PP&E and other Long-Term Assets PDF

CHAPTER 6 Property, Plant, and Equipment and Other Long-Term Assets 1  Property, Plant, and Equipment and Other Long-Term Assets After studying this chapter, you should be able to: 1. Define, classify, and account for the cost of...

CHAPTER 6 Property, Plant, and Equipment and Other Long-Term Assets 1  Property, Plant, and Equipment and Other Long-Term Assets After studying this chapter, you should be able to: 1. Define, classify, and account for the cost of property, plant, and equipment. 2. Compute depreciation using the following methods: straight-line method, units-of-production method, and double-declining-balance method. 3. Journalize entries for the disposal of property, plant, and equipment. 2  Property, Plant, and Equipment and Other Long-Term Assets After studying this chapter, you should be able to: 4. Compute depletion and journalize the entry for amortization of natural resources. 5. Describe the accounting for intangible assets and for goodwill. 3  Property, Plant, and Equipment and Other Long-Term Assets After studying this chapter, you should be able to: 6. Describe how depreciation and amortization expense and impairment losses are reported in an income statement and prepare a balance sheet that includes property, plant, and equipment and other long-term assets. 4 1 Define, classify, and account for the cost of property, plant, and equipment. 5  Nature of Property, Plant, and Equipment Property, plant, and equipment are long-term or relatively permanent assets, such as equipment, machinery, buildings, and land. Other descriptive titles for property, plant, and equipment are tangible capital assets or fixed assets. 6 Property, plant, and equipment have the following characteristics: 1. They exist physically (tangible assets). 2. They are owned and used by the company in its normal operations. 3. They are not offered for sale as part of normal operations. 4. They are expected to be used for more than one year. 7 Exhibit 1 Costs of Acquiring Property, Plant, and Equipment 8 Exhibit 1 Costs of Acquiring Property, Plant, and Equipment 9 Exhibit 1 Costs of Acquiring Property, Plant, and Equipment 10 Costs of acquiring capital assets do not include: 1. Vandalism 2. Mistakes in installation 3. Uninsured theft 4. Damage during unpacking and installing These costs are expenses. 11 EXAMPLE EXERCISE 9-1 Classifying Costs During March 2014, Comeau Lake Company decided to build a new retail outlet and purchased land for $125,000. An existing building was removed ($15,000), fencing was installed ($10,000), building permits were obtained ($1,200), and an architect developed plans for the new building ($25,000). An additional $500 was spent repainting the fence as the wrong paint had been applied initially. Determine the amounts to be allocated to the various accounts. Use Construction in Progress for the new building costs. 12 FOLLOW MY EXAMPLE 9-1 Classifying Costs Construction in Progress = $26,200 ($1,200 + $25,000) Land = $140,000 ($125,000 + $15,000) Land Improvements = $10,000 Miscellaneous Expense = $500 (the repainting cost is expensed as it does not increase the asset’s usefulness) For Practice: PE 9-1 13  Cost Model versus Revaluation Model Under IFRS, a company may choose to use the cost model or the revaluation model for its property, plant, and equipment. Under the revaluation model, long-term assets are carried at their fair value. Accounting for revaluations is discussed in more advanced accounting texts. 14  Lump-Sum Purchases A lump-sum purchase, or basket purchase, occurs when a group of assets is purchased in one transaction for a lump- sum amount. The lump-sum amount needs to be allocated to the individual assets as they have different expected useful lives and will be depreciated over different time frames or not at all, for land. 15  Lump-Sum Purchases If known, the fair value of the assets can be used to pre-rate the purchase price. Assume a company paid $1,100,000 for the purchase of a building and the fair values are: 16  Lump-Sum Purchases Asset: Fair values: Building $ 450,000 Land 600,000 Land improvements 150,000 Total $1,200,000 17  Lump-Sum Purchases The purchase price will be pre-rated as follows: Assume a company paid $1,100,000 for the purchase of a building and the fair values are: 18 Lump-Sum Purchases 19 Lump-Sum Purchases 20 EXAMPLE EXERCISE 9-2 Lump-Sum Purchase Biddell Construction Company paid $750,000 on June 12, 2014, for the assets of a company going out of business. The equipment, vehicles, and inventory were valued at $60,000, $280,000, and $460,000, respectively. Prepare the journal entry for the lump-sum purchase. 21 FOLLOW MY EXAMPLE 9-2 Lump-Sum Purchase For Practice: PE 9-2 22  Capital and Revenue Expenditures Expenditures that benefit only the current period are called revenue expenditures. Expenditures that improve the asset or extend its useful life are capital expenditures or betterments. 23  REVENUE CAPITAL EXPENDITURES EXPENDITURES Normal and Additions and ordinary repairs improvements and maintenance 24  Ordinary Maintenance and Repairs For example, the firm paid $300 for a tune-up of a delivery truck. This is a revenue expenditure. 25  Asset Improvements A $5,500 hydraulic lift was installed on the delivery truck to allow for easier and quicker loading of heavy cargo. This is a capital expenditure. 26 EXAMPLE EXERCISE 9-3 Capital and Revenue Expenditures On June 18, GTS Co. paid $1,200 to upgrade a hydraulic lift and $45 for an oil change for one of its delivery trucks. Journalize the entries for the hydraulic lift upgrade and oil change expenditures. 27 FOLLOW MY EXAMPLE 9-3 Capital and Revenue Expenditures For Practice: PE 9-3 28 2 Compute depreciation using the following methods: straight-line method, units-of- production method, and double-declining-balance method. 29  Depreciation Over time, property, plant, and equipment (with the exception of land), lose their ability to provide services. The periodic recording of the cost of property, plant, and equipment to expense is called depreciation or amortization. 30  Depreciation Under ASPE, the terms depreciation and amortization are used interchangeably for depreciating tangible and intangible capital assets; depletion may be used for depreciating natural resources. Under IFRS, the term depreciation is used for tangible capital assets, and the term amortization is used for natural resources and for intangible capital assets. 31 The adjusting entry to record depreciation is as follows: Accumulated depreciation is a contra asset account, allowing for the original cost of the asset to remain unchanged. 32 Depreciation allows the cost of the asset to be spread over the time of its use, making earnings more reflective of the true costs. 33  Depreciation does not measure a decline in the market value of these assets. Depreciation does not provide cash to replace assets as they wear out. 34  Factors in Computing Depreciation 1. The asset’s initial cost. 2. The asset’s expected useful life. 3. The asset’s estimated residual value. 35 The expected useful life of a capital asset is estimated at the time the asset is placed into service. The residual value of a capital asset at the end of its useful life is estimated at the time the asset is placed into service. 36  Three Commonly Used Depreciation Methods 1. Straight-line depreciation 2. Units-of-production depreciation 3. Double-declining-balance depreciation 37  Straight-Line Method The straight-line method provides for the same amount of depreciation expense for each year of the asset’s useful life. 38  Straight-Line Method Assume equipment cost $24,000. Its estimated residual value is $2,000 and its estimated useful life is five years. 39 EXAMPLE EXERCISE 9-4 Straight-Line Depreciation Equipment acquired on January 1, 2014, at a cost of $125,000, has an estimated residual value of $5,000 and an estimated useful life of 10 years. (a) Determine the annual straight-line depreciation and (b) journalize the end-of-year entry to record depreciation. 40 FOLLOW MY EXAMPLE 9-4 Straight-Line Depreciation a. $12,000 [($125,000 – $5,000)/10] b. For Practice: PE 9-4 41  Units-of-Production Method The units-of-production method provides for the same amount of depreciation expense for each unit produced or each unit of capacity used by the asset. 42  Units-of-Production Method Assume equipment cost $24,000. Its estimated residual value is $2,000 and it is expected to have an estimated life of 10,000 operating hours. 43  Units-of-Production Method During the year the asset was operated 2,100 hours. Depreciation Expense = Depreciation per Unit × Total Units of Production Used Depreciation Expense = $2.20 per Hour × 2,100 Hours = $4,620 44 EXAMPLE EXERCISE 9-5 Units-of-Production Depreciation Equipment acquired at a cost of $180,000 has an estimated residual value of $10,000 and an estimated useful life of 40,000 hours and was operated 3,600 hours during the first year and 5,200 hours during the second year. Determine (a) the depreciable cost, (b) the depreciation per unit, and the depreciation expense for (c) the first year and (d) the second year. 45 FOLLOW MY EXAMPLE 9-5 Units-of-Production Depreciation a. $170,000 ($180,000 – $10,000) b. $4.25 per hour ($170,000/40,000 hours) c. $15,300 (3,600 hours × $4.25) d. $22,100 (5,200 hours × $4.25) For Practice: PE 9-5 46  Double-Declining-Balance Method The double-declining-balance method provides for a declining periodic expense over the estimated useful life of the asset. 47 A double-declining balance rate is determined by doubling the straight-line rate. Step 1: Determine the straight-line percentage using the expected useful life. Step 2: Determine the double-declining- balance rate by multiplying the straight- line rate by 2. Step 3: Compute the depreciation by multiplying the double-declining-balance rate by the carrying amount of the assets. 48  Double-Declining-Balance Method Assume equipment cost $24,000. Its estimated residual value is $2,000 and its estimated useful life is five years. Straight-line rate = 20% (100%/5) Double-declining-balance rate = 40% (20% × 2) Depreciation expense = $9,600 ($24,000 × 40%) 49  Double-Declining-Balance Method For the first year, the cost of the asset is multiplied by 40 percent. After the first year, the declining carrying amount or book value of the asset is multiplied 40 percent. Continuing with the example where the asset cost $24,000 and has an expected residual value of $2,000, a table can be built. 50 $24,000 × 0.40 51 $14,400 × 0.40 52 53  “Forced” annual depreciation DEPRECIATION STOPS WHEN CARRYING AMOUNT EQUALS RESIDUAL VALUE. 54 EXAMPLE EXERCISE 9-6 Double-Declining-Balance Depreciation Equipment acquired at the beginning of the year at a cost of $125,000 has an estimated residual value of $5,000 and an estimated useful life of 10 years. Determine (a) the double-declining-balance rate and the double-declining-balance depreciation for (b) the first year and (c) the second year. 55 FOLLOW MY EXAMPLE 9-6 Double-Declining-Balance Depreciation a. 20% [(100%/10) × 2] b. $25,000 ($125,000 × 20%) c. $20,000 [($125,000 − $25,000) × 20%] For Practice: PE 9-6 56  Depreciation for Partial Years When an asset is purchased or sold throughout the year, depreciation needs to be calculated for partial years. Various methods are used to handle partial year depreciation. For this textbook, treat asset purchases and disposals occurring during the month as having occurred on the first day of that month. 57 Straight-line Method for Partial Years If the preceding equipment was purchased and placed into service on October 6, the depreciation would be $1,100, computed as follows: $4,400 × 3/12 = $1,100 58  Units-of-Production Method for Partial Years Because the units-of-production method calculates depreciation based on production, no adjustment is required for purchases and sales made throughout the year. 59  Double-Declining-Balance Method for Partial Years If the preceding equipment was purchased and placed into service on October 6, the depreciation would be $2,400, computed as follows: $9,600 × 3/12 = $2,400 60  Double-Declining-Balance Method for Partial Years The depreciation for the second year would then be $8,640, computed as follows: $8,640 = [40% × ($24,000 – $2,400)] 61 EXAMPLE EXERCISE 9-7 Double-Declining-Balance Method for Partial Years Refer to the information in Example Exercise 9-6. Assume the equipment was acquired on April 24. Determine (a) the double-declining-balance rate and (b) the double-declining-balance depreciation for the first year, and (c) for the second year. 62 FOLLOW MY EXAMPLE 9-7 Double-Declining-Balance Method for Partial Years a. 20% [(100%/10) × 2] b. $18,750 ($125,000 × 20% × 9/12) c. $21,250 [($125,000 – $18,750) × 20%] For Practice: PE 9-7 63 64 65  Impairment of Long-Term Assets If the carrying amount of an asset exceeds the market value, the asset has suffered an impairment. An impairment loss can result from obsolescence, abnormal wear and tear, or a decline in the market for the asset. 66  Impairment of Long-Term Assets Assume a building purchased on January 1, 2014, had the following data: 67  Impairment of Long-Term Assets At the end of 2016, the building’s carrying amount is $1,080,000, as shown below. Building Initial cost $1,200,000 Less accum. depreciation (40,000 × 3 years) 120,000 Carrying amount, end of third year $1,080,000 68  Impairment of Long-Term Assets On January 1, 2017, an appraisal evaluates that the building’s value has decreased to $942,000 and the residual value is reduced to $150,000. The journal entry for the impairment loss of $138,000 is: 69 EXAMPLE EXERCISE 9-8 Impairment Loss of Long-Term Assets In January 2005, Athabasca Mining Company acquired equipment for $545,000 that had an estimated useful life of 25 years and an expected residual value of $55,000. An appraisal of the equipment at the end of 2014 indicated the market value of the equipment was $300,000. Using this information, (a) calculate the annual depreciation expense up to and including 2014, (b) calculate the equipment’s carrying amount at December 31, 2014, and (c) journalize the impairment loss. 70 FOLLOW MY EXAMPLE 9-8 Impairment Loss of Long-Term Assets a. $19,600 [($545,000 – $55,000)/25] b. $349,000 [$545,000 – ($19,600 × 10)] c. For Practice: PE 9-8 71  Revised Depreciation (Straight-Line): Revised estimated Annual = residual value depreciation Remaining estimated life When new estimates are determined, they are used to calculate the depreciation expense in future periods. The depreciation expense recorded in earlier years is not affected. 72  Revising Depreciation Estimates The depreciation on the building (previous example) will need to be revised for periods starting in 2017: Annual Depreciation (S/L) = Annual Depreciation (S/L) = $36,000 per year 73 EXAMPLE EXERCISE 9-9 Revision of Depreciation A warehouse with a cost of $500,000 has an estimated residual value of $120,000 and an estimated useful life of 40 years and is depreciated by the straight-line method. (a) Determine the amount of the annual depreciation. (b) Determine the carrying amount at the end of the 20th year of use. (c) Assuming that at the start of the 21st year the remaining life is estimated to be 25 years and the residual value is estimated to be $150,000, determine the depreciation expense for each of the remaining 25 years. 74 FOLLOW MY EXAMPLE 9-9 Revision of Depreciation a. $9,500 [($500,000 – $120,000)/40] b. $310,000 [$500,000 – ($9,500 × 20)] c. $6,400 [($310,000 – $150,000)/25] For Practice: PE 9-9 75  Depreciation for Income Tax Purposes The Income Tax Act requires companies to use a declining-balance method, with the maximum rate predetermined, depending on the type of asset being depreciated. Capital cost allowance (CCA) is the term used for depreciation for tax purposes. 76 In using CCA rates, residual value is ignored. all assets are assumed to be put in service in the middle of the year: so for most asset categories only 50% of the normal CCA rate is allowed in the first year. 77 Examples of Maximum CCA rates 78 3 Journalize entries for the disposal of property, plant, and equipment. 79  Discarding Property, Plant, and Equipment A piece of equipment acquired at a cost of $25,000 is fully depreciated at December 31, 2014. On February 14, 2015, the equipment is discarded. 80 Equipment costing $6,000, with no residual value, is depreciated at an annual straight-line rate of 10%. After the December 31, 2014, adjusting entry, Accumulated Depreciation— Equipment has a $4,750 balance. On April 4, 2015, the asset is removed from service and discarded. 81 82 The discarding of the equipment is then recorded as follows (note that this is the second of two entries on April 4): 83  Selling Property, Plant, and Equipment Equipment was purchased at a cost of $10,000. It had no estimated residual value and was depreciated at a straight- line rate of 10%. The equipment is sold for cash on October 12 of the eighth year of its use. The balance of the accumulated depreciation account as of the preceding December 31 is $7,000. 84 The entry to update the depreciation for the nine months of the current year is as follows: 85  3 The entry to update the depreciation for the nine months of the current year is as follows:  Assumption 1 The equipment is sold on October 12 for $2,250. No gain or loss. 87  Assumption 2 The equipment is sold on October 12 for $1,000; a loss of $1,250. 88  Assumption 3 The equipment is sold on October 12 for $2,800; a gain of $550. 89 EXAMPLE EXERCISE 9-10 Sale of Equipment Equipment was acquired at the beginning of the year at a cost of $91,000. The equipment was depreciated using the straight-line method based on an estimated useful life of nine years and an estimated residual value of $10,000. a. What was the depreciation for the first year? b. Assuming the equipment was sold at the end of the second year for $78,000, determine the gain or loss on sale of the equipment. c. Journalize the entry to record the sale. 90 FOLLOW MY EXAMPLE 9-10 Sale of Equipment a. $9,000 [($91,000 – $10,000)/9] b. $5,000 gain {$78,000 – [$91,000 – ($9,000 × 2)]} c. For Practice: PE 9-10 91 4 Compute depletion and journalize the entry for amortization of natural resources. 92  Natural Resources The process of transferring the cost of natural resources to an expense account is called amortization, or depletion. 93 A business paid $400,000 for the mining rights to a mineral deposit estimated at 1,000,000 tonnes of ore. 94 Step 1: Determine the Amortization Rate per Tonne. Amortization Rate = Cost of Resource Estimated Total Units of Resource 95 Step 1: Determine the Amortization Rate per Tonne. $0.40 per Tonne = $400,000 1,000,000 Tonnes 96 Step 2: Multiply the amortization rate by the quantity extracted during the period. $0.40 per tonne × 90,000 Tonnes = $36,000 97 The adjusting entry to record the amortization is shown below. 98 EXAMPLE EXERCISE 9-11 Amortization of Natural Resource Earth’s Treasures Mining Co. acquired mineral rights for $45,000,000. The mineral deposit is estimated at 50,000,000 tonnes. During the current year, 12,600,000 tonnes were mined and sold. a. Determine the amortization rate. b. Determine the amount of amortization expense for the current year. c. Journalize the adjusting entry on December 31 to recognize the amortization expense. 99 FOLLOW MY EXAMPLE 9-11 Amortization of Natural Resource a. $0.90 per tonne ($45,000,000/50,000,000 tonnes) b. $11,340,000 (12,600,000 tonnes × $0.90 per tonne) c. For Practice: PE 9-11 100 5 Describe the accounting for intangible assets and for goodwill. 101  Intangible Assets Patents, copyrights, trademarks, and computer software are long-term assets that are useful in the operations of a business and not held for sale. These assets are called intangible assets because they do not exist physically. 102  Patent The exclusive right granted by the federal government to manufacturers to produce and sell goods with one or more unique features is a patent. These rights continue in effect for 20 years. 103  Amortizing a Patent At the beginning of its fiscal year, a business acquires a patent right for $100,000. Although the patent has a legal life of 14 years, it is expected to be useful for only five years. 104  Patent Because a patent (and other intangible assets) does not exist physically, it is acceptable to credit the asset. This approach is different from physical property, plant, and equipment that require the use of a contra asset account. 105  Copyright The exclusive right granted by the federal government to publish and sell a literary, artistic, or musical composition is a copyright. A copyright extends for 50 years beyond the author’s death. 106  Trademark A trademark is a unique name, term, or symbol used to identify a business and its products. Most businesses identify their trademarks with ® in their advertisements and on their products. 107  Trademark In some cases, the cost of the trademark is considered to have an indefinite useful life and is not amortized. Instead, trademarks are reviewed periodically for impaired value and written down with a loss recognized when impaired. 108  Goodwill Goodwill refers to an asset of a business that is created from such favourable factors as location, product quality, reputation, and managerial skill. Because goodwill does not exist separately from the business entity, it is not an intangible asset. 109  Goodwill Generally accepted accounting principles permit goodwill to be recorded in the accounts only if it is objectively determined by a transaction. For example: The purchase price of a business at a price in excess for the fair value of its net assets (assets – liabilities). The excess is recorded as goodwill. 110  Impaired Goodwill Goodwill is not amortized. Goodwill should be evaluated each year and a loss recorded if it is felt to be impaired. An impairment loss occurs when the carrying amount of the business exceeds its fair value. 111  Impaired Goodwill This loss would normally be disclosed in Other expenses on the income statement. The entry to record goodwill impairment is as follows: 112 EXAMPLE EXERCISE 9-12 Impaired Goodwill and Amortization of Patent On December 31, it was estimated that goodwill of $40,000 was impaired. In addition, a patent with an estimated useful economic life of 12 years was acquired for $84,000 on July 1. a. Journalize the adjusting entry on December 31 for the impaired goodwill. b. Journalize the adjusting entry on December 31 for the amortization of the patent rights. 113 FOLLOW MY EXAMPLE 9-12 Impaired Goodwill and Amortization of Patent For Practice: PE 9-12 114 6 Describe how depreciation and amortization expense and impairment losses are reported in an income statement and prepare a balance sheet that includes property, plant, and equipment and other long-term assets. 115 116  On the balance sheet, each class of long-term assets should be disclosed on the face of the statement or in the notes. The related accumulated depreciation should also be disclosed, either by class or in total. 117  If there are many classes of assets, a single amount may be presented in the balance sheet, supported by a note with a separate listing. Intangible assets are usually reported in a separate section following Property, Plant, and Equipment. 118  The balance in each class of intangible assets should be disclosed net of any amortization. Natural resources are normally shown as part of the Property, Plant, and Equipment section. Goodwill should be presented as a separate line item on the balance sheet. 119  Return on Assets One measure of the revenue-generating efficiency of property, plant and equipment is the return on assets ratio. It measures the profitability of total assets used within the company and is computed as follows: Return on = Net Income Assets Average Total Assets 120 For WestJet 121  Homework Read Chapter 6 Eye Openers #1-14 Practice Exercises #1-13 Exercises #1-27 (ODD only), 14 Answers posted to Brightspace 122