Plant And Intangible Assets PDF

Slide 9-1 Chapter PLANT AND INTANGIBLE 9 ASSETS McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002 Slide 9-2 Plant Assets Long-lived assets acquired for use in business operati...

Slide 9-1 Chapter PLANT AND INTANGIBLE 9 ASSETS McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002 Slide 9-2 Plant Assets Long-lived assets acquired for use in business operations. Similar to long-term prepaid expenses Date Description Debit Credit As years pass, and the The cost of plant assets services are used, the is the advance purchase cost is transferred to of services. depreciation expense. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002 Slide 9-3 Major Categories of Plant Assets Tangible Plant Intangible Natural Assets Assets Resources Long-term Noncurrent assets Sites acquired for assets having with no physical extracting valuable physical substance. substance. resources. Land, buildings, Patents, copyrights, Oil reserves, equipment, trademarks, timber, other furniture, fixtures. franchises, goodwill. minerals. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002 Slide 9-4 Accountable Events Acquisition. Allocation of the acquisition cost to expense over the asset’s useful life (depreciation). Sale or disposal. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002 Slide 9-5 Acquisition of Plant Assets Asset price Cost + Reasonable and necessary costs...... for getting... for getting the asset to the the asset ready desired location. for use. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002 Slide 9-6 Determining Cost On May 4, Heat Co., an Ohio maker of stoves, buys a new machine from a Texas company. The new machine has a price of $52,000. Sales tax was computed at 8%. Heat Co. pays $500 shipping cost to get the machine to Ohio. After the machine arrives, set-up costs of $1,300 are incurred, along with $4,000 in testing costs. Compute the cost of Heat Co.’s new machine. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002 Slide 9-7 Determining Cost List price $ 52,000 Sales tax @ 8% 4,160 Transportation cost 500 Set-up 1,300 Testing 4,000 Total cost to Heat Co. $ 61,960 Date Description Debit Credit May 4 New Machine 61,960 Cash 61,960 Prepare the journal entry. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002 Slide 9-8 Special Considerations Cost includes real estate commissions, escrow Land fees, legal fees, clearing and grading the property. Improvements to land Land such as driveways, Improvements fences, and landscaping are recorded separately. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002 Slide 9-9 Special Considerations Buildings are sometimes purchased with the intention of Buildings remodeling them prior to placing them in use. Costs incurred under these circumstances are charged to the Buildings account. However, ordinary repairs are considered to be maintenance expense when incurred. Related interest, insurance, and property Equipment taxes are treated as expenses of the current period. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002 Slide 9-10 Special Considerations Allocation of a Lump-Sum Purchase The total cost The allocation must be is based on allocated to the relative I think I’ll buy the separate Fair Market whole thing; barn, accounts for Value of each land, and animals. each asset. asset purchased. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002 Slide 9-11 Capital Expenditures and Revenue Expenditures Capital Revenue Expenditure Expenditure Any material expenditure Expenditure for that will benefit several ordinary repairs accounting periods. and maintenance. To capitalize an expenditure To expense an expenditure means to charge it to an means to charge it to an asset account. expense account. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002 Slide 9-12 Depreciation The allocation of the cost of a plant asset to expense in the periods in which services are received from the asset. Balance Sheet Cost of Assets: plant Plant and assets equipment as the services Income Statement are received Revenues: Expenses: Depreciation McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002 Slide 9-13 Depreciation Book Value Plant assets are shown in the balance sheet at their book values (or carrying values ). Book Value = Cost – Accumulated Depreciation Accumulated Depreciation ⚫ Contra-asset ⚫ Represents the portion of an asset’s cost that has already been allocated to expense. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002 Slide 9-14 Causes of Depreciation Physical deterioration Physical deterioration of a plant asset results from use, as Obsolescence well as from exposure to sun, The term obsolescence means the wind, and other climatic process of becoming out of date factors. because improved, more efficient assets become available. An airplane, for example, may become obsolete even though it is in excellent physical condition; it becomes obsolete because better planes of superior design and performance become available. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002 Slide 9-15 Straight-Line Depreciation Depreciation Cost - Residual Value = Expense per Year Years of Useful Life Residual value is the estimated amount that a company will receive when it disposes of an asset at the end of the asset's useful life. Often the residual value is estimated to be zero. However, we may assign some value to the scrap of some assets. Residual value is also referred to as disposal value, scrap value, or salvage value. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002 Slide 9-16 Straight-Line Depreciation On January 1, 2003, Bass Co. buys a new boat. Bass Co. pays $24,000 for the boat. The boat has an estimated residual value of $3,000 and an estimated useful life of 5 years. Compute depreciation for 2003 using the straight-line method. Cost – Residual Value $ 24,000 – $ 3,000 = Years of Useful Life 5 = $ 4,200 per year McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002 Slide 9-17 Straight-Line Depreciation Bass Co. will record $4,200 depreciation each year for five years. Total depreciation over the estimated useful life of the boat is: Depreciation Accumulated Accumulated Undepreciated Expense Depreciation Depreciation Balance Year (debit) (credit) Balance (book value) $ 24,000 2003 $ 4,200 $ 4,200 $ 4,200 19,800 2004 4,200 4,200 8,400 15,600 2005 4,200 4,200 12,600 11,400 2006 4,200 4,200 16,800 7,200 2007 4,200 4,200 21,000 3,000 $ 21,000 $ 21,000 Salvage Value McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002 Slide 9-18 Depreciation for Fractional Periods When an asset is acquired during the year, depreciation in the year of acquisition must be prorated. Half-Year Convention In the year of acquisition, record six months of depreciation. ½ McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002 Slide 9-19 Half-Year Convention Using the half-year convention, calculate the straight-line depreciation on December 31, 2001, for equipment purchased in 2003. The equipment cost $75,000, has a useful life of 10 years and an estimated salvage value of $5,000. Depreciation = ($75,000 - $5,000) ÷ 10 = $7,000 for a full year 1 Depreciation = $7,000 × /2 = $3,500 McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002 Slide 9-20 Declining-Balance Method Depreciation in the early years of an asset’s estimated useful life is higher than in later years. Accelerated Depreciation Remaining = × Depreciation Expense Book Value Rate The double-declining balance depreciation rate is 200% of the straight-line depreciation rate of 1/Useful Life. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002 Slide 9-21 Declining-Balance Method On January 1, 2003, Bass Co. buys a new boat. Bass Co. pays $24,000 for the boat. The boat has an estimated residual value of $3,000 and an estimated useful life of 5 years. Compute depreciation for 2003 using the double-declining balance method. 2003 Depr. Remaining Accelerated = × Expense Book Value Depreciation Rate = $ 24,000 × 2 × 1/ 5 = $ 24,000 × 40% = $ 9,600 McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002 Slide 9-22 Declining-Balance Method Total depreciation Compute over the estimated depreciation for theuseful restlife ofofthe an asset is the same using either the straight-line method or boat’s estimated useful life. the declining-balance method. Depr. Accumulated Book Year Computation Expense Depreciation Value 2003 $ 24,000 × 40% $ 9,600 $ 9,600 $ 14,400 2004 $ 14,400 × 40% $ 5,760 $ 15,360 $ 8,640 2005 $ 8,640 × 40% $ 3,456 $ 18,816 $ 5,184 2006 $ 5,184 × 40% $ 2,074 $ 20,890 $ 3,110 2007 Plug year # 5 $ 110 $ 21,000 $ 3,000 Total Depreciation $ 21,000 McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002 Slide 9-23 MACRS: The “Tax Method” MACRS = Modified Accelerated Cost Recovery System Based on The only accelerated method Declining- allowed by the IRS when Balance computing depreciation for tax Methods return purposes. Asset Cost × MACRS rate Rates are available from tables provided by the IRS. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002 Slide 9-24 Financial Statement Disclosures Estimates of Useful Life and Residual Value ⚫ May differ from company to company. ⚫ The reasonableness of management’s estimates is evaluated by external auditors. Principle of Consistency ⚫ Companies should avoid switching depreciation methods from period to period. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002 Slide 9-25 Revising Depreciation Rates Predicted Predicted salvage value useful life So depreciation is an estimate. Over the life of an asset, new information may come to light that indicates the original estimates need to be revised. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002 Slide 9-26 Revising Depreciation Rates On January 1, 2003, equipment was purchased that cost $30,000, has a useful life of 10 years and no salvage value. During 2006, the useful life was revised to 8 years total (5 years remaining). Calculate depreciation expense for the year ended December 31, 2006, using the straight-line method. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002 Slide 9-27 Revising Depreciation Rates When our estimates change, depreciation is: Book value at Salvage value at date of change – date of change Remaining useful life at date of change Asset cost $ 30,000 Accumulated depreciation, 12/31/2005 ($3,000 per year × 3 years) 9,000 Remaining book value $ 21,000 Divide by remaining life ÷5 Revised annual depreciation $ 4,200 McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002 Slide 9-28 Impairment of Assets An impaired asset is an asset that has a market value less than the value listed on the company's balance sheet (Book Value). If the cost of an asset cannot be recovered through future use or sale, the asset should be written down to its net realizable value (Market Value). McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002 Slide 9-29 Disposal of Plant and Equipment Update depreciation to the date of disposal. Journalize disposal by: Recording cash Recording a received (debit) gain (credit) or paid (credit). or loss (debit). Removing accumulated Removing the depreciation (debit). asset cost (credit). McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002 Slide 9-30 Disposal of Plant and Equipment If Cash > BV, record a gain (credit). If Cash < BV, record a loss (debit). If Cash = BV, no gain or loss. Recording cash Recording a received (debit) gain (credit) or paid (credit). or loss (debit). Removing accumulated Removing the depreciation (debit). asset cost (credit). McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002 Slide 9-31 Trading in Used Assets for New Ones The new FASB standard no longer distinguishes between dissimilar and similar asset exchanges. Instead it differentiates between exchanges that have commercial substance and those that do not have commercial substance. An exchange has commercial substance if, as a result of the exchange, future cash flows are expected to change significantly. For instance, if a company exchanges a building for land (a dissimilar exchange), the timing and the future cash flows are likely to be different than if the exchange had not occurred. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002 Slide 9-32 Trading in Used Assets for New Ones If a company exchanges one truck for another truck (a similar exchange) that will perform the same function as the old truck and for the same time period so that the future cash flows are not significantly different, then the exchange does not result in commercial substance. However, if the future cash flows are likely to be significantly different, then the exchange of similar assets has commercial substance. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002 Slide 9-33 Trading in Used Assets for New Ones Boot: Exchange transactions are oftentimes accompanied by giving or receiving boot. Boot is the term used to describe additional monetary consideration that may accompany an exchange transaction. Its presence only slightly modifies the accounting procedure by adding one more account (typically Cash) to the journal entry. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002 Slide 9-34 Intangible Assets Intangible assets have no physical substance but they have value because of the exclusive privileges and rights they provide to a business. Intangible assets generally arise from two sources: (1) exclusive privileges granted by governmental authority or by legal contract, such as patents, copyrights, franchises, trademarks and trade names, and leases; and (2) superior entrepreneurial capacity or management know-how and customer loyalty, which is called goodwill. All intangible assets are nonphysical, but not all nonphysical assets are intangibles. Such as accounts receivable and prepaid expenses. Intangible assets are generally both nonphysical and noncurrent; they appear in a separate long-term section of the balance sheet entitled “Intangible assets”. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002 Slide 9-35 Intangible Assets Noncurrent assets Often provide without physical exclusive rights substance. or privileges. Characteristics Useful life is Usually acquired often difficult for operational to determine. use. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002 Slide 9-36 Intangible Assets Record at current cash equivalent cost, including purchase price, legal fees, and filing fees. Examples: Patents. Copyrights Leaseholds Goodwill Trademarks and Trade Names McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002 Slide 9-37 Intangible Assets: Amortization Amortization is the systematic write-off of the cost of an intangible asset to expense. Straight-line amortization is calculated the same way as straight-line depreciation for plant assets. Generally, we record amortization by debiting Amortization Expense and crediting the intangible asset account. An accumulated amortization account could be used to record amortization. Amortize intangible assets over shorter of economic life or legal life, subject to a maximum of 40 years. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002 Slide 9-38 Intangible Assets – Goodwill Goodwill Occurs when one Only purchased company buys goodwill is an another company. intangible asset. The amount by which the purchase price exceeds the fair market value of net assets acquired. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002 Slide 9-39 Intangible Assets – Goodwill Eddy Company paid $1,000,000 to purchase all of James Company’s assets and assumed liabilities of $200,000. The acquired assets were appraised at a fair value of $900,000. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002 Slide 9-40 Intangible Assets –– Goodwill Intangible Assets Goodwill What amount of goodwill should be recorded on Eddy Company books? FMV of Assets $ 900,000 a. $100,000. Debt Assumed 200,000 FMV of Net Assets $ 700,000 b. $200,000. Purchase Price 1,000,000 c. $300,000. Goodwill $ 300,000 d. $400,000. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002 Slide 9-41 Intangible Assets – Patents Exclusive right granted by federal government to sell or manufacture an invention. Cost is purchase Amortize cost price plus legal over the shorter of cost to defend. useful life or 17 years. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002 Slide 9-42 Intangible Assets – Trademarks and Trade Names A symbol, design, or logo associated with a business. Purchased Internally trademarks developed are recorded trademarks at cost, and have no amortized over recorded shorter of legal asset cost. or economic life, or 40 years. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002 Slide 9-43 Intangible Assets – Franchises Legally protected right to sell products or provide services purchased by franchisee from franchisor. Purchase price is intangible asset which is amortized over the shorter of the protected right or 40 years. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002 Slide 9-44 Intangible Assets – Copyrights Exclusive right granted by the federal government to protect artistic or intellectual properties. Legal life is Amortize cost life of creator over a period not plus 50 years. to exceed 40 years. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002 Slide 9-45 Natural Resources Resources supplied by nature, such as ore deposits, mineral deposits, oil reserves, gas deposits, and timber stands, are natural resources or wasting assets. Natural resources represent inventories of raw materials that can be consumed (exhausted) through extraction or removal from their natural setting (e.g. removing oil from the ground). Natural resources are recorded at their cost of acquisition plus exploration and development costs. On the balance sheet, we report them at total cost less accumulated depletion. (Accumulated depletion is similar to the accumulated depreciation used for plant assets.) McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002 Slide 9-46 Depletion of Natural Resources Depletion is the exhaustion that results from the physical removal of a part of a natural resource. To record depletion, debit a Depletion account and credit an Accumulated Depletion account, which is a contra account to the natural resource asset account. Depletion is calculated using the units-of-production method. Unit depletion rate is calculated as follows: Cost – Salvage Value Total Units of Capacity McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002 Slide 9-47 Depletion of Natural Resources Total depletion cost for a period is: Unit Depletion Number of Units Rate × Extracted in Period Cost of Total goods sold Inventory depletion for sale cost Unsold Inventory McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002 Slide 9-48 Depletion of Natural Resources To illustrate the depletion of a natural resource, assume that Rainbow Minerals pays $45 million to acquire the Red Valley Mine, which is believed to contain 10 million tons of coal. The residual value of the mine after all of the coal is removed is estimated to be $5 million. The depletion that will occur over the life of the mine is the original cost minus the residual value, or $40 million. This depletion will occur at the rate of $4 per ton ($40 million 10 million tons) as the coal is removed from the mine. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002 Slide 9-49 End of Chapter 9 McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002