sa n d Eq u i p m e n t 7,073 6,195
Leaseholdlmprovements 1,207 1,191
Constructionin Progress 843 1,404
CapitalLeases 427 390
31,s30 28,437
LessAccumulatedDeoreciationand Amortization 6,629 5,711
Net P r oper tya n d E q u i p me n t 24,901 22,726
Intangible assetsthat are determined not to have an indefinite life mainly consist of artist
contracts, music catalogs, acquired patent rights and soffware to be sold, leasedor other-
wise marketed.Artist contracts and music catalogs are amortized on a straight-line basis
principally over a period of up to 40 years.Acquired patent rights and sofhuareto be sold,
leasedor otherwise marketed are amortized on a straisht-line basis over 3 to I0 years.
Required
a. What is Sony's primary method for depreciatingits assets?
b. How much did Sony pay for the machinery and equipment it owns?
c. Are any ofthe assetslisted as property,plant, and equipmentnot being
depreciated?
d. Can you tell how much depreciationexpenseSony had for the fiscal year ended
March 3I,2005?
e. Explain what the $18,877(in millions) of accumulateddepreciationrepresents.
f. Can you find a sentencein the notes that summarizesthe accounting treatment
for major overhaul or additions to assetsdiscussedin the chapter?
g. Describe how Sony evaluatesgoodwill for impairment.
CriticalThinkingProblems
Riskand Control
Whatkindsof risksdoesa firm like OfficeDepotfacewith respectto safeguarding its as-
sets?Whattypesof controlsdoyou thinkit alreadyhasin placeto minimizetheserisks?Are
anyspecificcontrolsmentionedin the 10-Kreportprovidedon thewebsitefor thisbook?
C H A P T E4R . I N T E R N E TE X E R C I S EB:E S TB U Y 207
Ethics
Rachel works in a real estateoffice that is equipped with up-to-date copiers, scanners,and
printers. She is frequently the only employee working in the offrce in the eveningsand of-
ten has sparetime to do personal work. She has begun to use the office equipment for her
children's school reports and for her husband'sbusiness.Do you think Rachel's use of the
office equipment is harmless,or is she behaving unethically? Why? If you believe her be-
havior is unethical, what controls could be in place to prevent it? Have you ever used office
resourcesfor personal tasks?Under what conditions could such use of office resourcesbe
justified?
GroupAssignment
Select one ofthe three depreciationmethodspresentedin the chapter.Discussreasonswhy
the method should be used and reasonswhy the method is not a good choice. Determine the
method you think is most consistentwith the objectives of financial reporting.
BestBuy
lnternetExercise:
Best Buy is the number-onespecialtyretailer of consumerelectronics,personalcomputers,
entertainment software, and appliances.Best Buy has about742 stores in 49 states,with
heavy concentrationsin the Midwest, Texas,California, and Florida.
IE4-1. Go to www.bestbuy.com,and select"For Our Investors" near the bottom of the page.
Then, selectBest Buy's most recent annual report in the PDF format. Use the consolidated
balance sheetsto answer the following questions.At the most recent year-end, examine
Property and Equipment.
a. What is the acguisitioncost of theseassets?
b. What is the book value (carrying value)?
c. What amount of the acquisition cost has already been expensed?
d. Are any ofthe assetslisted not being depreciated?
lE4-2. Use the notes to financial statementsto answerthe following questions(usually the
information can be found in note 1):
a. Find the heading Property and Equipment. What depreciationmethod does Best
Buy use for property and equipment?What is the range of useful lives for
buildings and for fixtures and equipment?Do theseuseful lives make sense?
b. Find the headingGoodwill. What type of an assetis goodwill? Does Best Buy
write off this asset?Explain what the company does.
IE4-3. On page25 of Best Buy's annualreportfor its fiscal year endedFebruary25,2006,
there is a 5-year summary of financial highlights.
a. Identify the amountsreported for total assetsat the four most recent year-ends.
b. Identify the amountsreported for Revenuesand Net Earnings (net income) for
the three most recent years.
c. Compute the assetturnover ratio for the two most recent fiscal years.In which
fiscal year did the company make best use of its assets?How can you tell?
Appendix
4
Depreciation
andTaxes
208