Reporting and Interpreting

Property, Plant and Equipment;

Natural Resources; and
Intangibles
Chapter 8

McGraw-Hill/Irwin

2009 The McGraw-Hill Companies, Inc.

Classifying Long-Lived Assets

Actively Used in Operations
Examples
Value represented by rights
that produce benefits
Land
Examples
Expected to Benefit Future Periods
Assets subject to depreciation
Definite life
Buildings and equipment
Patents
Furniture and fixtures
Copyrights
Natural resource
Intangible
assets
Tangible
Franchises
subject to depletion
Indefinite life
Physical
No Physical
Mineral deposits and timber
Trademarks
Substance
Substance
Goodwill
McGraw-Hill/Irwin

Slide 2

Measuring and Recording Acquisition

Cost
Acquisition cost includes the purchase price and all
expenditures needed to prepare the asset for its intended use.
Acquisition cost does not include
financing charges and cash discounts.
Buildings
Buildings
Purchase
Purchase price
price
Renovation
Renovation and
and repair
repair costs
costs
Legal
Legal and
and realty
realty fees
fees
Title
Title fees
fees

McGraw-Hill/Irwin

Slide 3

Measuring and Recording Acquisition

Cost
Acquisition On January 1, Southwest Air Lines purchased aircraft for
$70,000,000 cash.
for Cash

Acquisition
for Debt

McGraw-Hill/Irwin

On January 14, Southwest Air Lines purchased aircraft

for $1,000,000 cash and a $69,000,000 note payable.

Slide 4

Acquisition for Noncash Consideration

Record at the current market value of the consideration
given, or the current market value of the asset acquired,
whichever is more clearly evident.
On July 7, Southwest gave Boeing 9,000,000 shares of
$1.00 par value common stock with a market value of
$5.00 per share plus $25,000,000 in cash for aircraft.

McGraw-Hill/Irwin

Slide 5

Depreciation Concepts
Depreciation
Depreciation is
is aa cost
cost allocation
allocation process
process that
that
systematically
systematically and
and rationally
rationally matches
matches acquisition
acquisition costs
costs
of
of operational
operational assets
assets with
with periods
periods benefited
benefited by
by their
their use.
use.
Balance Sheet
Acquisition
Cost
(Unused)

Income Statement
Cost

Expense

Allocation

(Used)

Depreciation
Expense

Depreciation for
the current year

Income
Statement

Accumulated
Depreciation

Total of depreciation
to date on an asset

Balance
Sheet

McGraw-Hill/Irwin

Slide 6

Depreciation Concepts
The
The calculation
calculation of
of depreciation
depreciation requires
requires
three
three amounts
amounts for
for each
each asset:
asset:

Acquisition
Acquisition cost.
cost.

Estimated
Estimated useful
useful life.
life.

Estimated
Estimated residual
residual value.
value.

Alternative
Alternative depreciation
depreciation
methods:
methods:

Straight-line
Straight-line

Units-of-production
Units-of-production

Accelerated
Accelerated Method:
Method: Declining
Declining

McGraw-Hill/Irwin

Slide 7

Straight-Line Method
Depreciation
Expense per Year

Cost - Residual Value

Life in Years

At the beginning of the year, Southwest purchased ground

equipment for $62,500 cash. The equipment has an estimated
useful life of 3 years and an estimated residual value of $2,500.
Depreciation
Expense per Year

Depreciation
Expense per Year

McGraw-Hill/Irwin

$62,500 - $2,500
3 years
$20,000
Slide 8

Straight-Line Method
Depreciation Accumulated
Expense
Depreciation
Year
(debit)
(credit)
1
2
3

$ 20,000
20,000
20,000
$ 60,000

20,000
20,000
20,000
60,000

Accumulated
Depreciation
Balance
$

20,000
40,000
60,000

Undepreciated
Balance
(book value)
$
62,500
42,500
22,500
2,500

Residual Value

SL
McGraw-Hill/Irwin

More companies use the straight-line method

of depreciation in their financial reports than
all other methods combined.
Slide 9

Units-of-Production Method
Step 1:

Depreciation =
Rate

Cost - Residual Value

Life in Units of Production

Step 2:

Number of
Depreciation
Depreciation
Units Produced
=
Expense
Rate
for the Year
At the beginning of the year, Southwest purchased ground
equipment for $62,500 cash. The equipment has a 100,000
mile useful life and an estimated residual value of $2,500.
If the equipment is used 30,000 miles in the first year, what is
the amount of depreciation expense?
McGraw-Hill/Irwin

Slide 10

Units-of-Production Method
Step 1:

Depreciation = $62,500 - $2,500 = $.60 per mile

100,000 miles
Rate
Step 2:

Depreciation
= $.60 per mile 30,000 miles =
Expense
$18,000

McGraw-Hill/Irwin

Residual Value

Slide 11

Accelerated Depreciation
Accelerated depreciation matches higher
depreciation expense with higher revenues
in the early years of an assets useful life
when the asset is more efficient.

Depreciation
Expense
Early Years
High
Later Years

McGraw-Hill/Irwin

Low

Repair
Expense
Low
High

Slide 12

Declining-Balance Method
Declining balance rate
of 2 is double-decliningbalance (DDB) rate.

Cost Accumulated Depreciation

Annual
Depreciation =
expense

Net
Book
Value

2
Useful Life in Years

Annual
Annual computation
computation ignores
ignores residual
residual value.
value.
At the beginning of the year, Southwest purchased equipment
for $62,500 cash. The equipment has an estimated useful
life of 3 years and an estimated residual value of $2,500.
Calculate the depreciation expense for the first two years.
McGraw-Hill/Irwin

Slide 13

Declining-Balance Method
Annual
Depreciation
expense

Net
Book
Value

Year 1 Depreciation:
$62,500

2
3 years

McGraw-Hill/Irwin

) = $41,667

Year 2 Depreciation:
($62,500 $41,667)

2
Useful Life in Years

2
3 years

) = $13,889
Slide 14

Declining-Balance Method

Year
1
2
3

Depreciation
Expense
(debit)

Accumulated
Depreciation
Balance

41,667
13,889
4,629
60,185

41,667
55,556
60,185

Undepreciated
Balance
(book value)
$
62,500
20,833
6,944
2,315

Below residual value

($62,500 $55,556)
McGraw-Hill/Irwin

2
3 years

) = $4,629
Slide 15

Declining-Balance Method

Year
1
2
3

Depreciation
Expense
(debit)

Accumulated
Depreciation
Balance

41,667
13,889
4,444
60,000

41,667
55,556
60,000

Undepreciated
Balance
(book value)
$
62,500
20,833
6,944
2,500

Depreciation expense is limited to the amount that

reduces book value to the estimated residual value.
McGraw-Hill/Irwin

Slide 16

Repairs, Maintenance, and Additions

Type of
Capital or
Expenditure Revenue

Identifying Characteristics

Ordinary
Revenue 1. Maintains normal operating condition
repairs and
2. Does not increase productivity
maintenance
3. Does not extend life beyond original
estimate
Extraordinary
repairs

Capital

1. Major overhauls or partial

replacements
2. Extends life beyond original estimate

Additions

Capital

1. Increases productivity
2. May extend useful life
3. Improvements or expansions

McGraw-Hill/Irwin

Slide 17

Repairs, Maintenance, and Additions

Financial Statement Effect
Treatment

Statement

Expense

Current Current
Income Taxes

Capital
Expenditure

Balance sheet
account debited

Deferred

Higher

Higher

Revenue Income statement Currently

Expenditure account debited recognized Lower

Lower

To solve this problem, many companies have policies

regarding the expensing of all expenditures below a
certain amount according to the materiality constraint.
McGraw-Hill/Irwin

Slide 18

Disposal of Property, Plant, and

Equipment
Update depreciation
to the date of disposal.

Journalize disposal by:

Recording cash
received (debit)
or paid (credit).

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

Writing off accumulated

depreciation (debit).

Writing off the

asset cost (credit).

McGraw-Hill/Irwin

Slide 19

Disposal of Property, Plant, and

Equipment
If Cash > BV, record a gain (credit).
If Cash < BV, record a loss (debit).
If Cash = BV, no gain or loss.
Southwest
Southwest Airlines
Airlines sold
sold flight
flight equipment
equipment
for
for $5,000,000
$5,000,000 cash
cash at
at the
the end
end of
of its
its
17th
17th year
year of
of use.
use. The
The flight
flight equipment
equipment originally
originally
cost
cost $20,000,000,
$20,000,000, and
and was
was depreciated
depreciated using
using the
the
straight-line
straight-line method
method with
with zero
zero residual
residual value
value
and
and aa useful
useful life
life of
of 20
20 years.
years.
McGraw-Hill/Irwin

Slide 20

Disposal of Property, Plant, and

Equipment
Prepare the journal entry to record Southwests sale of
the equipment at the end of the 17th year.

McGraw-Hill/Irwin

Slide 21

Fixed Asset Turnover

Fixed
=
Asset
Turnover

Net Sales Revenue

Average Net Fixed Assets

This
This ratio
ratio measures
measures aa companys
companys ability
ability to
to generate
generate
sales
sales given
given an
an investment
investment in
in fixed
fixed assets.
assets.
During
During 2009,
2009, Southwest
Southwest Airlines
Airlines had
had $10,350
$10,350 of
of revenue.
revenue. EndEndof-year
of-year fixed
fixed assets
assets were
were $10,634
$10,634 and
and beginning-of-year
beginning-of-year fixed
fixed
assets
assets were
were $11,040.
$11,040. (All
(All numbers
numbers in
in millions.)
millions.)
Fixed
$10,350
=
= 0.96
Asset
($10,634 + $11,040) 2
Turnover

McGraw-Hill/Irwin

Slide 22

Acquisition and Depletion of Natural

Resources
Extracted from
the natural
environment.

A noncurrent
asset presented
at cost less
accumulated
depletion.

Total cost of
asset is the cost
of acquisition,
exploration,
and development.

Total cost is
allocated over
periods benefited
by means of
depletion.

Examples: oil, coal, gold

Depletion is like units-of-production depreciation.

McGraw-Hill/Irwin

Slide 23

Acquisition and Depletion of Natural

Resources
The unit depletion rate is calculated as follows:
Acquisition and
Development Cost

Residual
Value

Estimated Recoverable Units

Depletion cost for a period is:
UNIT DEPLETION
RATE

Depletion
cost
McGraw-Hill/Irwin

NUMBER OF UNITS
EXTRACTED IN PERIOD

Inventory
for sale

Cost of
goods sold
Unsold
Inventory
Slide 24

Acquisition and Amortization of

Intangible Assets
Noncurrent
Noncurrent assets
assets
without
without physical
physical
substance.
substance.
Useful
Useful life
life is
is
often
often difficult
difficult
to
to determine.
determine.

Intangible
Assets:
-Patents
-Trademarks
-Copyrights
-Franchises
-Licenses

Often
Often provide
provide
exclusive
exclusive rights
rights
or
or privileges.
privileges.
Usually
Usually acquired
acquired
for
for operational
operational
use.
use.

Record at current cash equivalent cost, including

purchase price, legal fees, and filing fees.
McGraw-Hill/Irwin

Slide 25

Acquisition and Amortization of

Intangible Assets
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.
Goodwill
Goodwill is
is not
not amortized.
amortized. Its
Its value
value must
must be
be reviewed
reviewed
at
at least
least annually
annually for
for possible
possible impairment,
impairment, and
and the
the
book
book value
value is
is reduced
reduced to
to fair
fair value
value ifif impaired.
impaired.
McGraw-Hill/Irwin

Slide 26

Acquisition and Amortization of

Intangible Assets
Definite
Definite Life
Life

Indefinite
Indefinite Life
Life

Amortize
Amortize over
over shorter
shorter of
of
economic
economic life
life or
or legal
legal
life,
life, subject
subject to
to rules
rules
specified
specified by
by GAAP.
GAAP.
Use
Use straight-line
straight-line method.
method.

Not
Not amortized.
amortized.
Tested
Tested at
at least
least annually
annually for
for
possible
possible impairment,
impairment, and
and
book
book value
value is
is reduced
reduced to
to
fair
fair value
value ifif impaired.
impaired.

Amortization is a cost allocation process

similar to depreciation and depletion.

McGraw-Hill/Irwin

Slide 27

Measuring Asset Impairment

Impairment is the loss of a significant portion
of the utility of an asset through . . .
Casualty.
Obsolescence.
Lack of demand for the assets services.

Recognize a
loss when
an asset
suffers a
permanent
impairment.

Determination
Determination of
of Asset
Asset Impairment
Impairment

Compare
Compare Net
Net Book
Book Value
Value to
to Estimated
Estimated Future
Future Cash
Cash Flows:
Flows:
IfIf FCF>NBV,
FCF>NBV, do
do nothing
nothing
IfIf FCF<NBV,
FCF<NBV, asset
asset is
is impaired
impaired
Record
Record Impairment:
Impairment:
Asset
Asset Impairment
Impairment Loss
Loss XXX
XXX

Asset
XXX
Asset
XXX
XXX=Difference
XXX=Difference between
between NBV
NBV and
and Fair
Fair (Market)
(Market) Value
Value

McGraw-Hill/Irwin

Slide 28

End of Chapter 8

2008 The McGraw-Hill Companies, Inc.