12-‹#›1Describe the characteristics, valuation, and amo.docx

12-‹#›
1Describe the characteristics, valuation, and amortization of
intangible assets.
2Describe the accounting for various types of intangible assets.
3Explain the accounting issues for recording goodwill.
LEARNING OBJECTIVES
4Explain impairment procedures and presentation requirements
for intangible assets.
5Describe accounting and presentation for research and
development and similar costs.
After studying this chapter, you should be able to:
Intangible Assets
12
12-‹#›
PREVIEW OF CHAPTER 12
Intermediate Accounting
16th Edition
Kieso ● Weygandt ● Warfield
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LO 1 Describe the characteristics, valuation, and amortization
of intangible assets.

Characteristics
Lack physical existence.
Not financial instruments.
Normally classified as long-term asset.
Common types of intangibles:
Patents
Copyrights
Franchises or licenses
Trademarks or trade names
Goodwill
INTANGIBLE ASSET ISSUES
The Coca-Cola Company’s success comes from its secret
formula for making Coca-Cola, not
its plant facilities.
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Purchased Intangibles
Recorded at cost.
Includes all costs necessary to make the intangible asset ready
for its intended use.
Typical costs include:
Purchase price.
Legal fees.
Other incidental expenses.
Valuation
LO 1
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Valuation
Google expensed the R&D costs incurred to develop its valuable
search engine.
Internally Created Intangibles
Recorded at cost.
Generally expensed.
Only capitalize direct costs incurred in developing the
intangible, such as legal costs.
LO 1
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Amortization of Intangibles
Limited-Life Intangibles
Amortize to expense over useful life.
Credit asset account or accumulated amortization.
Useful life should reflect the periods over which the asset will
contribute to cash flows.
Amortization should be cost less residual value.
Companies should evaluate the limited-life intangibles for
impairment.
LO 1
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Indefinite-Life Intangibles

No foreseeable limit on time the asset is expected to provide
cash flows.
Must test indefinite-life intangibles for impairment at least
annually.
No amortization.
LO 1
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ILLUSTRATION 12-1
Accounting Treatment for Intangibles
LO 1
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Does it matter how a company builds brand value? In a word,
yes. If the brand is internally developed, its value does not
appear in the financial statements. This is the case for The
Coca-Cola Company, whose brand value is estimated to be
roughly worth $79.2 billion but its balance sheet values its
“trademarks within definite-lives” (i.e., brands) at just $6.7
billion. As you are learning in this chapter, this reporting

results because the accounting rules prohibit companies from
recognizing brands and many other “intangible” assets if they
created them themselves. In contrast, when Procter & Gamble
(P&G) acquired Gillette in 2005, it realized an additional $24
billion in intangible assets on its balance sheet. That is, P&G
paid $57 billion for Gillette and
estimated the Gillette brand value to be worth $24 billion of the
total paid.
Some have criticized this inconsistency in accounting, noting
that information about the value of a brand is important to
investors in consumer-product companies. Those supporting the
difference in accounting cite the difficulty in arriving at reliable
estimates of internally generated intangible assets. This latter
argument seems to be carrying the day in support of the current
accounting, under which only purchased brands and other
intangible assets are recognized in accounting reports.
Source: “Untouchable Intangibles: Sometimes You See Brands
on the Balance Sheet, Sometimes You Don’t,” The Economist
(August 30, 2014).
WHAT DO THE NUMBERS MEAN? ARE ALL BRANDS THE
SAME?
LO 1
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Six Major Categories:
Marketing-related.
Customer-related.
Artistic-related.
Contract-related.
Technology-related.
Goodwill.

TYPES OF INTANGIBLE ASSETS
LO 2 Describe the accounting for various types of intangible
assets.
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Marketing-Related Intangible Assets
Examples:
Trademarks or trade names, newspaper mastheads, Internet
domain names, and non-competition agreements.
In the United States trademarks or trade names have legal
protection for indefinite number of 10 year renewal periods.
Capitalize acquisition costs.
No amortization.
LO 2
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Companies go to great extremes to protect their valuable
intangible assets. Consider how the creators of the highly
successful game Trivial Pursuit protected their creation. First,
they copyrighted the 6,000 questions that are at the heart of the

game. Then they shielded the Trivial Pursuit name by applying
for a registered trademark. As a third mode of protection, they
obtained a design patent on the playing board’s design as a
unique graphic creation.
Another more recent example is the case of Converse and its
efforts to protect its classic Chuck Taylor trademark. Converse
(owned by Nike) accused 31 companies (including Wal-Mart
Stores Inc., Kmart, and Skechers) of trademark infringement for
co-opting its widely recognizable Chuck
Taylor® sneakers. While Converse is suing for monetary
damages, its main goal is to get these imposters off store
shelves. The company went as far as filing a separate complaint
with the International Trade Commission to stop any shoes
considered to be counterfeit from entering the country. That
Converse (Nike) is going to these ends to protect its trademark
is understandable given the Nike reinvigorated the brand by
expanding the franchise, introducing more colors and styles,
and helping to push All Stars® into overseas markets.
Source: “Converse Sues to Product Its Chuck Taylor All Stars,”
The New
Work Times (October 14, 2014).
WHAT DO THE NUMBERS MEAN? KEEP YOUR HANDS
OFF MY INTANGIBLES?
LO 2
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Customer-Related Intangible Assets
Examples:
Customer lists, order or production backlogs, and both
contractual and non-contractual customer relationships.

Capitalize acquisition costs.
Amortized to expense over useful life.
LO 2
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Illustration: Green Market Inc. acquires the customer list of a
large newspaper for $6,000,000 on January 1, 2017. Green
Market expects to benefit from the information evenly over a
three-year period. Record the purchase of the customer list and
the amortization of the customer list at the end of each year.
Customer List 6,000,000
Jan. 1
2017
Cash 6,000,000
Amortization Expense 2,000,000
Dec. 31
2017
2018
2019
Customer List *2,000,000
* or Accumulated Amortization
LO 2
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Artistic-Related Intangible Assets
Examples:

Plays, literary works, musical works, pictures, photographs, and
video and audiovisual material.
Copyright granted for the life of the creator plus 70 years.
Capitalize costs of acquiring and defending.
Amortized to expense over useful life.
Mickey Mouse
and
LO 2
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Contract-Related Intangible Assets
Examples:
Franchise and licensing agreements, construction permits,
broadcast rights, and service or supply contracts.
Franchise (or license) with a limited life should be amortized to
expense over the life of the franchise.
Franchise with an indefinite life should be carried at cost and
not amortized.
LO 2
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Technology-Related Intangible Assets
Examples:
Patented technology and trade secrets granted by the U.S. Patent
and Trademark Office.
Patent gives holder exclusive use for 20 years.
Capitalize costs of purchasing a patent.
Expense any R&D costs in developing a patent.
Amortize over legal life or useful life, whichever is shorter.
LO 2
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The smartphone industry has been a patent battleground. For
example, Nokia filed patent lawsuits against Apple (and Apple
countersued) over cell phone features such as swiping gestures
on touch screens and the “app store” for downloading software.
Apple also targeted HTC for infringing on Apple’s patented
feature that allows screens to detect more than one finger touch
at a time. This facilitates the popular zoom-in and zoom-out
capability. HTC, in turn, sued Apple for infringing on patented
technology that helps extend battery life. The activity-tracker
product space is another patent battleground. Competition in
that market heated up when Under Armour recently paid $150
million to acquire MapMyFitness, which has 20 million people
registered to use its websites and mobile applications to
map, record, and share their workouts. To protect the value of
the patent related to its miCoach fitness tracking system, adidas

AG sued Under Armour. The lawsuit alleges that Under Armour
infringed on 10 adidas patents, underscoring the growing
importance of gadgetry and personal technology for sportswear
makers that traditionally focused on shoes and apparel.
Sources: J. Mintz, “Smart Phone Makers in Legal Fights over
Patents,” Wisconsin State Journal (December 19, 2010), p. F4;
and S. Germano, “Adidas Sues Under Armour Over Patents:
Company Alleges Under Armour Infringes on 10 MiCoach
Patents,” Wall Street Journal (February 4, 2014).
WHAT DO THE NUMBERS MEAN? PATENT BATTLES?
LO 2
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Illustration: Harcott Co. incurs $180,000 in legal costs on
January 1, 2017, to successfully defend a patent. The patent’s
useful life is 12 years, amortized on a straight-line basis.
Harcott records the legal fees and the amortization at the end of
2017 as follows.
Patents 180,000
Jan. 1
Cash 180,000
Amortization Expense 15,000
Dec. 31
Patents (or Accumulated Amortization) 15,000
LO 2
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After several espionage cases were uncovered, the secrets
contained within the Los Alamos nuclear lab seemed easier to
check out than a library book. But The Coca-Cola Company has
managed to keep the recipe for the world’s best-selling soft
drink under wraps for more than 100 years. The company offers
almost no information about its lifeblood, and the only written
copy of the formula resides in a bank vault in Atlanta. This
handwritten sheet is available to no one except by vote of Coca-
Cola’s board of directors.
Can’t science offer some clues? Coke purportedly contains 17 to
18 ingredients. That includes the usual caramel color and corn
syrup, as well as a blend of oils known as 7X (rumored to be a
mix of orange, lemon, cinnamon, and others).
Distilling natural products like these is complicated since they
are made of thousands of compounds. One ingredient you will
not find, by the way, is cocaine. Although the original formula
did contain trace amounts, today’s Coke doesn’t. When was it
removed? That too is a secret.
Some experts indicate that the power of the Coca-Cola formula
and related brand image account for almost $79.2 billion, or
roughly 43 percent, of Coke’s $182.2 billion stock value.
Sources: Adapted from Reed Tucker, “How Has Coke’s Formula
Stayeda Secret?” Fortune (July 24, 2000), p. 42; and “Best
Global Brands 2011,” www.interbrand.com (accessed August
30, 2014).
WHAT DO THE NUMBERS MEAN? VALUE OF SECRET
FORMULA?
LO 2
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Goodwill
Conceptually, represents the future economic benefits arising
from the other assets acquired in a business combination that
are not individually identified and separately recognized.
Only recorded when an entire business is purchased.
Goodwill is measured as the ...
excess of cost of the purchase over the FMV of the identifiable
net assets (assets less liabilities) purchased.
Internally created goodwill should not be capitalized.
LO 3Explain the accounting issues for recording goodwill.
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Illustration: Multi-Diversified, Inc. decides that it needs a parts
division to supplement its existing tractor distributorship. The
president of Multi-Diversified is interested in buying
Tractorling Company. The illustration presents the statement of
financial position of Tractorling Company.
Recording Goodwill
ILLUSTRATION 12-3
Tractorling Co. Balance Sheet
LO 3
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Multi-Diversified investigates Tractorling’s underlying assets to
determine their fair values.
Recording Goodwill
ILLUSTRATION 12-4
Fair Value of Tractorling’s Net Assets
LO 3
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Tractorling Company decides to accept Multi-Diversified’s
offer of $400,000. What is the value of the goodwill, if any?
Recording Goodwill
ILLUSTRATION 12-5
Determination of Goodwill—Master Valuation Approach
LO 3
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Cash 25,000
Accounts Receivables 35,000
Inventory122,000
Property, Plant, and Equipment 205,000
Patents 18,000
Goodwill 50,000
Liabilities 55,000
Cash 400,000
Multi-Diversified records this transaction as follows.

Recording Goodwill
LO 3
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Example: Global Corporation purchased the net assets of Local
Company for $300,000 on December 31, 2017. The balance
sheet of Local Company just prior to acquisition is:
FMV of Net Assets = $200,000
Recording Goodwill
LO 3
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Book Value = $130,000
Fair Value = $200,000
Purchase Price = $300,000
Revaluation
$70,000
Goodwill
$100,000

Company for $300,000 on December 31, 2017. The value
assigned to goodwill is determined as follows:
Recording Goodwill
LO 3
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Recording Goodwill
Company for $300,000 on December 31, 2017. The value
assigned to goodwill is determined as follows:
LO 3
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Journal entry recorded by Global:
Cash 15,000
Receivables10,000
Inventory70,000
Equipment130,000
Goodwill100,000
Accounts Payable25,000
Cash300,000
Company for $300,000 on December 31, 2017. Prepare the
journal entry to record the purchase of the net assets of Local.
Recording Goodwill

LO 3
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Goodwill Write-Off
Goodwill considered to have an indefinite life.
Should not be amortized.
Only adjust carrying value when goodwill is impaired.
Bargain Purchase
Purchase price less than the fair value of net assets acquired.
Amount is recorded as a gain by the purchaser.
Goodwill
LO 3
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Impairment of Limited-Life Intangibles
Same as impairment for long-lived assets in Chapter 11.
If the sum of the expected future net cash flows (undiscounted)
is less than the carrying amount of the asset, an impairment has
occurred (recoverability test).
The impairment loss is the amount by which the carrying
amount of the asset exceeds the fair value of the asset (fair
value test).
The loss is reported as part of income from continuing
operations, “Other expenses and losses” section.
IMPAIRMENT OF INTANGIBLE ASSETS
LO 4Explain impairment procedures and presentation
requirements for intangible assets.

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Illustration: Lerch, Inc. has a patent on how to extract oil from
shale rock. Unfortunately, several recent non-shale oil
discoveries adversely affected the demand for shale-oil
technology. As a result, Lerch performs a recoverability test. It
finds that the expected future net cash flows from this patent are
$35 million. Lerch’s patent has a carrying amount of $60
million. Discounting the expected future net cash flows at its
market rate of interest, Lerch determines the fair value of its
patent to be $20 million. Perform the recoverability test.
Expected future net cash flows $ 35,000,000
Carrying value60,000,000
Asset impaired$ (25,000,000)
LO 4
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Illustration: Perform the fair value test and the journal entry (if
any) to record the impairment of the asset.
Carrying amount of patent $ 60,000,000
Fair value 20,000,000
Loss on impairment$ 40,000,000
Loss on Impairment 40,000,000

Patents40,000,000
Companies may not recognize restoration of the previously
recognized impairment loss.
LO 4
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Impairment of Indefinite-Life Intangibles Other than Goodwill
Should be tested for impairment at least annually.
Impairment test is a fair value test.
If the fair value of asset is less than the carrying amount, an
impairment loss is recognized for the difference.
Recoverability test is not used.
LO 4
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Illustration: Arcon Radio purchased a broadcast license for
$2,000,000. Arcon Radio has renewed the license with the FCC
twice, at a minimal cost. Because it expects cash flows to last
indefinitely, Arcon reports the license as an indefinite-life
intangible asset. Recently the FCC decided to auction these
licenses to the highest bidder instead of renewing them. Arcon
Radio expects cash flows for the remaining two years of its
existing license. It performs an impairment test and determines
that the fair value of the intangible asset is $1,500,000.

ILLUSTRATION 12-7
Computation of Loss on Impairment of Broadcast License
LO 4
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Impairment of Goodwill
Two Step Process:
Step 1: If fair value is less than the carrying amount of the net
assets (including goodwill), then perform a second step to
determine possible impairment.
Step 2: Determine the fair value of the goodwill (implied value
of goodwill) and compare to carrying amount.
LO 4
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Illustration: Kohlbuy Corporation purchased one division, Pritt
Products, four years ago for $2 million. Kohlbuy management is
now reviewing the division for purposes of recognizing an
impairment. Illustration 12-8 lists the Pritt Division’s net
assets, including the associated goodwill of $900,000 from the
purchase.
ILLUSTRATION 12-8
Net Assets of Pritt Division, Including Goodwill
Assume that the fair value of the Pritt Division is $1,900,000.

LO 4
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Illustration: Prepare the journal entry (if any) to record the
impairment.
Step 1:
The fair value of the reporting unit is below its carrying value.
Therefore, an impairment has occurred.
Step 2:
Loss on Impairment 500,000
Goodwill 500,000
$ 1,900,000
1,500,000
400,000
900,000
$ (500,000)
ILLUSTRATIONS 12-9 and 12-10
LO 4
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Impairment Summary
ILLUSTRATION 12-11
Summary of Intangible Asset Impairment Tests

LO 4
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As shown in the chart below, goodwill impairments spiked in
2008 and 2009, coinciding with the stock market downturn in
the wake of the financial crisis.
WHAT DO THE NUMBERS MEAN? IMPAIRMENT RISK
LO 4
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Balance Sheet
Intangible assets shown as a separate item.
Reporting is similar to the reporting of property, plant, and
equipment.
Contra accounts are not normally shown for intangibles.
Companies should report as a separate item all intangible assets
other than goodwill.
Presentation of Intangible Assets
LO 4
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Income Statement
Report amortization expense and impairment losses in

continuing operations.
Goodwill impairment losses should also be presented as a
separate line item in the continuing operations section, unless
the goodwill impairment is associated with a discontinued
operation.
LO 4
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ILLUSTRATION 12-12
Intangible Asset
LO 4
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LO 5 Describe accounting and presentation for research and
development and similar costs.
Frequently results in something that a company patents or
copyrights such as:
new product,
process,
idea,
formula,
composition, or
literary work.
Research and development (R&D) costs are not in themselves
intangible assets.

RESEARCH AND DEVELOPMENT COSTS
Companies must expense all research and development costs
when incurred.
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Companies spend considerable sums on research and
development.
ILLUSTRATION 12-13
R&D Outlays, as a Percentage of Sales
LO 5
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Identifying R & D Activities
Research Activities
Planned search or critical investigation aimed at discovery of
new knowledge.
Examples
Laboratory research aimed at discovery of new knowledge;
searching for applications of new research findings.
Development Activities
Translation of research findings or other knowledge into a plan
or design for a new product or process or for a significant
improvement to an existing product or process whether intended
for sale or use.

Examples
Conceptual formulation and design of possible product or
process alternatives; construction of prototypes and
operation of pilot plants.
LO 5
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Accounting for R & D Activities
Costs Associated with R&D Activities:
Materials, Equipment, and Facilities.
Personnel.
Purchased Intangibles.
Contract Services.
Indirect Costs.
LO 5
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1. Investment in a subsidiary company.
2. Timberland.
3. Cost of engineering activity required to advance the design
of a product to the manufacturing stage.
4. Lease prepayment.
5. Cost of equipment obtained.

6. Cost of searching for applications of new research
findings.
Item
Classification
E12-1: Indicate how items on the list below would generally be
reported in the financial statements.
Long-term investments
PP&E
R&D expense
Prepaid rent
PP&E
R&D expense
LO 5
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Cost incurred in the formation of a corporation.
Operating losses incurred in the start-up of a business.
Training costs incurred in start-up of new operation.
Purchase cost of a franchise.
Goodwill generated internally.
Cost of testing in search of product alternatives.
Expense
Item
Classification
Operating loss
Expense
Intangible
Not recorded
R&D expense

LO 5
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Goodwill acquired in the purchase of a business.
Cost of developing a patent.
Cost of purchasing a patent from an inventor.
Legal costs incurred in securing a patent.
Unrecovered costs of a successful legal suit to protect the
patent.
Intangible
Item
Classification
R&D expense
Intangible
Intangible
Intangible
LO 5
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Cost of conceptual formulation of possible product
alternatives.
Cost of purchasing a copyright.
Research and development costs.
Long-term receivables.
Cost of developing a trademark.
Cost of purchasing a trademark.
R&D expense

Item
Classification
Intangible
R&D expense
Long-term investment
Expense
Intangible
LO 5
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Costs Similar to R & D Costs
Start-up costs for a new operation.
Initial operating losses.
Advertising costs.
Computer software costs.
LO 5
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Cost of equipment acquired that will have alternative uses in
future R&D projects over the next 5 years.
Materials consumed in R&D projects
Consulting fees paid to outsiders for R&D projects
Personnel costs of persons involved in R&D projects
Indirect costs reasonably allocable to R&D projects
Materials purchased for future R&D projects
$280,000

59,000
100,000
128,000
50,000
34,000
$56,000
59,000
100,000
128,000
50,000
0
R&D Expense
$393,000
$280,000 ÷ 5 = $56,000
E12-17: Compute the amount to be reported as research and
development expense.
LO 5
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For many companies, developing a strong brand image is as
important as developing the products they sell. Now more than
ever, companies see the power of a strong brand, enhanced by
significant and effective advertising investments. As the

following chart indicates, the value of brand investments is
substantial. Apple heads the list with an estimated brand value
of about $119 billion.
WHAT DO THE NUMBERS MEAN? BRANDED
LO 5
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Occasionally you may find the value of a brand included in a
company’s financial statements under goodwill. But generally
you will not find the estimated values of brands recorded in
companies’ balance sheets. The reason? The subjectivity that
goes into estimating a brand’s value. In some cases, analysts
base an estimate of brand value on opinion polls or on some
multiple of ad spending. For example, in estimating the brand
values shown to the left, Interbrand Corp. estimates the
percentage of the overall future revenues the brand will
generate and then discounts the net cash flows, to arrive at a
present value. Some analysts believe that information on brand
values is relevant. Others voice valid concerns about the
reliability of brand value estimates due to subjectivity in the
estimates for revenues, costs, and the risk component of the
discount rate. For example, another brand valuation firm,
Millward Brown, ranks Apple as number one with an estimated
brand value of $183 billion (or about one-third of Apple’s
market value). These data support the highly subjective nature
of brand valuation estimates.
Sources: “Best Global Brands 2014,” www.interbrand.com; and
S. Vranica and J. Hansegard, “Ikea Discloses an $11 Billion
Secret,” Wall Street Journal (August 9, 2012).

WHAT DO THE NUMBERS MEAN? BRANDED
LO 5
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Presentation of Research and Development Costs
ILLUSTRATION 12-16
Income Statement Disclosure of R&D Costs
LO 5
12-‹#›
RELEVANT FACTS
Similarities
Like GAAP, under IFRS intangible assets (1) lack physical
substance and (2) are not financial instruments. In addition,
under IFRS an intangible asset is identifiable. To be
identifiable, an intangible asset must either be separable from
the company (can be sold or transferred) or it arises from a
contractual or legal right from which economic benefits will
flow to the company. Fair value is used as the measurement
basis for intangible assets under IFRS, if it is more clearly
evident.
LO 6 Compare the accounting for intangible assets under
GAAP and IFRS.
12-‹#›

RELEVANT FACTS
Similarities
IFRS and GAAP are very similar for intangibles acquired in a
business combination. That is, companies recognize an
intangible asset separately from goodwill if the intangible
represents contractual or legal rights or is capable of being
separated or divided and sold, transferred, licensed, rented, or
exchanged. In addition, under both GAAP and IFRS, companies
recognize acquired in-process research and development
(IPR&D) as a separate intangible asset if it meets the definition
of an intangible asset and its fair value can be measured
reliably.
As in GAAP, under IFRS the costs associated with research and
development are segregated into the two components. Costs in
the research phase are always expensed under both IFRS and
GAAP.
LO 6
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RELEVANT FACTS
Differences
IFRS permits revaluation on limited-life intangible assets.
Revaluations are not permitted for goodwill and other
indefinite-life intangible assets.
IFRS permits some capitalization of internally generated
intangible assets (e.g., brand value) if it is probable there will
be a future benefit and the amount can be reliably measured.
GAAP requires expensing of all costs associated with internally

generated intangibles.
IFRS requires an impairment test at each reporting date for
long-lived assets and intangibles, and records an impairment if
the asset’s carrying amount exceeds its recoverable amount. The
recoverable amount is the higher of the asset’s fair value less
costs to sell and its value-in-use. Value-in-use is the future cash
flows to be derived from the particular assets, discounted to
present value. Under GAAP, impairment loss is measured as the
excess of the carrying amount over the asset’s fair value.
LO 6
12-‹#›
RELEVANT FACTS
Differences
IFRS allows reversal of impairment losses when there has been
a change in economic conditions or in the expected use of
limited-life intangibles. Under GAAP, impairment losses cannot
be reversed for assets to be held and used; the impairment loss
results in a new cost basis for the asset. IFRS and GAAP are
similar in the accounting for impairments of assets held for
disposal.
Under IFRS, costs in the development phase of a research and
development project are capitalized once technological
feasibility (referred to as economic viability) is achieved.
LO 6
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ON THE HORIZON

At one time, the IASB and FASB identified a project that would
consider expanded recognition of internally generated
intangible assets. As indicated, IFRS permits more recognition
of intangibles compared to GAAP. Thus, it will be challenging
to develop converged standards for intangible assets, given the
long-standing prohibition on capitalizing internally generated
intangible assets and research and development in GAAP. At
present, this project is not active.
LO 6
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IFRS SELF-TEST QUESTIONS
Research and development costs are:
expensed under GAAP.
expensed under IFRS.
expensed under both GAAP and IFRS.
None of the above.
LO 6
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A loss on impairment of an intangible asset under IFRS is the
asset’s:
carrying amount less the expected future net cash flows.
carrying amount less its recoverable amount.
recoverable amount less the expected future net cash flows.
book value less its fair value.

LO 6
12-‹#›
Recovery of impairment is recognized for all the following
except:
patent held for sale.
patent held for use.
trademark.
goodwill.
LO 6
12-‹#›
“Copyright © 2016 John Wiley & Sons, Inc. All rights reserved.
Reproduction or translation of this work beyond that permitted
in Section 117 of the 1976 United States Copyright Act without
the express written permission of the copyright owner is
unlawful. Request for further information should be addressed
to the Permissions Department, John Wiley & Sons, Inc. The
purchaser may make back-up copies for his/her own use only
and not for distribution or resale. The Publisher assumes no
responsibility for errors, omissions, or damages, caused by the
use of these programs or from the use of the information
contained herein.”
COPYRIGHT

12-‹#›
AssetsCostFMV
Cash15,000$ 15,000$
Receivables10,000 10,000
Inventories50,000 70,000
Equipment80,000 130,000
Total155,000$ 225,000$
Liabilities and Equities
Accounts payable25,000$ 25,000$
Common stock100,000
Retained earnings30,000
Total155,000$ 25,000$
Sheet1AssetsCostFMVCash$ 15,000$
15,000Receivables10,00010,000Inventories50,00070,000Equip
ment80,000130,000Total$ 155,000$ 225,000Liabilities and
EquitiesAccounts payable$ 25,000$ 25,000Common
stock100,000Retained earnings30,000Total$ 155,000$ 25,000
&A
Page &P
Calculation of Goodwill:
Cash15,000$
Receivables10,000
Inventories70,000
Equipment130,000
Accounts payable(25,000)
FMV of identifiable net assets200,000
Purchase price300,000
Goodwill100,000$
Sheet1Calculation of Goodwill:Cash$
15,000Receivables10,000Inventories70,000Equipment130,000A
ccounts payable(25,000)FMV of identifiable net
assets200,000Purchase price300,000Goodwill$ 100,000
&A
Page &P

Fair value
Carrying amount, net of goodwill
Implied goodwill
Carrying value of goodwill
Loss on impairment
Sheet1Fair valueCarrying amount, net of goodwillImplied
goodwillCarrying value of goodwillLoss on impairment
&A
Page &P
11-‹#›
16th Edition
11-‹#›
Understand depreciation concepts and methods of depreciation.
Explain special depreciation methods and other depreciation
issues.
Explain the accounting issues related to asset impairment.
LEARNING OBJECTIVES
Explain the accounting procedures for depletion of natural
resources.
Explain how to report and analyze property, plant, equipment,
and natural resources.

Depreciation, Impairments, and Depletion
11
LO 1
11-‹#›
Allocating costs of long-lived assets:
Fixed assets = Depreciation expense
Intangibles = Amortization expense
Natural resources = Depletion expense
Depreciation is the accounting process of allocating the cost of
tangible assets to expense in a systematic and rational manner
to those periods expected to benefit from the use of the asset.
DEPRECIATION—METHOD OF COST ALLOCATION
LO 1
11-‹#›
Factors Involved in the Depreciation Process
Three basic questions:
What depreciable base is to be used?
What is the asset’s useful life?
What method of cost apportionment is best for this asset?
METHOD OF COST ALLOCATION
LO 1
11-‹#›

Depreciable Base for the Asset
ILLUSTRATION 11-1
Computation of Depreciation Base
LO 1
11-‹#›
Estimation of Service Lives
Service life often differs from physical life.
Companies retire assets for two reasons:
Physical factors (casualty or expiration of physical life).
Economic factors (inadequacy, supersession, and obsolescence).
LO 1
11-‹#›
Some companies try to imply that depreciation is not a cost. For
example, in their press releases they will often make a bigger
deal over earnings before interest, taxes, depreciation, and
amortization (often referred to as EBITDA) than net income
under GAAP. They like it because it “dresses up” their earnings
numbers. Some on Wall Street buy this hype because they don’t
like the allocations that are required to determine net income.
Some banks, without batting an eyelash, even let companies
base their loan covenants on EBITDA. For example, look at

Premier Parks, which operates the Six Flags chain of amusement
parks. Premier touts its EBITDA performance. But that number
masks a big part of how the company operates—and how it
spends its money. Premier argues that analysts should ignore
depreciation for big-ticket items like roller coasters because the
rides have a long life. Critics, however, say that the amusement
industry has to spend as much as 50 percent of its EBITDA just
to keep its rides and attractions current. Those expenses are not
optional—let the rides get a little rusty, and ticket sales start to
tail off. That means analysts really should view depreciation
associated with the costs of maintaining the rides (or buying
new ones) as an everyday expense.
WHAT’S YOUR PRINCIPLE
WHAT DO THE NUMBERS MEAN? ALPHEBET DUPE
(continued)
LO 1
11-‹#›
It also means investors in those companies should have strong
stomachs. What’s the risk of trusting a fad accounting measure?
Just look at one year’s bankruptcy numbers. Of the 147
companies tracked by Moody’s that defaulted on their debt,
most borrowed money based on EBITDA performance. The
bankers in those deals probably wish they had looked at a few
other factors. On the other hand, nonﬁnancial companies in the
S&P 500 recently generated a substantial EBITDA margin of
20.9 percent. Some analysts are concerned that such a high
number suggests that companies are reluctant to incur costs and
want to stockpile cash. The lesson? Investors will do well to
avoid focus on any single accounting measure.

Sources: Adapted from Herb Greenberg, “Alphabet Dupe: Why
EBITDA Falls Short,” Fortune (July 10, 2000), p. 240; and V.
Monga, “Operating Efficiency Runs High at U.S. Firms,” Wall
Street Journal (February 28, 2012), p. B7.
WHAT DO THE NUMBERS MEAN? ALPHEBET DUPE
LO 1
11-‹#›
The profession requires the method employed be “systematic
and rational.” Methods used include:
Methods of Depreciation
Activity method (units of use or production).
Straight-line method.
Sum-of-the-years’-digits.
Declining-balance method.
Group and composite methods.
Hybrid or combination methods.
Decreasing charge methods
Special methods
LO 1
11-‹#›

Activity Method
Illustration 11-2
Data Used to Illustrate Depreciation Methods
Illustration: If Stanley uses the crane for 4,000 hours the first
year, the depreciation charge is:
Stanley Coal Mines Facts
Illustration 11-3
Depreciation Calculation, Activity Method—Crane Example
LO 1
11-‹#›
Straight-Line Method
Illustration: Stanley computes depreciation as follows:
Illustration 11-2
Illustration 11-4
Depreciation Calculation, Straight-Line Method— Crane
Example
LO 1
11-‹#›

Decreasing-Charge Methods
Sum-of-the-Years’-Digits. Each fraction uses the sum of the
years as a denominator (5 + 4 + 3 + 2 + 1 = 15). The numerator
is the number of years of estimated life remaining as of the
beginning of the year.
n(n+1)
2
=
5(5+1)
2
=
15
Alternate sum-of-the-years’ calculation
Illustration 11-2
LO 1
11-‹#›
Sum-of-the-Years’-Digits
Illustration 11-6
Sum-of-the-Years’-Digits Depreciation Schedule— Crane
Example
LO 1

11-‹#›
Decreasing-Charge Methods
Declining-Balance Method
Utilizes a depreciation rate (percentage) that is some multiple of
the straight-line method.
Does not deduct the salvage value in computing the depreciation
base.
Illustration 11-2
LO 1
11-‹#›
Declining-Balance Method
Illustration 11-7
Double-Declining Depreciation Schedule— Crane Example
LO 1
11-‹#›
Illustration—(Four Methods): Maserati Corporation purchased

a new machine for its assembly process on August 1, 2017. The
cost of this machine was $150,000. The company estimated that
the machine would have a salvage value of $24,000 at the end
of its service life. Its life is estimated at 5 years and its
working hours are estimated at 21,000 hours. Year-end is
December 31.
Instructions: Compute the depreciation expense under the
following methods.
(a) Straight-line depreciation. (c) Sum-of-the-years’-digits.
(b) Activity method(d) Double-declining balance.
LO 1
11-‹#›

Straight-line Method
LO 1
11-‹#›
Activity Method
(Assume 800 hours used in 2017)
LO 1

11-‹#›
Sum-of-the-Years’-Digits Method
5/12 = .41667
7/12 = .58333

LO 1
11-‹#›
Double-Declining Balance Method

LO 1
11-‹#›
issues.
LEARNING OBJECTIVES
resources.
11
LO 2
11-‹#›

Two methods of depreciating multiple-asset accounts exist:
Special Depreciation Methods
Group method used when the assets are similar in nature and
have approximately the same useful lives.
Composite method used when the assets are dissimilar and have
different lives.
The choice of method depends on the nature of the assets
involved.
The computation for group or composite methods is essentially
the same: find an average and depreciate on that basis.
SPECIAL DEPRECIATION METHODS AND OTHER ISSUES
LO 2
11-‹#›
Illustration: Mooney Motors establishes the composite
depreciation rate for its fleet of cars, trucks, and campers as
shown below.
Group and Composite Methods
Illustration 11-8
Depreciation Calculation, Composite Basis
LO 2
11-‹#›
If Mooney retires an asset before or after the average service
life of the group is reached, it buries the resulting gain or loss
in the Accumulated Depreciation account.
Illustration: Suppose that Mooney Motors sold one of the

campers with a cost of $5,000 for $2,600 at the end of the third
year. The entry is:
Accumulated Depreciation 2,400
Cash2,600
Cars, Trucks, and Campers5,000
LO 2
11-‹#›
If Mooney purchases a new type of asset (mopeds, for example),
it must compute a new depreciation rate and apply this rate in
subsequent periods.
ILLUSTRATION 11-9
Disclosure of Group
Depreciation Method
LO 2
11-‹#›
Hybrid or Combination Methods
Companies are also free to develop tailor-made depreciation
methods, provided the method results in the allocation of an
asset’s cost over the asset’s life in a systematic and rational
manner.
SPECIAL DEPRECIATION METHODS

ILLUSTRATION 11-10
Disclosure of Hybrid Depreciation Method
LO 2
11-‹#›
Which depreciation method should management select? Many
believe that the method that best matches revenues with
expenses should be used. For example, if revenues generated by
the asset are constant over its useful life, select straight-line
depreciation. On the other hand, if revenues are higher (or
lower) at the beginning of the asset’s life, then use a decreasing
(or increasing) method. Thus, if a company can reliably
estimate revenues from the asset, selecting a depreciation
method that best matches costs with those revenues would seem
to provide the most useful information to investors and creditors
for assessing the future cash ﬂows from the asset. Managers in
the real estate industry face a different challenge when
considering depreciation choices. Real estate managers object to
traditional depreciation methods because in their view, real
estate often does not decline in value. In addition, because real
estate is highly debt-ﬁnanced, most real estate concerns report
losses in earlier years of operations when the sum of
depreciation and interest exceeds the revenue from the real
estate project. As a result, real estate companies, like Kimco
Realty, argue for some form of increasing-charge method of
depreciation (lower depreciation at the beginning and higher
depreciation at the end). With such a method, companies would
report higher total assets and net income in the earlier years of
the project.
WHAT DO THE NUMBERS MEAN? DECELERATING
DEPRECIATION

LO 2
11-‹#›
How should companies compute depreciation for partial
periods?
Does depreciation provide for the replacement of assets?
How should companies handle revisions in depreciation rates?
Other Depreciation Issues
See slides for LO 1
Funds for the replacement of assets come from revenues.
LO 2
11-‹#›
Changes in estimates are a continual and inherent part of any
estimation process.
Accounted for in the current period and prospective periods.
No change to previously reported results.
Revision of Depreciation Rates
Other Depreciation Issues
LO 2
11-‹#›
Questions:

What is the journal entry to correct the prior years’
depreciation?
Calculate the depreciation expense for
2017.
No Entry
Required
Arcadia HS, purchased equipment for $510,000 which was
estimated to have a useful life of 10 years with a residual value
of $10,000 at the end of that time. Depreciation has been
recorded for 7 years on a straight-line basis. In 2017 (year 8), it
is determined that the total estimated life should be 15 years
with a residual value of $5,000 at the end of that time.
LO 2
11-‹#›
Equipment
$510,000
Accumulated depreciation
350,000
Net book value (NBV)
$160,000
Balance Sheet (Dec. 31, 2016)
After 7 years
Equipment cost $510,000
Salvage value - 10,000
Depreciable base500,000
Useful life (original) 10 years
Annual depreciation $ 50,000
x 7 years = $350,000

First, establish NBV at date of change in estimate.
LO 2
11-‹#›
Net book value $160,000
Salvage value (new) 5,000
Depreciable base155,000
Useful life remaining 8 years
Annual depreciation $ 19,375
Depreciation Expense calculation for 2017.
Depreciation Expense 19,375
Journal entry for 2017
After 7 years
LO 2
11-‹#›

WHAT DO THE NUMBERS MEAN? DEPRECIATION
CHOICES
LO 2
The amount of depreciation expense recorded depends on both
the depreciation method used and estimates of service lives and
salvage values of the assets. Differences in these choices and
estimates can significantly impact a company’s reported results
and can make it difficult to compare the depreciation numbers of
different companies.
An analyst determines the impact of these management choices
and judgments on the amount of depreciation expense by
examining the notes to financial statements. For example,
Willamette Industries provided the note to the right to its
financial statements. As indicated, when Willamette Industries
extended the estimated service lives of its machinery and
equipment by five years, it increased income by nearly $54
million.
During the year, the estimated service lives for most machinery
and equipment were extended five years. The change was based
upon a study performed by the company’s engineering
department, comparisons to typical industry practices, and the
effect of the company’s extensive capital investments which
have resulted in a mix of assets with longer productive lives due
to technological advances. As a result of the change, net income
was increased by $54,000,000.
11-‹#›

issues.
LEARNING OBJECTIVES
resources.
11
LO 3
11-‹#›
Events leading to an impairment:
A significant decrease in the fair value of an asset.
A significant change in the manner in which an asset is used.
A significant adverse change in legal factors or in the business
climate that affects the value of an asset.
An accumulation of costs in excess of the amount originally
expected to acquire or construct an asset.
A projection or forecast that demonstrates continuing losses
associated with an asset.
IMPAIRMENTS
When the carrying amount of an asset is not recoverable, a
company records a write-off referred to as an impairment.
LO 3
11-‹#›

Review events for possible impairment.
If the review indicates impairment, apply the recoverability test.
If the sum of the expected future net cash flows from the long-
lived asset is less than the carrying amount of the asset, an
impairment has occurred.
3. Assuming an impairment, the impairment loss is the amount
by which the carrying amount of the asset exceeds the fair value
of the asset. The fair value is the market value or the present
value of expected future net cash flows.
Measuring Impairments
IMPAIRMENTS
LO 3
11-‹#›
ILLUSTRATION 11-16
Graphic of Accounting for Impairments
Loss reported as part of income from continuing operations, in
the “Other expenses and losses” section.
LO 3
11-‹#›

No Impairment
Example 1: M. Alou Inc. has equipment that, due to changes in
its use, it reviews for possible impairment. The equipment’s
carrying amount is $600,000 ($800,000 cost less $200,000
accumulated depreciation). Alou determines the expected future
net cash flows (undiscounted) from the use of the equipment
and its eventual disposal to be $650,000. Determine whether an
Recoverability Test
IMPAIRMENTS
LO 3
11-‹#›
Example 2: M. Alou Inc. has equipment that, due to changes in
its use, it reviews for possible impairment. The equipment’s
carrying amount is $600,000 ($800,000 cost less $200,000
accumulated depreciation). Alou determines the expected future
net cash flows (undiscounted) from the use of the equipment
and its eventual disposal to be $580,000. Determine whether an
Impairment
Recoverability Test
IMPAIRMENTS
LO 3

11-‹#›
Example 2: The recoverability test indicates that the expected
future net cash flows of $580,000 from the use of the asset are
less than its carrying amount of $600,000. Therefore, an
impairment has occurred. Assume this asset has a fair value of
$525,000. Determine the impairment loss, if any.
Impairment
Loss
Measurement of Loss
IMPAIRMENTS
LO 3
11-‹#›
Example 2:
Measurement of Loss
Loss on Impairment 75,000
M. Alou records the impairment loss as follows:
IMPAIRMENTS
LO 3

11-‹#›
After recording an impairment loss,
the reduced carrying amount becomes its new cost basis.
No change in the new cost basis except for depreciation or
amortization in future periods or for additional impairments.
No restoration of impairment loss for an asset held for use.
Rationale is that the new cost basis puts the impaired asset on
an equal basis with other assets that are unimpaired.
Restoration of Impairment Loss
IMPAIRMENTS
LO 3
11-‹#›
Assets held for disposal are like inventory; companies
Should report them at the lower-of-cost-or-net realizable value.
Can write up or down an asset held for disposal in future
periods, as long as the carrying value after the write-up never
exceeds the carrying amount of the asset before the impairment.
Should report losses or gains related to these impaired assets as
part of income from continuing operations.
Impairment of Assets to Be Disposed Of
IMPAIRMENTS
LO 3
11-‹#›

issues.
LEARNING OBJECTIVES
resources.
11
LO 4
11-‹#›
Natural resources, often called wasting assets, include
petroleum, minerals, and timber.
They have two main features:
complete removal (consumption) of the asset, and
replacement of the asset only by an act of nature.
DEPLETION
Depletion is the process of allocating the cost of natural
resources.
LO 4
11-‹#›
Establishing a Depletion Base
Computation of the depletion base involves four factors:
Acquisition cost.

Exploration costs.
Development costs.
Restoration costs.
DEPLETION
LO 4
11-‹#›
Write-off of Resource Cost
Normally, companies compute depletion (cost depletion) on a
units-of-production method (activity approach). Depletion is a
function of the number of units extracted during the period.
Calculation:
Total cost – Salvage value
Total estimated units available
= Depletion cost per unit
Units extracted x Cost per unit
= Depletion
DEPLETION
LO 4
11-‹#›
Illustration: MaClede Co. acquired the right to use 1,000 acres
of land in Alaska to mine for silver. The lease cost is $50,000,
and the related exploration costs on the property are $100,000.
Intangible development costs incurred in opening the mine are

$850,000. MaClede estimates that the mine will provide
approximately 100,000 ounces of silver.
DEPLETION
ILLUSTRATION 11-17
Computation of Depletion Rate
LO 4
11-‹#›
If MaClede extracts 25,000 ounces in the first year, then the
depletion for the year is $250,000 (25,000 ounces x $10).
Inventory (silver)250,000
Silver Mine250,000
Some companies use an Accumulated Depletion account. In that
case, MaClede’s balance sheet would presented as follows:
MaClede debits Cost of Goods Sold when the silver is sold.
DEPLETION
ILLUSTRATION 11-17
Computation of Depletion Rate
LO 4
11-‹#›
Estimating Recoverable Reserves
Same as accounting for changes in estimates.

Revise the depletion rate on a prospective basis.
Divide the remaining cost by the new estimate of the
recoverable reserves.
DEPLETION
LO 4
11-‹#›
Cuts in the estimates of oil and natural gas reserves at Royal
Dutch Shell, El Paso Corporation, and other energy companies
at one time highlighted the importance of reserve disclosures.
Investors believe that these disclosures provide useful
information for assessing the future cash ﬂows from a
company’s oil and gas reserves. For example, when Shell’s
estimates turned out to be overly optimistic (to the tune of 3.9
billion barrels or 20 percent of reserves), Shell’s stock price
fell.
The experience at Shell and other companies has led the SEC to
look at how companies are estimating their “proved” reserves.
Proved reserves are quantities of oil and gas that can be shown
“with reasonable certainty to be recoverable in future years. . .
.” The phrase “reasonable certainty” is crucial to this guidance,
but differences in interpretation of what is reasonably certain
can result in a wide range of estimates.
And the problem of evaluation is compounded by determining
the prices for crude oil. For example, the price of crude oil fell
more than 50 percent from $115 per barrel in June 2014 to $50
per barrel in early January 2015. These
WHAT DO THE NUMBERS MEAN? RESERVE SURPRISE
LO 4

(continued)
11-‹#›
rapidly changing oil prices can make it difﬁcult to judge the
present value of assets for investment decisions on capital
allocation or for evaluation of impairments. In one case, for
example, ExxonMobil’s estimate was 29 percent higher than an
estimate the SEC developed. ExxonMobil was more optimistic
about the effects of new technology that enables the industry to
retrieve more of the oil and gas it ﬁnds. Thus, to ensure the
continued usefulness of reserve information disclosures, the
SEC continues to work on measurement methodologies that
keep up with technology changes in the oil and gas industry.
Sources: S. Labaton and J. Gerth, “At Shell, New Accounting
and Rosier Outlook,” New York Times (nytimes.com) (March
12, 2004); J. Ball, C. Cummins, and B. Bahree, “Big Oil Differs
with SEC on Methods to Calculate the Industry’s Reserves,”
Wall Street Journal (February 24, 2005), p. C1; and H. Bashir
and D. Holtam, “The Impact of Plummeting Crude Oil Prices on
Company Finances,” Deloitte UK (2015),
http://www2.deloitte.com/uk/en/pages/ energy-and-
resources/articles/crude-awakening.html#.
WHAT DO THE NUMBERS MEAN? RESERVE SURPRISE
LO 4
11-‹#›

Liquidating Dividends - Dividends greater than the amount of
accumulated net income.
Illustration: Callahan Mining had a retained earnings balance of
$1,650,000, accumulated depletion on mineral properties of
$2,100,000, and paid-in capital in excess of par of $5,435,493.
Callahan’s board declared a dividend of $3 a share on the
1,000,000 shares outstanding. It records the $3,000,000 cash
dividend as follows.
Retained Earnings 1,650,000
Paid-in Capital in Excess of Par 1,350,000
Cash 3,000,000
DEPLETION
LO 4
11-‹#›
Oil and Gas Industry:
Full cost concept
Successful efforts concept
Continuing Controversy
Cost of drilling
a dry hole is a cost needed to find the commercially profitable
wells.
Companies should capitalize only the costs of successful
projects.
DEPLETION
LO 4
11-‹#›

The controversy in the oil and gas industry provides a number
of lessons. First, it demonstrates the strong influence that the
federal government has in financial reporting matters. Second,
the concern for economic consequences places pressure on the
FASB to weigh the economic effects of any required standard.
Third, the experience with RRA highlights the problems that
accompany any proposed change from an historical cost to a fair
value approach. Fourth, this controversy illustrates the
difficulty of establishing standards when affected groups have
differing viewpoints.
Indeed, failure to consider the economic consequences of
accounting principles is a frequent criticism of the profession.
However, the neutrality concept requires that the statements be
free from bias. Freedom from bias requires that the statements
reflect economic reality, even if undesirable effects occur.
Finally, the debate over oil and gas accounting reinforces the
need for a conceptual framework with carefully developed
guidelines for recognition, measurement, and reporting, so that
interested parties can more easily resolve issues of this nature
in the future.
EVOLVING ISSUEFULL-COST OR SUCCESSFUL-EFFORTS?
LO 4
11-‹#›
issues.
LEARNING OBJECTIVES

resources.
11
LO 5
11-‹#›
Presentation of Property, Plant, Equipment, and Natural
Resources
PRESENTATION AND ANALYSIS
Because of the significant impact on the financial statements of
the depreciation method(s) used, companies should disclose the
following.
Depreciation expense for the period.
Balances of major classes of depreciable assets, by nature and
function.
Accumulated depreciation.
A general description of the method or methods used in
computing depreciation with respect to major classes of
depreciable assets.
LO 5
11-‹#›
Measure of a firm’s ability to generate sales from a particular
investment in assets.
Analysis of Property, Plant, and Equipment

Asset Turnover Ratio
ILLUSTRATION 11-20
Asset Turnover
LO 5
11-‹#›
Profit Margin on Sales
Measure of the ability to generate operating income from a
particular level of sales.
ILLUSTRATION 11-21
LO 5
11-‹#›

Rate of Return on Assets
ILLUSTRATION 11-22
Return on Assets
Measures a firm’s success in using assets to generate earnings.
LO 5
11-‹#›
Analyst obtains further insight into the behavior of ROA by
disaggregating it into components of profit margin on sales and
asset turnover as follows:
Net Income
Average Total Assets
=
Net Income
Net Sales
=
Net Sales

Asset Turnover
x
x
Average Total Assets
LO 5
11-‹#›
$16,323
($131,119 + $132,683) ÷ 2
=
$16,323
$74,331
=
$74,331
Asset Turnover
x
x
12.37%
21.96%
=
x
.56

($131,119 + $132,683) ÷ 2
Analyst obtains further insight into the behavior of ROA by
disaggregating it into components of profit margin on sales and
asset turnover as follows:
LO 5
11-‹#›
LO 6 Describe income tax methods of depreciation.
MODIFIED ACCELERATED COST RECOVERY SYSTEM
MACRS differs from GAAP in three respects:
a mandated tax life, which is generally shorter than the
economic life;
cost recovery on an accelerated basis; and
an assigned salvage value of zero.
APPENDIX 11A
INCOME TAX DEPRECIATION
11-‹#›
Modified Accelerated Cost Recovery System
Tax Lives (Recovery Periods)
APPENDIX 11A
ILLUSTRATION 11A-1
MACRS Property Classes
LO 6
11-‹#›

Tax Depreciation Methods
APPENDIX 11A
ILLUSTRATION 11A-2
Depreciation Method for Various MACRS Property Classes
LO 6
11-‹#›
Illustration: Computer and peripheral equipment purchased by
Denise Rode Company on January 1, 2016.
APPENDIX 11A
LO 6
11-‹#›
Illustration:
APPENDIX 11A
ILLUSTRATION 11A-3
IRS Table of MACRS Depreciation Rates, by Property Class

LO 6
11-‹#›
LO 6
ILLUSTRATION 11A-4
ILLUSTRATION 11A-5
Illustration: Using the rates from the MACRS depreciation rate
schedule for a 5-year class of property, Rode computes
depreciation as follows
For GAAP, Rode used straight-line, with $16,000 salvage value
and a useful life of 7 years.
APPENDIX 11A
11-‹#›
OPTIONAL STRAIGHT-LINE METHOD
Applies to six classes of property previously described.
Applies the straight-line method to the MACRS recovery
periods.
Ignores salvage value.
APPENDIX 11A
LO 6
11-‹#›

TAX VERSUS BOOK DEPRECIATION
Tax laws and financial reporting have different objectives. The
purpose of:
taxation is to raise revenue from constituents in an equitable
manner.
financial reporting is to reflect the economic substance of a
transaction as closely as possible and to help predict the
amounts, timing, and uncertainty of future cash flows.
The adoption of one method for both tax and book purposes in
all cases is not in accordance with GAAP.
APPENDIX 11A
LO 6
11-‹#›
LO 7 Compare the accounting for property, plant, and
equipment under GAAP and IFRS.
RELEVANT FACTS - Similarities
The definition of property, plant, and equipment is essentially
the same under GAAP and IFRS.
Under both GAAP and IFRS, changes in depreciation method
and changes in useful life are treated in the current and future
periods. Prior periods are not affected.
The accounting for plant asset disposals is the same under
GAAP and IFRS.
The accounting for the initial costs to acquire natural resources
is similar under GAAP and IFRS.
Under both GAAP and IFRS, interest costs incurred during
construction must be capitalized. Recently, IFRS converged to
GAAP.

11-‹#›
The accounting for exchanges of nonmonetary assets has
recently converged between IFRS and GAAP. GAAP now
requires that gains on exchanges of nonmonetary assets be
recognized if the exchange has commercial substance. This is
the same framework used in IFRS.
GAAP also views depreciation as allocation of cost over an
asset’s life. GAAP permits the same depreciation methods
(straight-line, diminishing-balance, units-of-production) as
IFRS.
RELEVANT FACTS - Similarities
LO 7
11-‹#›
RELEVANT FACTS - Differences
IFRS requires component depreciation. Under GAAP,
component depreciation is permitted but is rarely used.
Under IFRS, companies can use either the historical cost model
or the revaluation model. GAAP does not permit revaluations of
property, plant, and equipment or mineral resources.
In testing for impairments of long-lived assets, GAAP uses a
two-step model to test for impairments. As long as future
undiscounted cash flows exceed the carrying amount of the
asset, no impairment is recorded. The IFRS impairment test is
stricter. However, unlike GAAP, reversals of impairment losses
are permitted.

LO 7
11-‹#›
ON THE HORIZON
With respect to revaluations, as part of the conceptual
framework project, the Boards will examine the measurement
bases used in accounting. It is too early to say whether a
converged conceptual framework will recommend fair value
measurement (and revaluation accounting) for property, plant,
and equipment. However, this is likely to be one of the more
contentious issues, given the long-standing use of historical
cost as a measurement basis in GAAP.
LO 7
11-‹#›
Which of the following statements is correct?
Both IFRS and GAAP permit revaluation of property, plant, and
equipment.
IFRS permits revaluation of property, plant, and equipment but
not GAAP.
Both IFRS and GAAP do not permit revaluation of property,
plant, and equipment.
GAAP permits revaluation of property, plant, and equipment but
not IFRS.
IFRS SELF-TEST QUESTION

LO 7
11-‹#›
Hilo Company has land that cost $350,000 but now a fair value
of $500,000. Hilo Company decides to use the revaluation
method specified in IFRS to account for the land. Which of the
following statements is correct?
Hilo Company must continue to report the land at $350,000.
Hilo Company would report a net income increase of $150,000
due to an increase in the value of the land.
Hilo Company would debit Revaluation Surplus for $150,000.
Hilo Company would credit Revaluation Surplus by $150,000.
LO 7
11-‹#›
Under IFRS, value-in-use is defined as:
net realizable value.
fair value.
future cash flows discounted to present value.
total future undiscounted cash flows.

LO 7
11-‹#›
“Copyright © 2016 John Wiley & Sons, Inc. All rights reserved.
Reproduction or translation of this work beyond that permitted
in Section 117 of the 1976 United States Copyright Act without
the express written permission of the copyright owner is
unlawful. Request for further information should be addressed
to the Permissions Department, John Wiley & Sons, Inc. The
purchaser may make back-up copies for his/her own use only
and not for distribution or resale. The Publisher assumes no
responsibility for errors, omissions, or damages, caused by the
use of these programs or from the use of the information
contained herein.”
COPYRIGHT
11-‹#›
Current
DepreciableAnnual PartialYearAccum.
YearBaseYearsExpenseYearExpenseDeprec.
2017126,000$ /5=25,200$ x5/12=10,500$ 10,500$
2018126,000 /5=25,200 x=25,200 35,700
2019126,000 /5=25,200 x=25,200 60,900
2020126,000 /5=25,200 x=25,200 86,100
2021126,000 /5=25,200 x=25,200 111,300
2022126,000 /5=25,200 x7/12=14,700 126,000
126,000$
Journal entry:
2017Depreciation Expense10,500
Accumultated Depreciation10,500

Straight-
lineCurrentDepreciableAnnualPartialYearAccum.YearBaseYear
sExpenseYearExpenseDeprec.2017$ 126,000/5=$
25,200x5/12=$ 10,500$
10,5002018126,000/5=25,200x=25,20035,7002019126,000/5=25
,200x=25,20060,9002020126,000/5=25,200x=25,20086,1002021
126,000/5=25,200x=25,200111,3002022126,000/5=25,200x7/12
=14,700126,000$ 126,000Journal entry:2017Depreciation
Expense10,500Accumultated Depreciation10,500
&A
Page &P
($126,000 / 21,000 hours = $6 per hour)
(Given)Current
Hours Rate perAnnual PartialYearAccum.
YearUsedHoursExpenseYearExpenseDeprec.
2017800 x$6=4,800$ 4,800$ 4,800$
2018x=
2019x=
2020x=
2021x=
800 4,800$
Journal entry:
Sheet2Sale price$12,400Less book value:Cost$
20,000Accumulated depreciation(9,000)Net book
value11,000Gain on sale$1,400Cash12,400Accumulated
depreciation9,000Equipment20,000
Sheet1YearSLDDBActivity200314,40030,80010,800200414,400
18,48014,400200514,40011,08821,600200614,4006,65318,0002
00714,4004,9797,20072,00072,00072,000Sale price$12,400Less
book value:Asset cost$20,000Less:
accumulateddepreciation9,000 11,000= Gain on sale$1,400
Straight-line($126,000 / 21,000 hours = $6 per
hour)(Given)CurrentHoursRate
perAnnualPartialYearAccum.YearUsedHoursExpenseYearExpen

seDeprec.2017800x$6=$ 4,800$ 4,800$
4,8002018x=2019x=2020x=2021x=800$ 4,800Journal
entry:2017Depreciation Expense4,800Accumultated
Depreciation4,800
&A
Page &P
DDBDouble-Declining
Balance:CurrentAnnualPortionYearYearBaseRateExpenseof
YearExpense200377,000x40%=30,80030,800200446,200x40%=
18,48018,480200527,720x40%=11,08811,088200616,632x40%=
6,6536,65320079,979x40%=4,9794,97972,000(0)72,000(0)Depr
eciation expense- 0Accumulated depreciation- 0
&A
Page &P
SYDSum-of-the-Years' DigitsCurrent(77,000-
5,000)AnnualPortionYearAccum.YearBaseFactorExpenseof
YearExpenseDeprec.- 0- 0
&A
Page &P
ACTIVITYActivity Method:CurrentHours
ofAnnualPortionYearYearActivityRateExpenseof
YearExpense2003150x$ 72=10,800- 02004200x72=14,400-
02005300x72=21,600- 02006250x72=18,000-
02007100x72=7,200- 01,000$ 72,000$ - 072000100072
&A
Page &P
Current
DepreciableAnnual PartialYearAccum.
YearBaseYearsExpenseYearExpenseDeprec.
2017126,000$ x5/15=42,000 x5/1217,500$ 17,500$
2018126,000 x4.58333/15=38,500 38,500 56,000
2019126,000 x3.58333/15=30,100 30,100 86,100
2020126,000 x2.58333/15=21,700 21,700 107,800
2021126,000 x1.58333/15=13,300 13,300 121,100
2022126,000 x.58333/15=4,900 4,900 126,000
126,000$

Journal entry:
Straight-
lineCurrentDepreciableAnnualPartialYearAccum.YearBaseYear
sExpenseYearExpenseDeprec.2017$
126,000x5/15=42,000x5/12$ 17,500$
17,5002018126,000x4.58333/15=38,50038,50056,0002019126,0
00x3.58333/15=30,10030,10086,1002020126,000x2.58333/15=2
1,70021,700107,8002021126,000x1.58333/15=13,30013,300121
,1002022126,000x.58333/15=4,9004,900126,000$
126,000Journal entry:2017Depreciation
Expense17,500Accumultated Depreciation17,500
&A
Page &P
Current
Net BookRateAnnual PartialYear
YearValueper YearExpenseYearExpense
2017150,000$ x40%=60,000$ x5/12=25,000$
2018125,000 x40%=50,000 50,000
201975,000 x40%=30,000 30,000
202045,000 x40%=18,000 18,000
202127,000 x40%=10,800 Plug3,000
126,000$
Journal entry:
Straight-lineCurrentNet
BookRateAnnualPartialYearAccum.YearValueper
YearExpenseYearExpenseDeprec.2017$ 150,000x40%=$
60,000x5/12=$ 25,000$
25,0002018125,000x40%=50,00050,00075,000201975,000x40%
=30,00030,000105,000202045,000x40%=18,00018,000123,0002
02127,000x40%=10,800Plug3,000126,000$ 126,000Journal
entry:2017Depreciation Expense25,000Accumultated
Depreciation25,000

&A
Page &P
Expected future cash flows $ 650,000
Carrying value of asset:
Cost $ 800,000
Accumulated depreciation-200,000600,000
50,000
Sheet1Expected future cash flows$ 650,000Carrying value of
asset:Cost$ 800,000Accumulated depreciation-
200,000600,00050,000
Sheet2
Sheet3
Expected future cash flows $ 580,000
Cost $ 800,000
-20,000
Sheet1Expected future cash flows$ 580,000Carrying value of
200,000600,000-20,000
Sheet2
Sheet3
Fair value of equipment $ 525,000
Cost $ 800,000
-75,000
Sheet1Fair value of equipment$ 525,000Carrying value of
200,000600,000-75,000
Sheet2
Sheet3
Fair value of equipment $ 525,000
Cost $ 800,000

Impairment loss-75,000
Sheet1Fair value of equipment$ 525,000Carrying value of
200,000600,000Impairment loss-75,000
Sheet2
Sheet3
10-‹#›
16th Edition
10-‹#›
Understand property, plant, and equipment and its related costs.
Describe the accounting problems associated with self-
constructed assets.
Describe the accounting problems associated with interest
capitalization.
LEARNING OBJECTIVES
Understand accounting issues related to acquiring and valuing
plant assets.
Describe the accounting treatment for costs subsequent to
acquisition.
Describe the accounting treatment for the disposal of property,

Acquisition and Disposition of Property, Plant, and Equipment
10
LO 1
10-‹#›
“Used in operations” and not for resale.
Long-term in nature and usually depreciated.
Possess physical substance.
Property, plant, and equipment are assets of a durable nature.
Other terms commonly used are plant assets and fixed assets.
PROPERTY, PLANT, AND EQUIPMENT
Includes:
Land,
Building structures (offices, factories, warehouses), and
Equipment (machinery, furniture, tools).
LO 1
10-‹#›
LO 1
Historical cost measures the cash or cash equivalent price of
obtaining the asset and bringing it to the location and condition
necessary for its intended use.
Acquisition of Property, Plant, and Equipment
Main reasons for historical cost valuation:
Historical cost is reliable.
Companies should not anticipate gains and losses but should
recognize gains and losses only when the asset is sold.
PROPERTY, PLANT, AND EQUIPMENT

10-‹#›
Includes all expenditures to acquire land and ready it for use.
Costs typically include:
Cost of Land
purchase price;
closing costs, such as title to the land, attorney’s fees, and
recording fees;
costs of grading, filling, draining, and clearing;
assumption of any liens, mortgages, or encumbrances on the
property; and
additional land improvements that have an indefinite life.
LO 1
10-‹#›
Improvements with limited lives, such as private driveways,
walks, fences, and parking lots, are recorded as Land
Improvements and depreciated.
Land acquired and held for speculation is classified as an
investment.
Land held by a real estate concern for resale should be
classified as inventory.
Cost of Land
LO 1

10-‹#›
Includes all expenditures related directly to acquisition or
construction. Costs include:
materials, labor, and overhead costs incurred during
construction and
professional fees and building permits.
Cost of Buildings
LO 1
10-‹#›
Cost of Equipment
Include all expenditures incurred in acquiring the equipment
and preparing it for use. Costs include:
purchase price,
freight and handling charges,
insurance on the equipment while in transit,
cost of special foundations if required,
assembling and installation costs, and
costs of conducting trial runs.
LO 1
10-‹#›
Money borrowed to pay building contractor

Payment for construction from note proceeds
Cost of land fill and clearing
Delinquent real estate taxes on property assumed
Premium on 6-month insurance policy during construction
Refund of 1-month insurance premium because construction
completed early
Illustration: The expenditures and receipts below are related to
land, land improvements, and buildings acquired for use in a
business enterprise. Determine how the following should be
classified:
Notes Payable
Building
Land
Land
Building
(Building)
LO 1
10-‹#›
(g) Architect’s fee on building
(h) Cost of real estate purchased as a plant site (land $200,000
and building $50,000)
(i) Commission fee paid to real estate agency
(j) Installation of fences around property
(k) Cost of razing and removing building
Proceeds from salvage of demolished building
Cost of parking lots and driveways
Cost of trees and shrubbery (permanent)
Building

Land
Land
Land Improvements
Land
(Land)
Land Improvements
Land
Illustration: The expenditures and receipts below are related to
land, land improvements, and buildings acquired for use in a
business enterprise. Determine how the following should be
classified:
LO 1
10-‹#›
constructed assets.
capitalization.
LEARNING OBJECTIVES
plant assets.
acquisition.
10
LO 2

10-‹#›
Self-Constructed Assets
Costs include:
Materials and direct labor
Overhead can be handled in two ways:
Assign no fixed overhead.
Assign a portion of all overhead to the construction process.
Companies use the second method extensively.
LO 2
10-‹#›
constructed assets.
capitalization.
LEARNING OBJECTIVES
plant assets.
acquisition.
10
LO 3

10-‹#›
Three approaches have been suggested to account for the
interest incurred in financing the construction.
Interest Costs During Construction
Capitalize no interest during construction
Capitalize all costs of funds
GAAP
$ 0
$ ?
Increase to Cost of Asset
ILLUSTRATION 10-1 Capitalization of Interest Costs
Capitalize actual costs incurred during construction
LO 3
10-‹#›
GAAP requires — capitalizing actual interest (with
modification).
Consistent with historical cost.
Capitalization considers three items:
Qualifying assets.
Capitalization period.
Amount to capitalize.

LO 3
10-‹#›
Require a period of time to get them ready for their intended
use.
Two types of assets:
Assets under construction for a company’s own use.
Assets intended for sale or lease that are constructed or
produced as discrete projects.
Qualifying Assets
LO 3
10-‹#›
Capitalization Period
Begins when:
Expenditures for the asset have been made.
Activities for readying the asset are in progress .
Interest costs are being incurred.
Ends when:
The asset is substantially complete and ready for use.
LO 3
10-‹#›

Amount to Capitalize
Capitalize the lesser of:
Actual interest costs.
2.Avoidable interest - the amount of interest cost during the
period that a company could theoretically avoid if it had not
made expenditures for the asset.
LO 3
10-‹#›
Interest Capitalization Illustration: Assume a company
borrowed $200,000 at 12% interest from State Bank on Jan. 1,
2017, for specific purposes of constructing special-purpose
equipment to be used in its operations. Construction on the
equipment began on Jan. 1, 2017, and the following
expenditures were made prior to the project’s completion on
Dec. 31, 2017:
Other general debt existing on Jan. 1, 2017:
$500,000, 14%, 10-year bonds payable
$300,000, 10%, 5-year note payable
LO 3
10-‹#›

Step 1 - Determine which assets qualify for capitalization of
interest.
Special purpose equipment qualifies because it requires a period
of time to get ready and it will be used in the company’s
operations.
Step 2 - Determine the capitalization period.
The capitalization period is from Jan. 1, 2017 through Dec. 31,
2017, because expenditures are being made and interest costs
are being incurred during this period while construction is
taking place.
LO 3
10-‹#›
A company weights the construction expenditures by the amount
of time (fraction of a year or accounting period) that it can
incur interest cost on the expenditure.
Step 3 - Compute weighted-average accumulated expenditures.
LO 3
10-‹#›
Selecting Appropriate Interest Rate:
For the portion of weighted-average accumulated expenditures
that is less than or equal to any amounts borrowed specifically
to finance construction of the assets, use the interest rate

incurred on the specific borrowings.
For the portion of weighted-average accumulated expenditures
that is greater than any debt incurred specifically to finance
construction of the assets, use a weighted average of interest
rates incurred on all other outstanding debt during the period.
Step 4 - Compute the Actual and Avoidable Interest.
LO 3
10-‹#›
Step 4 - Compute the Actual and Avoidable Interest.
Avoidable Interest
Weighted-average interest rate on general debt
Actual Interest
$100,000 $800,000
= 12.5%
LO 3
Amount by which the weighted-average accumulated
expenditures exceeds the construction loan.
10-‹#›

Journal entry to Capitalize Interest:
Equipment 30,250
Interest Expense30,250
Step 5 – Capitalize the lesser of Avoidable interest or Actual
interest.
LO 3
10-‹#›
Comprehensive Illustration: On November 1, 2016, Shalla
Company contracted Pfeifer Construction Co. to construct a
building for $1,400,000 on land costing $100,000 (purchased
from the contractor and included in the first payment). Shalla
made the following payments to the construction company
during 2017.
LO 3
10-‹#›
Pfeifer Construction completed the building, ready for
occupancy, on December 31, 2017. Shalla had the following
debt outstanding at December 31, 2017.
Compute weighted-average accumulated expenditures for 2017.
Specific Construction Debt

1. 15%, 3-year note to finance purchase of land and
construction of the building, dated December 31, 2016, with
interest payable annually on December 31
Other Debt
2. 10%, 5-year note payable, dated December 31, 2013, with
interest payable annually on December 31
3. 12%, 10-year bonds issued December 31, 2012, with interest
payable annually on December 31
$750,000
$550,000
$600,000
LO 3
10-‹#›
Compute weighted-average accumulated expenditures for 2017.
ILLUSTRATION 10-4 Computation of Weighted-Average
Accumulated Expenditures
LO 3
10-‹#›

Compute the avoidable interest.
ILLUSTRATION 10-5
Computation of Avoidable Interest
LO 3
10-‹#›
Compute the actual interest cost, which represents the maximum
amount of interest that it may capitalize during 2017.
The interest cost that Shalla capitalizes is the lesser of $120,228
(avoidable interest) and $239,500 (actual interest), or $120,228.
ILLUSTRATION 10-6
Computation of Actual Interest Cost
LO 3
10-‹#›
Shalla records the following journal entries during 2017:
January 1Land 100,000

Buildings (or CIP) 110,000
Cash 210,000
March 1Buildings 300,000
Cash 300,000
May 1Buildings540,000
Cash 540,000
December 31Buildings450,000
Cash 450,000
Buildings (Capitalized Interest) 120,228
Interest Expense 119,272
Cash 239,500
LO 3
10-‹#›
At December 31, 2017, Shalla discloses the amount of interest
capitalized either as part of the income statement or in the notes
accompanying the financial statements.
ILLUSTRATION 10-7
Capitalized Interest Reported in the Income Statement
ILLUSTRATION 10-8
Capitalized Interest Disclosed in a Note
LO 3
Note 1: Accounting Policies. Capitalized Interest. During 2017,
total interest cost was $239,500, of which $120,228 was
capitalized and $119,272 was charged to expense.
10-‹#›

The requirement to capitalize interest can significantly impact
financial statements. For example, when earnings of building
manufacturer Jim Walter’s Corporation dropped from $1.51 to
$1.17 per share, the company offset 11 cents per share of the
decline by capitalizing the interest on coal mining projects and
several plants under construction.
How do statement users determine the impact of interest
capitalization on a company’s bottom line? They examine the
notes to the financial statements. Companies with material
interest capitalization must disclose the amounts of capitalized
interest relative to total interest costs. For example,
WHAT ‘S I YOUR INTEREST?
Anadarko Petroleum Corporation capitalized nearly 30 percent
of its total interest costs in a recent year and provided the
following footnote related to capitalized interest.
Financial Footnotes
Total interest costs incurred during the year were $82,415,000.
Of this amount, the Company capitalized $24,716,000.
Capitalized interest is included as part of the cost of oil and gas
properties. The capitalization rates are based on the Company’s
weighted-average cost of borrowings used to finance the
expenditures.
WHAT DO THE NUMBERS MEAN? WHAT’S IN YOUR
INTEREST?
LO 3
10-‹#›

Special Issues Related to Interest Capitalization
Expenditures for Land
If the company purchases land as a site for a structure, interest
costs capitalized during the period of construction are part of
the cost of the plant, not the land.
Conversely, if the company develops land for lot sales, it
includes any capitalized interest cost as part of the acquisition
cost of the developed land.
Interest Revenue
In general, companies should not net or offset interest revenue
against interest cost.
LO 3
10-‹#›
constructed assets.
capitalization.
LEARNING OBJECTIVES
plant assets.
acquisition.
10
LO 4

10-‹#›
Companies should record property, plant, and equipment:
at the fair value of what they give up or
at the fair value of the asset received,
whichever is more clearly evident.
VALUATION OF PROPERTY, PLANT, AND EQUIPMENT
LO 4
10-‹#›
Cash Discounts — Discount for prompt payment.
Deferred-Payment Contracts — Assets purchased on long-term
credit contracts at the present value of the consideration
exchanged.
Lump-Sum Purchases — Allocate the total cost among the
various assets on the basis of their relative fair market values.
Issuance of Stock — The market price of the stock issued is a
fair indication of the cost of the property acquired.
VALUATION OF PP&E
LO 4
10-‹#›
Ordinarily accounted for on the basis of:
the fair value of the asset given up or
the fair value of the asset received,

whichever is clearly more evident.
Exchanges of Nonmonetary Assets
Companies should recognize immediately any gains or losses on
the exchange when the transaction has commercial substance.
VALUATION OF PP&E
LO 4
10-‹#›
Meaning of Commercial Substance
Exchange has commercial substance if the future cash flows
change as a result of the transaction. That is, if the two parties’
economic positions change, the transaction has commercial
substance.
* If cash is 25% or more of the fair value of the exchange,
recognize entire gain because earnings process is complete.
VALUATION OF PP&E
ILLUSTRATION 10-10
Accounting for Exchanges
LO 4
10-‹#›
Companies recognize a loss immediately whether the exchange
has commercial substance or not.
Rationale: Companies should not value assets at more than their
cash equivalent price; if the loss were deferred, assets would be
overstated.
Exchanges—Loss Situation

VALUATION OF PP&E
LO 4
10-‹#›
Illustration: Information Processing, Inc. trades its used
machine for a new model at Jerrod Business
Solution
s Inc. The exchange has commercial substance. The used
machine has a book value of $8,000 (original cost $12,000 less
$4,000 accumulated depreciation) and a fair value of $6,000.
The new model lists for $16,000. Jerrod gives Information
Processing a trade-in allowance of $9,000 for the used machine.
Information Processing computes the cost of the new asset as
follows.
VALUATION OF PP&E
ILLUSTRATION 10-11
Computation of Cost of New Machine
LO 4

10-‹#›
Equipment 13,000
Accumulated Depreciation—Equipment 4,000
Loss on Disposal of Equipment 2,000
Equipment 12,000
Cash 7,000
Illustration: Information Processing records this transaction as
follows:
Loss on Disposal
VALUATION OF PP&E
ILLUSTRATION 10-12
Computation of Loss on Disposal of Used Machine
LO 4
10-‹#›
Exchanges—Gain Situation
Has Commercial Substance. Company usually records the cost

of a nonmonetary asset acquired in exchange for another
nonmonetary asset at the fair value of the asset given up, and
immediately recognizes a gain.
VALUATION OF PP&E
LO 4
10-‹#›
Illustration: Interstate Transportation Company exchanged a
number of used trucks plus cash for a semi-truck. The used
trucks have a combined book value of $42,000 (cost $64,000
less $22,000 accumulated depreciation). Interstate’s purchasing
agent, experienced in the secondhand market, indicates that the
used trucks have a fair market value of $49,000. In addition to
the trucks, Interstate must pay $11,000 cash for the semi-truck.
Interstate computes the cost of the semi-truck as follows.
VALUATION OF PP&E
ILLUSTRATION 10-13
Computation of Semi-Truck Cost
LO 4

10-‹#›
Truck (semi) 60,000
Accumulated Depreciation—Trucks 22,000
Trucks (used)64,000
Gain on Disposal of Trucks7,000
Cash 11,000
Illustration: Interstate records the exchange transaction as
follows:
Gain on Disposal
VALUATION OF PP&E
ILLUSTRATION 10-14
Computation of Gain on Disposal of Used Trucks
LO 4
10-‹#›

Lacks Commercial Substance—No Cash Received. Now assume
that Interstate Transportation Company exchange lacks
commercial substance.
Interstate defers the gain of $7,000 and reduces the basis of the
semi-truck.
VALUATION OF PP&E
LO 4
10-‹#›
Trucks (semi) 53,000
Accumulated Depreciation—Trucks 22,000
Trucks (used)64,000
Cash 11,000
Illustration: Interstate records the exchange transaction as
follows:
VALUATION OF PP&E
ILLUSTRATION 10-15
Basis of Semi-Truck—Fair Value vs. Book Value

LO 4
10-‹#›
Lacks Commercial Substance—Some Cash Received. When a
company receives cash (sometimes referred to as “boot”) in an
exchange that lacks commercial substance, it may immediately
recognize a portion of the gain. The general formula for gain
recognition when an exchange includes some cash is as follows:
VALUATION OF PP&E
ILLUSTRATION 10-16
Formula for Gain Recognition, Some Cash Received
LO 4
10-‹#›
Illustration: Queenan Corporation traded in used machinery
with a book value of $60,000 (cost $110,000 less accumulated

depreciation $50,000) and a fair value of $100,000. It receives
in exchange a machine with a fair value of $90,000 plus cash of
$10,000.
VALUATION OF PP&E
ILLUSTRATION 10-17
Computation of Total Gain
LO 4
10-‹#›
The portion of the gain a company recognizes is the ratio of
monetary assets (cash in this case) to the total consideration
received.
VALUATION OF PP&E
ILLUSTRATION 10-18

Computation of Gain Based on Ratio of Cash Received to Total
Consideration Received
LO 4
10-‹#›
Queenan would record the following entry.
Cash10,000
Machine (new)54,000
Accumulated Depreciation—Machinery50,000
Machine 110,000
Gain on Disposal of Machinery4,000
VALUATION OF PP&E
ILLUSTRATION 10-19
Computation of Basis
LO 4
10-‹#›

Summary of Gain and Loss Recognition on Exchanges of Non-
Monetary Assets
ILLUSTRATION 10-20
VALUATION OF PP&E
LO 4
10-‹#›
Illustration: Santana Company exchanged equipment used in its
manufacturing operations plus $2,000 in cash for similar
equipment used in the operations of Delaware Company. The
following information pertains to the exchange.
Instructions: Prepare the journal entries to record the exchange
on the books of both companies.
VALUATION OF PP&E
LO 4
10-‹#›

Calculation of Gain or Loss
VALUATION OF PP&E
LO 4
10-‹#›
Has Commercial Substance
Santana:
Equipment 15,500
Accumulated Depreciation19,000
Cash2,000
Equipment28,000
Gain on Exchange4,500
Delaware:
Cash2,000

Equipment 13,500
Loss on Exchange2,500
Equipment28,000
VALUATION OF PP&E
LO 4
10-‹#›
Santana (Has Commercial Substance):
Equipment 15,500
Cash2,000
Equipment28,000
Gain on Disposal of Equipment4,500
Santana (LACKS Commercial Substance):
Equipment (15,500 – 4,500) 11,000
Cash2,000
Equipment28,000

VALUATION OF PP&E
LO 4
10-‹#›
Delaware (Has Commercial Substance):
Delaware (LACKS Commercial Substance):
Cash2,000
Equipment 13,500
Loss on Disposal of Equipment2,500
Equipment28,000
Cash2,000
Equipment 13,500
Loss on Disposal of Equipment2,500
Equipment28,000
VALUATION OF PP&E
LO 4

10-‹#›
LO 4
In a press release, Roy Olofson, former vice president of
finance for Global Crossing, accused company executives of
improperly describing the company’s revenue to the public. He
said the company had improperly recorded long-term sales
immediately rather than over the term of the contract, had
improperly booked as cash transactions swaps of capacity with
other carriers, and had fi red him when he blew the whistle.
The accounting for the swaps involves exchanges of similar
network capacity. Companies have said they engage in such
deals because swapping is quicker and less costly than building
segments of their own networks, or because such pacts provide
redundancies to make their own networks more reliable. In one
expert’s view, an exchange of similar network capacity is the
equivalent of trading a blue truck for a red truck-it shouldn’t
boost a company’s revenue.
But Global Crossing and Qwest, among others, counted as
revenue the money received from the other company in the

swap. (In general, in transactions involving leased capacity, the
companies booked the revenue over the life of the contract.)
Some of these companies then treated their own purchases as
capital expenditures, which were not run through the income
statement. Instead, the spending led to the addition of assets on
the balance sheet (and an inflated bottom line).
The SEC questioned some of these capacity exchanges, because
it appeared they were a device to pad revenue. This reaction
was not surprising, since revenue growth was a key factor in the
valuation of companies such as Global Crossing and Qwest
during the craze for tech stocks in the late 1990s and 2000.
Source: Adapted from Henny Sender, “Telecoms Draw Focus
for Moves in Accounting,” Wall Street Journal (March 26,
2002), p. C7.
WHAT DO THE NUMBERS MEAN? ABOUT THOSE SWAPS
10-‹#›
Companies should use:

the fair value of the asset to establish its value on the books and
should recognize contributions received as revenues in the
period received.
Accounting for Contributions
VALUATION OF PP&E
LO 4
10-‹#›
Illustration: Max Wayer Meat Packing, Inc. has recently
accepted a donation of land with a fair value of $150,000 from
the Memphis Industrial Development Corp. In return Max
Wayer Meat Packing promises to build a packing plant in
Memphis. Max Wayer’s entry is:
Contributions
Land150,000
Contribution Revenue 150,000
VALUATION OF PP&E
LO 4
10-‹#›

When a company contributes a non-monetary asset, it should
record the amount of the donation as an expense at the fair
value of the donated asset.
Illustration: Kline Industries donates land to the city of Los
Angeles for a city park. The land cost $80,000 and has a fair
value of $110,000. Kline Industries records this donation as
follows.
Contributions
Contribution Expense 110,000
Land 80,000
Gain on Disposal of Land 30,000
VALUATION OF PP&E
LO 4
10-‹#›
constructed assets.

capitalization.
LEARNING OBJECTIVES
plant assets.
acquisition.
10
LO 5
10-‹#›
COSTS SUBSEQUENT TO ACQUISITION
In general, costs incurred to achieve greater future benefits
should be capitalized, whereas expenditures that simply
maintain a given level of services should be expensed.
In order to capitalize costs, one of three conditions must be
present:
useful life must be increased,

quantity of units produced must be increased, and
quality of units produced must be enhanced.
LO 5
10-‹#›
LO 5
10-‹#›
It all started with a check of the books by an internal auditor for
WorldCom Inc. The telecom giant’s newly installed chief
executive had asked for a ﬁnancial review, and the auditor was
spot-checking records of capital expenditures. She found the
company was using an unorthodox technique to account for one
of its biggest expenses: charges paid to local telephone

networks to complete long-distance calls.
Instead of recording these charges as operating expenses,
WorldCom recorded a significant portion as capital
expenditures. The maneuver was worth hundreds of millions of
dollars to WorldCom’s bottom line. It effectively turned a loss
for all of 2001 and the first quarter of 2002 into a profit. The
graph below compares WorldCom’s accounting to that under
GAAP. Soon after this discovery, WorldCom filed for
bankruptcy.
WHAT DO THE NUMBERS MEAN? DISCOUNNECTED
LO 5
10-‹#›
Source: Adapted from Jared Sandberg, Deborah Solomon, and
Rebecca Blumenstein, “Inside WorldCom’s Unearthing of a
Vast Accounting Scandal,” Wall Street Journal (June 27, 2002),

p. A1.
WHAT DO THE NUMBERS MEAN? DISCOUNNECTED
LO 5
10-‹#›
Summary
ILLUSTRATION 10-21
Summary of Costs Subsequent to Acquisition of Property, Plant,
and Equipment
LO 5
10-‹#›

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