7-1

CHAPTER 6

Accounting for and Presentation of Property, Plant, and Equipment, and Other Noncurrent Assets
McGraw-Hill/Irwin 2008 The McGraw-Hill Companies, Inc., All Rights

7-2

What Should You Learn in Chapter 6?

4. The accounting treatment of maintenance and repair expenditures. 5. The effect on the financial statements of the disposition of noncurrent assets, either by sale or abandonment. 6. The difference between an operating lease and a capital lease. 7. The similarities in the financial statement effects of buying an asset compared to using a capital lease to acquire the rights to an asset.

7-3

What Should You Learn in Chapter 6?

8. The meaning of various intangible assets, how their values are measured, and how their costs are reflected in the income statement.

7-4

LO4

Maintenance and Repair Expense

Preventative maintenance expenditures and routine repair costs are clearly expenses of the period in which they are incurred.

7-5

LO5

Disposal of Depreciable Assets

Update depreciation to the date of disposal. Journalize disposal by:

Recording cash received (debit).

Recording a gain (credit) or loss (debit). Removing the asset cost (credit).

Removing accumulated depreciation (debit).

7-6

LO5

Disposal of Depreciable Assets

Determining Gain or Loss

Cash > BV, record a gain (credit). Cash < BV, record a loss (debit). Cash = BV, no gain or loss.

Recording a gain (credit) or loss (debit).

7-7

LO5

Selling Plant Assets

On 9/30/2008, Evans Company sells a machine Date purchased Cost Depreciation Method Salvage Value Estimated Useful Life Selling price 1/1/2003 $100,000 Straight Line $20,000 10 years $60,000

7-8

LO5

Selling Plant Assets

The The amount amount of of depreciation depreciation recorded recorded on on September September 30, 30, 2008, 2008, to to bring bring depreciation depreciation up up to to date date is: is:
a. a. b. b. c. c. d. d. $8,000. $8,000. $6,000. $6,000. $4,000. $4,000. $2,000. $2,000.

7-9

LO5

Selling Plant Assets

The The amount amount of of depreciation depreciation recorded recorded on on September September 30, 30, 2008, 2008, to to bring bring depreciation depreciation up up to to date date is: is:
a. a. b. b. c. c. d. d. $8,000. $8,000. $6,000. $6,000. Annual Depreciation: $4,000. $4,000. ($100,000 - $20,000) 10 Yrs. = $8,000 $2,000. $2,000.
Depreciation to Sept. 30: 9 /12 $8,000 = $6,000

7-10

LO5

Selling Plant Assets

After After updating updating the the depreciation, depreciation, the the machines machines net net book book value value on on September September 30, 30, 2008, 2008, is: is:
a. a. b. b. c. c. d. d. $54,000. $54,000. $46,000. $46,000. $40,000. $40,000. $60,000. $60,000.

7-11

LO5

Selling Plant Assets

After After updating updating the the depreciation, depreciation, the the machines machines book book value value on on September September 30, 30, 2008, 2008, is: is:
a. a. b. b. c. c. d. d. $54,000. $54,000. $46,000. $46,000. $40,000. $40,000. $60,000. $60,000.

Cost Accumulated Depreciation: (5 yrs. $8,000) + $6,000 = Book Value

$ 100,000 46,000 $ 54,000

7-12

LO5

Selling Plant Assets

The The machines machines sale sale resulted resulted in: in:
a. a. b. b. c. c. d. d. a a gain gain of of $6,000. $6,000. a a gain gain of of $4,000. $4,000. a a loss loss of of $6,000. $6,000. a a loss loss of of $4,000. $4,000.

7-13

LO5

Selling Plant Assets

The The machines machines sale sale resulted resulted in: in:
a. a. b. b. c. c. d. d. a a gain gain of of $6,000. $6,000. a a gain gain of of $4,000. $4,000. a a loss loss of of $6,000. $6,000. a a loss loss of of $4,000. $4,000.

Cost Accum. Depr. Book Value Cash Received Gain

$ 100,000 46,000 54,000 60,000 $ 6,000

Now, you are ready to prepare the journal entry to record the sale of the asset.

7-14

LO5

Selling Plant Assets

Date Description Sept 30 Cash Accumulated Depreciation Gain on Sale Machine Debit Credit 60,000 46,000 6,000 100,000

7-15

LO6

Assets Acquired by Finance Lease

A finance lease results in the lessee (renter) assuming virtually all of the benefits and risks of ownership for the leased asset.

An operating lease is an ordinary lease for the use of an asset that does not involve any attributes of ownership.

7-16

LO6

Assets Acquired by Finance Lease

*Finance Lease Determination according to IAS 17:

A lease is classified as a finance lease if it transfers substantially all the risks and rewards incidental to ownership.

*Finance (Capital) Lease Determination per US GAAP:

If the lease meets one of the following it is a capital lease 1.Transfers ownership to lessee. 2.Includes nominal purchase price. 3.Lease term is 75% of life of asset. 4.Present value of lease payments is 90% of fair value of asset.

7-17

LO7

Buy or Lease an Asset?

y u B

Buy or Lease ?

s a e L

Computer equipment Cost: $217,765 Issue a 10%, 6 year Note Payable Annual payment: $50,000.

Computer Equipment Annual payment: $50,000. Present Value of Lease Payments: $50,000 @ 10%, 6 years = $217,765

7-18

LO8

Intangible Assets
Often Oftenprovide provide exclusive exclusiverights rights or orprivileges. privileges.

Noncurrent Noncurrent assets assets without withoutphysical physical substance. substance.

Intangible Assets
Useful Usefullife lifeis is often oftendifficult difficult to todetermine. determine. Usually Usuallyacquired acquired for foroperational operational use. use.

7-19

LO8

Intangible Assets
Initially record at current cash equivalent cost, including purchase price, legal fees, and filing fees.

Patents Copyrights Leaseholds Leasehold Improvements Franchises and Licenses Trademarks and Trade Names Goodwill

7-20

LO8

International Accounting Standard 38 Intangible Assets An entity shall assess whether the useful life of an intangible asset is finite or indefinite. An intangible asset shall be regarded by the entity as having an indefinite useful life when, based on an analysis of all of the relevant factors, there is no foreseeable limit to the period over which the asset is expected to generate net cash inflows for the entity. An intangible asset with a finite useful life is amortized and an intangible asset with an indefinite useful life is not.

7-21

LO8

Finite Intangible Assets

Amortization is the term used to refer to the allocation of the cost of an intangible asset over its finite useful life.

The depreciable amount of an intangible asset with a finite useful life shall be allocated on a systematic basis over its useful life. Amortization (or Amortisation) shall begin when the asset is available for use and shall cease at the earlier of the date that the asset is classified as held for sale and the date that the asset is derecognised. Straight-line method is most often used.

7-22

LO8

Indefinite Intangible Assets

An intangible asset shall be regarded by the entity as having an indefinite useful life when there is no foreseeable limit to the period over which the asset is expected to generate net cash inflows for the entity.

An intangible asset with an indefinite useful life shall not be amortized but tested for impairment. Test for impairment by comparing the assets recoverable amount with its carrying amount (book value). Reduce impaired assets to recoverable amounts.

7-23

LO8

Goodwill

Goodwill
Occurs when one company buys another company. Only purchased goodwill is an intangible asset.

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

7-24

LO8

Goodwill
Eddy Company paid $1,000,000 to purchase all of James Companys assets and assumed liabilities of $200,000. The acquired assets were appraised at a fair value of $900,000.

7-25

LO8

Goodwill
What What amount amount of of goodwill goodwill should should be be recorded recorded on on Eddy Eddy Companys Companys books? books? a. a. b. b. c. c. d. d. $100,000. $100,000. $200,000. $200,000. $300,000. $300,000. $400,000. $400,000.

7-26

LO8

Goodwill

What What amount amount of of goodwill goodwill should should be be recorded recorded on on Eddy Eddy Companys Companys books? books? a. a. b. b. c. c. d. d. $100,000 $100,000 $200,000 $200,000 $300,000 $300,000 $400,000 $400,000
FMV of Assets Debt Assumed FMV of Net Assets Purchase Price Goodwill $ $ 900,000 200,000

700,000 1,000,000 $ 300,000

7-27

LO8

Goodwill
US GAAP and IFRS have the same nonamortization approach to account for purchased goodwill. Under the impairment approach, goodwill will only be amortized when the initial recorded value of the asset has deteriorated.

7-28

LO8

Natural Resources
Extracted from the natural environment and reported at cost less accumulated depletion.

Total cost, including exploration and development, is charged to depletion expense over periods benefited.

Examples: oil, coal, gold

7-29

LO8

Natural Resources
Depletion is the term used to refer to the allocation of the cost of a natural resource over its useful life.

The process is similar to units-of-production depreciation.

7-30

LO8

Other Noncurrent Assets

Long-term Investments Notes Receivables (with maturities more than a year after the balance sheet date) Long-term Deferred Income Tax Assets
When these assets become current, they will be reclassified to current assets.

7-31

End of Chapter 6

7-32

CHAPTER 7

Accounting for and Presentation of Liabilities

McGraw-Hill/Irwin

2008 The McGraw-Hill Companies, Inc., All Rights

7-33

What Should You Learn in Chapter 7?

1. The financial statement presentation of short-term and current maturities of longterm debt. 2. The difference between interest calculated on a straight basis and on a discount basis. 3. What unearned revenues are and how they are presented in the balance sheet. 4. The importance of making estimates for certain accrued liabilities and how these items are presented in the balance sheet.

7-34

What Should You Learn in Chapter 7?

5. The different characteristics of a bond, which is the formal document representing most long-term debt. 6. Why bond discount or premium arises and how it is accounted for. 7. What noncontrolling (minority) interest is, why it arises, and what it means in the balance sheet.

7-35

LO1

Nature of Liabilities
Liabilities Liabilities are are obligations obligations that that represent represent probable probable future future sacrifice sacrifice of of economic economic benefits benefits. . The The term term accrued accrued expenses expenses is is often often used used on on the the balance balance sheet sheet to to describe describe liabilities. liabilities. Current Current liabilities liabilities are are those those liabilities liabilities that that will will be be paid paid within within one one year year of of the the current current balance balance sheet sheet date. date.

7-36

LO1

Nature of Liabilities
Current liabilities include: Accounts payable Short-term debt (Notes payable) Current maturities of long-term debt Unearned revenue or deferred credits Other accrued liabilities Noncurrent liabilities include: Long-term debt (Bonds payable) Deferred tax liabilities Minority interest in subsidiaries

7-37

LO1

Current Liabilities
Short-Term Debt
On 1 January, 2008 Matrix, Inc. borrows $25,000 from 1st National Bank to provide working capital. The following entry is recorded:

Financial Statement effect of this transaction

Assets + Cash $25,000 = Liabilities + Debt $25,000 + Owners' Equity Net income = Revenues Expenses

7-38

LO1

Current Liabilities
Interest Expense
The following entry is recorded to accrue interest each month:

Financial Statement effect of this transaction

Assets = Liabilities + Interest payable $187.50 + Owners' Equity Net income = Revenues Expenses + Interest expense $187.50

7-39

LO2

Interest Calculation Methods

Straight Interest
Interest = Principal Rate Time in years = $25,000 0.09 1 = $ 2,250 per year or $187.50 per month

Annual Percentage Interest Rate (APR)

APR = Interest Paid Money available Time = $2,250 $25,000 1 = 9%

7-40

LO2

Interest Calculation Methods

Discount Basis - Interest is Paid in Advance
Proceeds = Principal Interest = $25,000 $2,250 = $22,750

Annual Percentage Interest Rate (APR)

APR = Interest Paid Money available Time = $2,250 $22,750 1 = 9.89%

7-41

LO2

Current Liabilities
Discount Basis
On 1 January, 2008, Matrix, Inc. borrows $25,000 from 1st National Bank to provide working capital. The note was discounted by the bank and the net proceeds given to Matrix.

Financial Statement effect of this transaction

Balance Sheet Assets Cash + 22,750 = Liabilities + Short-term Debt +25,000 Discount on ST Debt -2,250 + Owners' Equity Net income Income Statement = Revenues Expenses

7-42

LO2

Current Liabilities

The Prepaid interest on the Note Payable will be reclassified as an expense each month using an adjusting entry

Financial Statement effect of this transaction

Balance Sheet Assets = Liabilities - Discount on ST Debt -$187.50 + Owners' Equity Net income Income Statement = Revenues Expenses + Interest Expense $187.50

Principal of note Discount on ST debt Carrying value after adj

$ $

25,000.00 2,062.50 22,937.50

7-43

LO2

Current Maturities on Long-Term Debt

Any portion of long-term debt that is to be repaid within a year of the balance sheet date is reclassified from the noncurrent liability section to the current liability section under the title, current maturities of long-term debt.

7-44

LO3

Unearned Revenue or Deferred Credits

Unearned revenue is created when customers pay for services or products before delivery. On 1 January, 2008, Matrix, Inc. receives $2,400 cash as an advance payment for a one-year subscription to its monthly investment newsletter.

Cash received for one-year subscription

< 12-month subscription >

1/1/08

31/01/08 Month end

28/02/08 Month end

31/01/08 Month end

Our goal is to recognize revenue as the subscription is fulfilled each month.

7-45

LO3

Unearned Revenue or Deferred Credits

On 1 January, 2008, Matrix, Inc. receives $2,400 cash as an advance payment for a one-year subscription to its monthly investment newsletter.

Financial Statement effect of this transaction

Balance Sheet Assets = Liabilities Unearned revenue +2,400 + Owners' Equity Net income Income Statement = Revenues Expenses

Cash +2,400

7-46

LO3

Unearned Revenue or Deferred Credits

On 31 January 2008, Matrix would prepare the following adjusting entry to recognize revenue earned.

$2,400 12 = $200

Financial Statement effect of this transaction

Balance Sheet Assets = Liabilities Uearned revenue 200 + Owners' Equity Net income Income Statement = Revenues Subscription revenue +200 Expenses

7-47

LO4

Liability for Warranties

It is appropriate to recognize the estimated warranty expense in the same period as the sale is recorded.

Matrix, Inc. sells 1,000 DVD recorders for $500 each during 2008. Each DVD has a two-year warranty. Matrix estimates that warranty costs will be $30 per recorder.

Financial Statement effect of this transaction

Balance Sheet Assets Cash +500,000 = Liabilities + Owners' Equity Net income Income Statement = Revenues Sales revenue +500,000 Expenses

7-48

LO4

Liability for Warranties

Adjusting Entry to reflect Warranty Liability for 2008 Sales

Financial Statement effect of this transaction

Balance Sheet Assets = Liabilities Estimated warranty liability $30,000 + Owners' Equity Net income Income Statement = Revenues Expenses Estimated warranty expense $ 30,000

7-49

LO4

Liability for Warranties

During 2008, Matrix paid $3,500 in warranty costs.

Financial Statement effect of this transaction

Balance Sheet Assets = Liabilities Estimated warranty liability 3,500 + Owners' Equity Net income Income Statement = Revenues Expenses

Cash 3,500

7-50

LO5

Bond Terminology
Bond Indenture Trustee of Bonds Registered Bonds Coupon Bonds Convertible Bonds Debenture Bonds Mortgage Bonds Term Bonds Serial Bonds

7-51

LO5

Bonds Payable - Terminology

Interest 10% 30/06 & 31/12

Face Value $1,000

BOND PAYABLE
Bond Date 1/1/2008 Maturity Date 31/12/2012

Face Value is the amount an investor will receive at maturity. Bond Date is the date the bond was issued. Stated Interest Rate is typically an annual rate. Interest Payment Dates are dates when investor is paid interest. Maturity Date is date when face value of bond is repaid to investor.

7-52

LO5

Issuance of Bonds Payable At Par Value

On 1/1/08 Matrix, Inc. issued the following bonds: Par Value = $1,500,000 (1,500 bonds @ $1,000 face) Stated Interest Rate = 10% Market Interest Rate = 10% Interest Dates = 30/06 & 31/12 of each year Bond Date = 1 January , 2008 Maturity Date = 31 Dec. , 2012 (5 years)

Financial Statement effect of this transaction

Balance Sheet Assets Cash +1,500,000 = Liabilities Bonds Payable +1,500,000 + Owners' Equity Net income Income Statement = Revenues Expenses