Accounting & Financial Reporting

1. Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
Chapter 8
Reporting and
Interpreting Property,
Plant, and Equipment;
Natural Resources;
and Intangibles

2. 8-2
Understanding The Business
How much
is enough?
Insufficient
capacity results
in lost sales.
Costly excess
capacity reduces
profits.

3. 8-3
Learning Objectives
Define, classify, and explain the nature of
long-lived productive assets and interpret
the fixed asset turnover ratio.

4. 8-4
Tangible
Physical
Substance
Intangible
No Physical
Substance
Expected to Benefit Future Periods
Actively Used in Operations
Classifying Long-Lived Assets

5. 8-5
Tangible
Physical
Substance
Intangible
No Physical
Substance
Expected to Benefit Future Periods
Actively Used in Operations
 Land
 Assets subject to depreciation
 Buildings and equipment
 Furniture and fixtures
 Natural resource assets
subject to depletion
 Mineral deposits and timber
Examples
Classifying Long-Lived Assets

6. 8-6
Tangible
Physical
Substance
Intangible
No Physical
Substance
Expected to Benefit Future Periods
Actively Used in Operations
 Value represented by rights
that produce benefits
Patents
Copyrights
Trademarks
Franchises
Goodwill
 Subject to amortization
Examples
Classifying Long-Lived Assets

7. 8-7
Fixed Asset Turnover
Fixed
Asset
Turnover
Net Sales Revenue
Average Net Fixed Assets
=
This ratio measures a company’s
ability to generate sales given an
investment in fixed assets.
For the year 2003, Delta Airlines had $13,303 of
revenue. End-of-year fixed assets were $16,752
and beginning-of-year fixed assets were $16,524.
(All numbers in millions.)

8. 8-8
Fixed
Asset
Turnover
$13,303
($16,524 + $16,752) ÷ 2
= = 0.80
Fixed
Asset
Turnover
Net Sales Revenue
Average Net Fixed Assets
=
Delta Southwest United
0.8 0.84 0.85
2003 Fixed Asset Turnover Comparisons
Fixed Asset Turnover

9. 8-9
Learning Objectives
Apply the cost principle to measure the
acquisition and maintenance of property,
plant, and equipment.

10. 8-10
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.

11. 8-11
 Purchase price
 Renovation and
repair costs
 Legal and realty
fees
 Title fees
Acquisition Cost – Buildings

12. 8-12
 Purchase price
 Installation costs
 Modification to building
necessary to install
equipment
 Transportation costs
Acquisition Cost – Equipment

13. 8-13
 Purchase price
 Real estate commissions
 Title insurance premiums
 Delinquent taxes
 Surveying fees
 Title search and transfer fees
Land is not depreciable.
Acquisition Cost – Land

14. 8-14
Acquisition for Cash
On January 1, Delta Air Lines purchased
aircraft for $70,000,000 cash.
GENERAL JOURNAL Page 8
Date Description Debit Credit
Jan. 1

15. 8-15
Acquisition for Cash
GENERAL JOURNAL Page 8
Date Description Debit Credit
Jan. 1 Flight equipment 70,000,000
Cash 70,000,000
On January 1, Delta Air Lines purchased
aircraft for $70,000,000 cash.

16. 8-16
Acquisition for Debt
GENERAL JOURNAL Page 9
Date Description Debit Credit
Jan. 14
On January 14, Delta Air Lines purchased
aircraft for $1,000,000 cash and a
$69,000,000 note payable.

17. 8-17
GENERAL JOURNAL Page 9
Date Description Debit Credit
Jan. 14 Flight equipment 70,000,000
Cash 1,000,000
Note payable 69,000,000
Acquisition for Debt
On January 14, Delta Air Lines purchased
aircraft for $1,000,000 cash and a
$69,000,000 note payable.

18. 8-18
Record at the current market value of
the consideration given, or the current
market value of the asset acquired,
whichever is more clearly evident.
Acquisition for Noncash Consideration

19. 8-19
GENERAL JOURNAL Page 10
Date Description Debit Credit
July 7
Acquisition for Noncash Consideration
On July 7, Delta gave Boeing 6,000,000 shares of
$1.50 par value common stock with a market value of
$7 per share plus $28,000,000 in cash for aircraft.

20. 8-20
GENERAL JOURNAL Page 10
Date Description Debit Credit
July 7 Flight equipment 70,000,000
Cash 28,000,000
Common stock 9,000,000
Additional paid-in capital 33,000,000
Acquisition for Noncash Consideration
On July 7, Delta gave Boeing 6,000,000 shares of
$1.50 par value common stock with a market value of
$7 per share plus $28,000,000 in cash for aircraft.

21. 8-21
Acquisition by Construction
Asset cost includes:
All materials and
labor traceable to
the construction.
A reasonable
amount of
overhead.
Interest on debt
incurred during
the construction.

22. 8-22
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 Capital 1. Major overhauls or partial
repairs replacements
2. Extends life beyond original estimate
Additions Capital 1. Increases productivity
2. May extend useful life
3. Improvements or expansions

23. 8-23
Capital and Revenue Expenditures
Many companies have policies expensing all
expenditures below a certain amount according to the
materiality constraint.
Financial Statement Effect
Current Current
Treatment Statement Expense Income Taxes
Capital Balance sheet
Expenditure account debited Deferred Higher Higher
Revenue Income statement Currently
Expenditure account debited recognized Lower Lower

24. 8-24
Learning Objectives
Apply various cost allocation methods as
assets are held and used over time.

25. 8-25
Depreciation is a cost allocation process
that systematically and rationally matches
acquisition costs of operational assets
with periods benefited by their use.
Cost
Allocation
(Unused)
Balance Sheet
(Used)
Income Statement
Expense
Depreciation
Acquisition
Cost

26. 8-26
Depreciation
Expense
Income
Statement
Balance
Sheet
Accumulated
Depreciation
Depreciation for
the current year
Total of depreciation
to date on an asset
Depreciation

27. 8-27
Property and Equipment:
Flight equipment 21,008
$
Less: Accumulated depreciation 6,497 14,511
$
Equipment under capial lease 463
Less: Accumulated amortization 353 110
Ground property and equipment 4,477
Less: Accumulated depreciation 2,408 2,069
Advance payments for equipment 62
Total property and equipment 16,752
$
Book Values
Depreciation on Delta’s 2003 Balance Sheet
Book value = Market value
/

28. 8-28
Depreciation Concepts
The calculation of depreciation requires
three amounts for each asset:
 Acquisition cost.
 Estimated useful life.
 Estimated residual value.

29. 8-29
Alternative Depreciation Methods
 Straight-line
 Units-of-production
 Accelerated Method:
Declining balance

30. 8-30
Straight-Line Method
At the beginning of the year, Delta 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.
Cost - Residual Value
Life in Years
Depreciation
Expense per Year
=
SL

31. 8-31
Depreciation
Expense per Year
=
Depreciation
Expense per Year
= $20,000
$62,500 - $2,500
3 years
Cost - Residual Value
Life in Years
Depreciation
Expense per Year
=
SL
Straight-Line Method

32. 8-32
Depreciation Accumulated Accumulated Undepreciated
Expense Depreciation Depreciation Balance
Year (debit) (credit) Balance (book value)
62,500
$
1 20,000
$ 20,000
$ 20,000
$ 42,500
2 20,000 20,000 40,000 22,500
3 20,000 20,000 60,000 2,500
60,000
$ 60,000
$
Residual Value
SL
More companies use the straight-line
method of depreciation in their financial
reports than all other methods combined.
Straight-Line Method

33. 8-33
Units-of-Production Method
Depreciation
Rate
= Cost - Residual Value
Life in Units of Production
Step 1:
Step 2:
Depreciation
Expense
=
Depreciation
Rate
×
Number of
Units Produced
for the Year

34. 8-34
At the beginning of the year, Delta 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?
Units-of-Production Method

35. 8-35
$62,500 - $2,500
100,000 miles
= $.60 per mile
Depreciation
Rate
=
Step 1:
Step 2:
$.60 per mile × 30,000 miles = $18,000
Depreciation
Expense
=
Units-of-Production Method

36. 8-36
Units-of-Production Method
Accumulated Undepreciated
Depreciation Depreciation Balance
Year Miles Expense Balance (book value)
62,500
$
1 30,000 18,000
$ 18,000
$ 44,500
2 50,000
3 20,000
100,000

37. 8-37
Accumulated Undepreciated
Depreciation Depreciation Balance
Year Miles Expense Balance (book value)
62,500
$
1 30,000 18,000
$ 18,000
$ 44,500
2 50,000 30,000 48,000 14,500
3 20,000 12,000 60,000 2,500
100,000 60,000
$
Residual Value
Units-of-Production Method

38. 8-38
Accelerated Depreciation
Depreciation Repair
Expense Expense
Early Years High Low
Later Years Low High
Accelerated depreciation matches higher
depreciation expense with higher revenues
in the early years of an asset’s useful life when
the asset is more efficient.

39. 8-39
Double-Declining-Balance Method
Annual
Depreciation
expense
Net
Book
Value
( )
Useful Life in Years
2
= ×
Cost – Accumulated Depreciation
Declining balance rate of 2 is
double-declining-balance (DDB) rate.
Annual computation ignores residual value.

40. 8-40
At the beginning of the year, Delta
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.
Double-Declining-Balance Method

41. 8-41
Annual
Depreciation
expense
Net
Book
Value
( )
Useful Life in Years
2
= ×
( )
$62,500 × 3 years
2
= $41,667
( )
($62,500 – $41,667) × 3 years
2
= $13,889
Double-Declining-Balance Method
Year 1 Depreciation:
Year 2 Depreciation:

42. 8-42
Depreciation Accumulated Undepreciated
Expense Depreciation Balance
Year (debit) Balance (book value)
62,500
$
1 41,667
$ 41,667
$ 20,833
2 13,889 55,556 6,944
3 4,629 60,185 2,315
60,185
$
( )
($62,500 – $55,556) × 3 years
2
= $4,629
Below residual value
Double-Declining-Balance Method

43. 8-43
Depreciation expense is limited to the amount that
reduces book value to the estimated residual value.
Depreciation Accumulated Undepreciated
Expense Depreciation Balance
Year (debit) Balance (book value)
62,500
$
1 41,667
$ 41,667
$ 20,833
2 13,889 55,556 6,944
3 4,444 60,000 2,500
60,000
$
Double-Declining-Balance Method

44. 8-44
Depreciation and Federal Income Tax
For tax purposes, most corporations use the
Modified Accelerated Cost Recovery System
(MACRS).
MACRS depreciation provides for rapid write-
off of an asset’s cost in order to stimulate
new investment.

45. 8-45
Depreciation Methods in Other Countries
Many countries, including Australia, Brazil,
England, and Mexico, use other methods
such as depreciation based
on the current fair value of assets.

46. 8-46
Learning Objectives
Explain the effect of asset impairment
on financial statements.

47. 8-47
Asset Impairment
Impairment is the loss of a significant portion
of the utility of an asset through . . .
 Casualty.
 Obsolescence.
 Lack of demand for the asset’s services.
A loss should be recognized when an
asset suffers a permanent impairment.

48. 8-48
Learning Objectives
Analyze the disposal of property,
plant, and equipment.

49. 8-49
Disposal of Property, Plant, and Equipment
 Voluntary disposals:
 Sale
 Trade-in
 Retirement
 Involuntary disposals:
 Fire
 Accident

50. 8-50
Disposal of Property, Plant, and Equipment
 Update depreciation
to the date of disposal.
 Journalize disposal by:
Writing off accumulated
depreciation (debit).
Writing off the
asset cost (credit).
Recording cash
received (debit)
or paid (credit).
Recording a
gain (credit)
or loss (debit).

51. 8-51
If Cash > BV, record a gain (credit).
If Cash < BV, record a loss (debit).
If Cash = BV, no gain or loss.
Disposal of Property, Plant, and Equipment

52. 8-52
Delta Airlines sold flight equipment
for $5,000,000 cash at the end of its
17th year of use. The flight equipment
originally cost $20,000,000, and was
depreciated using the straight-line
method with zero residual value
and a useful life of 20 years.
Let’s answer the following questions.
Disposal of Property, Plant, and Equipment

53. 8-53
The amount of depreciation expense
recorded at the end of the 17th year to
bring depreciation up to date is:
a. $0.
b. $1,000,000.
c. $2,000,000.
d. $4,000,000.
Disposal of Property, Plant, and Equipment

54. 8-54
The amount of depreciation expense
recorded at the end of the 17th year to
bring depreciation up to date is:
a. $0.
b. $1,000,000.
c. $2,000,000.
d. $4,000,000.
Annual Depreciation:
($20,000,000 - $0) ÷ 20 Years.
= $1,000,000
Disposal of Property, Plant, and Equipment

55. 8-55
After updating the depreciation,
the equipment’s book value at the
end of the 17th year is:
a. $3,000,000.
b. $16,000,000.
c. $17,000,000.
d. $4,000,000.
Disposal of Property, Plant, and Equipment

56. 8-56
After updating the depreciation,
the equipment’s book value at the
end of the 17th year is:
a. $3,000,000.
b. $16,000,000.
c. $17,000,000.
d. $4,000,000.
Accumulated Depreciation =
(17yrs. × $1,000,000) = $17,000,000
BV = Cost - Accumulated Depreciation
BV = $20,000,000 - $17,000,000
= $3,000,000
Disposal of Property, Plant, and Equipment

57. 8-57
The equipment’s sale resulted in:
a. a gain of $2,000,000.
b. a gain of $3,000,000.
c. a gain of $4,000,000.
d. a loss of $2,000,000.
Disposal of Property, Plant, and Equipment

58. 8-58
The equipment’s sale resulted in:
a. a gain of $2,000,000.
b. a gain of $3,000,000.
c. a gain of $4,000,000.
d. a loss of $2,000,000.
Gain = Cash Received - Book Value
Gain = $5,000,000 - $3,000,000 = $2,000,000
Disposal of Property, Plant, and Equipment

59. 8-59
GENERAL JOURNAL Page 8
Date Description Debit Credit
Prepare the journal entry to record Delta’s sale
of the equipment at the end of the 17th year.
Disposal of Property, Plant, and Equipment

60. 8-60
GENERAL JOURNAL Page 8
Date Description Debit Credit
Cash 5,000,000
Accumulated Depreciation 17,000,000
Gain on Sale 2,000,000
Flight Equipment 20,000,000
Prepare the journal entry to record Delta’s sale
of the equipment at the end of the 17th year.
Disposal of Property, Plant, and Equipment

61. 8-61
Learning Objectives
Apply measurement and reporting concepts
for natural resources and intangible assets.

62. 8-62
Natural Resources
Examples: oil, coal, gold
Extracted from
the natural
environment.
A noncurrent
asset presented
at cost less
accumulated
depletion.

63. 8-63
Depletion is like depreciation.
Total cost of
asset is the cost
of acquisition,
exploration,
and development.
Total cost is
allocated over
periods benefited
by means of
depletion.
Natural Resources

64. 8-64
Depletion of Natural Resources
Depletion is calculated using the
units-of-production method.
Unit depletion rate is calculated as follows:
Estimated Recoverable Units
Acquisition and Residual
Development Cost Value
–

65. 8-65
Total depletion cost for a period is:
UNIT DEPLETION
RATE
NUMBER OF UNITS
EXTRACTED IN PERIOD
×
Total
depletion
cost
Inventory
for sale
Unsold
Inventory
Cost of
goods sold
Depletion of Natural Resources

66. 8-66
Specialized plant assets may be required to extract
the natural resource.
These assets are recorded in a separate account
and depreciated.
Natural Resources

67. 8-67
Intangible Assets
Noncurrent assets
without physical
substance.
Useful life is
often difficult
to determine.
Usually acquired
for operational
use.
Often provide
exclusive rights
or privileges.
Intangible
Assets

68. 8-68
 Goodwill
 Trademarks
 Patents
 Copyrights
 Franchises
 Licensing Rights
 Technology
Record at current
cash equivalent
cost, including
purchase price,
legal fees, and
filing fees.
Intangible Assets

69. 8-69
Definite Life
 Amortize over shorter of
economic life or legal life,
subject to rules specified
by GAAP.
 Use straight-line method.
Intangible Assets
Indefinite Life
 Not amortized.
 Tested at least annually
for possible impairment,
and book value is reduced
to fair value if impaired.
Amortization is a cost allocation process
similar to depreciation and depletion.

70. 8-70
Occurs when one
company buys
another company.
The amount by which the
purchase price exceeds the fair
market value of net assets acquired.
Only purchased
goodwill is an
intangible asset.
Goodwill
Intangible Assets – Goodwill

71. 8-71
Intangible Assets – Goodwill
Goodwill
Indefinite Life
Not amortized.
Value must be reviewed
at least annually for
possible impairment, and
book value is reduced
to fair value if impaired.

72. 8-72
Arpec Company paid $2,000,000 to purchase
all of Utek Company’s assets and assumed
liabilities of $400,000. The acquired assets were
appraised at a fair value of $1,800,000.
Intangible Assets – Goodwill

73. 8-73
What amount of goodwill should be
recorded on Arpec Company books?
a. $200,000
b. $400,000
c. $600,000
d. $800,000
Intangible Assets – Goodwill

74. 8-74
What amount of goodwill should be
recorded on Arpec Company books?
a. $200,000
b. $400,000
c. $600,000
d. $800,000
FMV of Assets 1,800,000
$
Debt Assumed 400,000
FMV of Net Assets 1,400,000
Purchase Price 2,000,000
Goodwill 600,000
$
Intangible Assets – Goodwill

75. 8-75
Intangible Assets – Trademarks
A symbol, design, or logo
associated with a business.
Purchased
trademarks
are recorded
at cost.
Internally
developed
trademarks
have no
recorded
asset cost.

76. 8-76
Intangible Assets – Patents
Exclusive right granted by federal government
to sell or manufacture an invention.
Cost is purchase
price plus legal
cost to defend.
Amortize cost
over the shorter of
useful life or 20 years.
Research and development costs that might result
in a patent are normally expensed as incurred.

77. 8-77
Intangible Assets – Copyrights
Exclusive right granted by the federal
government to protect artistic or
intellectual properties.
Amortize cost
over the period
benefited.
Legal life is
life of creator
plus 70 years.

78. 8-78
Intangible Assets – Franchises
Legally protected right to sell products or
provide services purchased by franchisee
from franchisor.
Purchase price is an intangible
asset that is amortized.

79. 8-79
Intangible Assets – Licensing Rights
Limited permissions to use a product
or service according to specific terms
and conditions.
You may be using computer
software that is made
available to you through a
campus licensing agreement.

80. 8-80
Intangible Assets - Technology
A category of intangible
assets that includes a
company’s website and
any computer programs
written by its employees.

81. 8-81
Learning Objectives
Explain the impact on cash flows of acquiring,
using, and disposing of long-lived assets.

82. 8-82
Focus on Cash Flows

83. 8-83
Changes in Depreciation Estimates
Chapter Supplement A

84. 8-84
Changes in Estimates
Depreciation Expense is based on . . .
ESTIMATED
useful life
ESTIMATED
residual value
If the estimates change, the book value less
any residual value at the date of change is
depreciated over the remaining useful life.

85. 8-85
Delta purchased an aircraft for $60,000,000. The
aircraft is depreciated using the straight-line method
with a useful life of 20 years and an estimated
residual value of $3,000,000. In year 5, Delta
changed the estimated useful life to 25 years and
lowered the residual value to $2,400,000
Calculate depreciation expense for the
fifth year using the straight-line method.
Changes in Estimates

86. 8-86
Asset cost 60,000,000
$
Accumulated depreciation
($2,850,000 per year × 4 years) 11,400,000
Remaining book value 48,600,000
Less estimated residual value 2,400,000
Depreciable base 46,200,000
Divide by remaining life ÷ 21
Revised annual depreciation 2,200,000
$
Changes in Estimates

87. 8-87
End of Chapter 8