Chapter 7 Plant Assets, Intangible Assets, and Related Expenses

Learning Objective 1 Determine the cost of a plant asset.

Determine the cost of a plant asset.

Types of Assets Long-lived assets used in operations Plant Assets Intangible Assets

Long-lived assets used in operations

Plant Assets

Intangible Assets

Plant Assets Terminology Plant Assets - Depreciation Natural Resources - Depletion Intangibles - Amortization

Plant Assets - Depreciation

Natural Resources - Depletion

Intangibles - Amortization

Determining the Cost of Land A business signs a $300,000 note payable to purchase land for a new store site. It pays: $10,000 in back property tax $8,000 in transfer taxes $5,000 for removal of an old building $1,000 survey fee $260,000 to pave the parking lot. What is the cost of the land?

A business signs a $300,000 note payable to purchase land for a new store site. It pays:

$10,000 in back property tax

$8,000 in transfer taxes

$5,000 for removal of an old building

$1,000 survey fee

$260,000 to pave the parking lot.

What is the cost of the land?

Determining the Cost of Land Purchase price of land $300,000 Add related costs: Back property taxes $10,000 Transfer taxes 8,000 Removal of buildings 5,000 Survey fees 1,000 24,000 Total cost of land $324,000

Purchase price of land $300,000

Add related costs:

Back property taxes $10,000

Transfer taxes 8,000

Removal of buildings 5,000

Survey fees 1,000 24,000

Total cost of land $324,000

Determining the Cost of Buildings: Construction Architectural fees Building permits Contractor’s charges Materials Labor Overhead Cost of interest

Architectural fees

Building permits

Contractor’s charges

Materials

Labor

Overhead

Cost of interest

Determining the Cost of Buildings: Purchase Purchase price Brokerage commissions Sales and other taxes Repairing or renovating building for its intended purpose

Purchase price

Brokerage commissions

Sales and other taxes

Repairing or renovating building for its intended purpose

Determining the Cost of Machinery and Equipment Purchase price less discounts Transportation charges Insurance in transit Sales and other taxes Purchase commission Installation costs Expenditures to test the asset Special platforms

Purchase price less discounts

Transportation charges

Insurance in transit

Sales and other taxes

Purchase commission

Installation costs

Expenditures to test the asset

Special platforms

Determining the Cost of Land and Leasehold Improvements Land improvements Paving Fences Sprinkler systems Lights in parking lot

Land improvements

Paving

Fences

Sprinkler systems

Lights in parking lot

Leasehold Improvement: Cost of improvements to leased assets Depreciate (amortize) over term of the lease. Determining the Cost of Land and Leasehold Improvements

Leasehold Improvement: Cost of improvements to leased assets

Depreciate (amortize) over term of the lease.

Lump-Sum (or Basket) Purchases of Assets Xerox Corporation paid $2,800,000 for a combined purchase of land and a building. The land is appraised at $300,000 and the building at $2,700,000. How much of the purchase price is allocated to land and how much to the building?

Xerox Corporation paid $2,800,000 for a combined purchase of land and a building.

The land is appraised at $300,000 and the building at $2,700,000.

How much of the purchase price is allocated to land and how much to the building?

Lump-Sum (or Basket) Purchases of Assets Total appraised value = $3,000,000 Land: $300,000 ÷ $3,000,000 = 10% $2,800,000 × 10% = $280,000 Building: $2,700,000 ÷ $3,000,000 = 90% $2,800,000 × 90% = $2,520,000

Total appraised value = $3,000,000

Land: $300,000 ÷ $3,000,000 = 10% $2,800,000 × 10% = $280,000

Building: $2,700,000 ÷ $3,000,000 = 90% $2,800,000 × 90% = $2,520,000

Capital Expenditure versus an Immediate Expense NO NO Does expenditure increase capacity or efficiency or extend useful life? Capital Record an asset Expenses Record an expense YES Does expenditure increase capacity or efficiency or extend useful life? Capital Record an asset Expenses Record an expense YES

Learning Objective 2 Account for depreciation.

Account for depreciation.

Straight-line (SL) Units-of-production (UOP) Double-declining balance (DDB) Depreciation Methods

Straight-line (SL)

Units-of-production (UOP)

Double-declining balance (DDB)

Depreciation Methods Data Items Amount Cost of truck $41,000 Estimated residual value ( 1,000) Depreciable cost $40,000 Estimated useful life 5 years Units of production 100,000 miles

Straight-Line Method (Cost – Residual value) ÷ Years of useful life ($41,000 – $1,000) ÷ 5 = $8,000 Year 1 depreciation: $ 8,000 Year 2 depreciation: 8,000 Year 3 depreciation: 8,000 Year 4 depreciation: 8,000 Year 5 depreciation: 8,000 Total depreciation: $40,000

Units-of-Production Method ($41,000 – $1,000) ÷ 100,000 = $.40/mile Year 1: 20,000 miles × $.40 = $ 8,000 Year 2: 30,000 miles × $.40 = 12,000 Year 3: 25,000 miles × $.40 = 10,000 Year 4: 15,000 miles × $.40 = 6,000 Year 5: 10,000 miles × $.40 = 4,000 $40,000

Double-Declining-Balance Method Straight-line rate per year: 100% ÷ 5 = 20% Book value of truck at the end of the first year: $41,000 × 40% = $16,400 $41,000 – $16,400 = $24,600 Double-declining balance: 2 times the straight-line rate = 40%

Comparing Depreciation Methods Year 1 2 3 4 5 Total SL $ 8,000 8,000 8,000 8,000 8,000 $40,000 UOP $ 8,000 12,000 10,000 6,000 4,000 $40,000 DDB $16,400 9,840 5,904 3,542 4,314 $40,000 Amount of Depreciation per Year

Depreciation Methods Used by 600 Companies 84% Straight-line 5% Units-of-production 10% Accelerated 1% Other

Learning Objective 3 Select the best depreciation method.

Select the best depreciation method.

Relationship Between Depreciation and Taxes ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren Cash revenues $400,000 $400,000 Cash operating expenses 300,000 300,000 Cash provided by operations before tax $100,000 $100,000 Depreciation expense 8,000 16,400 Income before income tax $ 92,000 $ 83,600 Income tax expense (30%) 27,600 25,080 Net income $ 64,400 $ 58,520 Straight-line Accelerated

Relationship Between Depreciation and Taxes Cash-flow analysis $100,000 $100,000 Income tax expense 27,600 25,080 Cash provided by operations before taxes $ 72,400 $ 74,920 Extra cash available for investment if DDB is used ($74,920 – $72,400) $ 2,520 Straight-line Accelerated ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

Modified Accelerated Cost Recovery System (MACRS) Assets are grouped into one of eight classes identified by asset life.

Assets are grouped into one of eight classes identified by asset life.

Depreciation for Partial Years Suppose a calendar-year business purchases a building on April 1 for $500,000 with an estimated life of 20 years and an estimated residual value of $80,000. What is the current year’s depreciation using the straight-line method?

Suppose a calendar-year business purchases a building on April 1 for $500,000 with an estimated life of 20 years and an estimated residual value of $80,000.

What is the current year’s depreciation using the straight-line method?

Depreciation for Partial Years Partial-year depreciation: $21,000 × 9/12 = $15,750 Full-year depreciation: ($500,000 – $80,000) ÷ 20 = $21,000

Assume an asset cost of $50,000, an ten-year useful life with no residual value, and the straight-line method. Changing the Useful Life of a Depreciable Asset $50,000 ÷ 10 = $5,000 depreciation per year What is the book value after four years? $50,000 – $20,000 = $30,000

Assume an asset cost of $50,000, an ten-year useful life with no residual value, and the straight-line method.

Changing the Useful Life of a Depreciable Asset Management determines that the asset will be useful for an additional ten years. How much depreciation expense would be recognized each year starting in year five? $30,000 / 10 years = $3,000

Management determines that the asset will be useful for an additional ten years. How much depreciation expense would be recognized each year starting in year five?

Learning Objective 4 Analyze the effect of a plant asset disposal.

Analyze the effect of a plant asset disposal.

Accounting for Disposal of Plant Assets: Example Fixtures cost: $4,000 Accumulated depreciation: $3,000 Book value $1,000 Accumulated Depreciation 3,000 Loss of Disposal of Asset 1,000 Store Fixtures 4,000 To dispose of store fixtures Accumulated Depreciation 3,000 Loss of Disposal of Asset 1,000 Store Fixtures 4,000 To dispose of store fixtures ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

Selling a Plant Asset: Example Equipment which cost $10,000 on 1/1/2002 is sold on 9/30/2005 for $5,000. It has been depreciated on a straight-line basis over its 10 years’ estimated useful life. There is no residual value.

Equipment which cost $10,000 on 1/1/2002 is sold on 9/30/2005 for $5,000. It has been depreciated on a straight-line basis over its 10 years’ estimated useful life. There is no residual value.

Selling a Plant Asset: Example What is the accumulated depreciation on September 30, 2005? $10,000 ÷ 10 = $1,000/year $1,000 × 3 years = $3,000 $1,000 × 9/12 = $750 $3,000 + $750 = $3,750

What is the accumulated depreciation on September 30, 2005?

Selling a Plant Asset: Example Sep 30 Cash 5,000 Accumulated Depreciation 3,750 Loss of Sale of Equipment 1,250 Equipment 10,000 To record sale of equipment. ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

Exchanging Plant Assets Assume than an old delivery car with a cost of $9,000 and a book value of $1,000 is exchanged for a new car. Cash payment is $10,000. What is the cost of the new car? $10,000 + $1,000 = $11,000

Assume than an old delivery car with a cost of $9,000 and a book value of $1,000 is exchanged for a new car. Cash payment is $10,000. What is the cost of the new car?

Exchanging Plant Assets Delivery Auto (new) 11,000 Accumulated Depreciation (old) 8,000 Delivery Auto (old) 9,000 Cash 10,000 To record exchange of auto. ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

Learning Objective 5 Account for natural resources and depletion.

Account for natural resources and depletion.

Natural gas and oil Precious metals and gems Timber, coal, and iron ore Accounting for Natural Resources and Depletion (Cost – Residual value) ÷ Estimated units of natural resource = Depletion per unit

Natural gas and oil

Precious metals and gems

Timber, coal, and iron ore

Accounting for Natural Resources and Depletion Assume an oil lease cost $100,000 and contains an estimated 10,000 barrels of oil. If 3,000 barrels are extracted during the year,depletion expense is $30,000. Accumulated Depletion is a contra account similar to Accumulated Depreciation Depletion rate: $100,000 ÷ 10,000 = $10 per barrel.

Assume an oil lease cost $100,000 and contains an estimated 10,000 barrels of oil.

Learning Objective 6 Account for intangible assets and amortization

Account for intangible assets and amortization

Intangible Assets Have no physical form Patents Copyrights Trademarks Franchises Leaseholds Goodwill

Have no physical form

Patents

Copyrights

Trademarks

Franchises

Leaseholds

Goodwill

Intangible Assets Amortization expense - can be written off directly against asset account Assets with an indefinite useful life are not amortized. All intangible assets are subject to impairment

Amortization expense - can be written off directly against asset account

Assets with an indefinite useful life are not amortized.

All intangible assets are subject to impairment

Intangible Assets: Patents Federal government grants giving holder the right to produce and sell an invention. Suppose a company pays $170,000 to acquire a patent on January 1. The company believes that its expected useful life is 5 years.

Federal government grants giving holder the right to produce and sell an invention.

Suppose a company pays $170,000 to acquire a patent on January 1. The company believes that its expected useful life is 5 years.

Intangible Assets: Patets Jan 1 Patents 170,000 Cash 170,000 To record acquisition of patent. Dec 31 Amortization Expense 34,000 Patents 34,000 To amortize cost of patent ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

Literary compositions (novels) Musical compositions Films (movies) Software Other works of art Extend 50 years beyond author’s life. Intangible Assets: Copyrights

Literary compositions (novels)

Musical compositions

Films (movies)

Software

Other works of art

Extend 50 years beyond author’s life.

Trademarks, Trade Names, or Brand Names - assets that represent distinctive identifications of a product or service Intangible Assets: Trademarks

Trademarks, Trade Names, or Brand Names - assets that represent distinctive identifications of a product or service

Intangible Assets: Franchises Privileges granted by private business or government to sell a product or service

Privileges granted by private business or government to sell a product or service

Intangible Assets: Goodwill Purchase price paid for Mexana Company $10 million Assets at market value $9 million Less: Mexana’s liabilities $1 million Market value of Mexana’s net assets 8 million Goodwill $ 2 million

Research and Development Expensed as it is incurred

Expensed as it is incurred

Learning Objective 7 Report plant asset transactions on the statement of cash flows.

Report plant asset transactions on the statement of cash flows.

Reporting Plant Asset Transactions: Statement of Cash Flows Acquisitions (an investing activity) Sales Depreciation (including amortization and depletion)

Acquisitions (an investing activity)

Sales

Depreciation (including amortization and depletion)

End of Chapter 7