Financial Accounting IFRS 4th Edition Chapter 9 PDF

Financial Accounting IFRS 4th Edition Weygandt Kimmel Kieso Chapter 9 Plant Assets, Natural Resources, and Intangible Assets Chapter Outline Learning Objectives LO 1 Explain the accounting for plant asset expenditures. LO 2 Apply depreciation methods to plant a...

Financial Accounting IFRS 4th Edition Weygandt Kimmel Kieso Chapter 9 Plant Assets, Natural Resources, and Intangible Assets Chapter Outline Learning Objectives LO 1 Explain the accounting for plant asset expenditures. LO 2 Apply depreciation methods to plant assets. LO 3 Explain how to account for the disposal of plant assets. LO 4 Describe how to account for natural resources and intangible assets. LO 5 Discuss how plant assets, natural resources, and intangible assets are reported and analyzed. Copyright ©2019 John Wiley & Sons, Inc. 2 Learning Objective 1 Explain the Accounting for Plant Asset Expenditures Copyright ©2019 John Wiley & Sons, Inc. 3 Plant Asset Expenditures (1 of 2) Plant assets are resources that have physical substance (a definite size and shape), are used in the operations of a business, are not intended for sale to customers, are expected to provide service to the company for a number of years, except for land. Referred to as property, plant, and equipment; plant and equipment; and fixed assets. Copyright ©2019 John Wiley & Sons, Inc. 4 Plant Asset Expenditures (2 of 2) Plant assets play a key role in ongoing operations. Copyright ©2019 John Wiley & Sons, Inc. 5 The Cost of Plant Assets (1 of 10) Historical Cost Principle Requires that companies record plant assets at cost Cost consists of all expenditures necessary to acquire an asset and make it ready for its intended use Copyright ©2019 John Wiley & Sons, Inc. 6 The Cost of Plant Assets (2 of 10) Land All necessary costs incurred in making land ready for its intended use increase (debit) the Land account. Costs typically include: 1. cash purchase price 2. closing costs such as title and attorney’s fees 3. real estate brokers’ commissions 4. accrued property taxes and other liens on land assumed by purchaser Copyright ©2019 John Wiley & Sons, Inc. 7 The Cost of Plant Assets (3 of 10) Illustration: Lew Ltd. acquires real estate at a cash cost of HK$2,000,000. The property contains an old warehouse that is razed at a net cost of HK$60,000 (HK$75,000 in costs less HK$15,000 proceeds from salvaged materials). Additional expenditures are the attorney’s fee, HK$10,000, and the real estate broker’s commission, HK$80,000. Determine the amount to be reported as the cost of the land. Copyright ©2019 John Wiley & Sons, Inc. 8 The Cost of Plant Assets (4 of 10) Required: Determine amount to be reported as the cost of the land. Land Cash price of property (HK$2,000,000) HK$2,000,000 Net removal cost of warehouse (HK$60,000) 60,000 Attorney's fees (HK$10,000) 10,000 Real estate broker’s commission (HK$80,000) 80,000 Cost of Land HK$2,150,000 Lew makes the following entry: Land 2,150,000 Cash 2,150,000 Copyright ©2019 John Wiley & Sons, Inc. 9 The Cost of Plant Assets (5 of 10) Land Improvements Structural additions with limited lives that are made to land. Cost includes all expenditures necessary to make the improvements ready for their intended use. Examples: driveways, parking lots, fences, landscaping, and underground sprinklers Limited useful lives Expense (depreciate) cost of land improvements over their useful lives Copyright ©2019 John Wiley & Sons, Inc. 10 The Cost of Plant Assets (6 of 10) Buildings Includes all costs related directly to purchase or construction. Purchase costs: Purchase price, closing costs (attorney’s fees, title insurance, etc.) and real estate broker’s commission Remodeling and replacing or repairing the roof, floors, electrical wiring, and plumbing Copyright ©2019 John Wiley & Sons, Inc. 11 The Cost of Plant Assets (7 of 10) Buildings Includes all costs related directly to purchase or construction. Construction costs: Contract price Payments for architects’ fees Building permits Excavation costs Copyright ©2019 John Wiley & Sons, Inc. 12 The Cost of Plant Assets (8 of 10) Equipment Include all costs incurred in acquiring the equipment and preparing it for use. Costs typically include: Cash purchase price Sales taxes Freight charges Insurance during transit paid by purchaser Assembling, installing, and testing Copyright ©2019 John Wiley & Sons, Inc. 13 The Cost of Plant Assets (9 of 10) Illustration: Lenard Huang Group purchases a delivery truck at a cash price of HK$420,000. Related expenditures consist of sales taxes HK$13,200, painting and lettering HK$5,000, motor vehicle license HK$800, and a three-year accident insurance policy HK$16,000. Compute the cost of the delivery truck. Blank Truck Cash price HK$420,000 Sales taxes 13,200 Painting and lettering 5,000 Blank Blank Cost of Delivery Truck HK$438,200 Copyright ©2019 John Wiley & Sons, Inc. 14 The Cost of Plant Assets (10 of 10) Illustration: Lenard Huang Group purchases a delivery truck at a cash price of HK$420,000. Related expenditures consist of sales taxes HK$13,200, painting and lettering HK$5,000, motor vehicle license HK$800, and a three-year accident insurance policy HK$16,000. Prepare the journal entry to record these costs. Equipment 438,200 License Expense 800 Prepaid Insurance 16,000 Cash 455,000 Copyright ©2019 John Wiley & Sons, Inc. 15 Expenditures During Useful Life Ordinary Repairs are expenditures to maintain the operating efficiency and productive life of the unit. Debit to Maintenance and Repairs Expense Referred to as revenue expenditures Additions and Improvements are costs incurred to increase the operating efficiency, productive capacity, or useful life of a plant asset. Debit plant asset affected Referred to as capital expenditures Copyright ©2019 John Wiley & Son, Inc. 16 DO IT! 1: Cost of Plant Assets Assume that Jing Feng Heating and Cooling purchases a delivery truck for ¥150,000 cash, plus sales taxes of ¥9,000 and delivery costs of ¥5,000. The buyer also pays ¥2,000 for painting and lettering, ¥6,000 for an annual insurance policy, and ¥800 for a motor vehicle license. Explain how each of these costs would be accounted for. Solution The first four payments (¥150,000, ¥9,000, ¥5,000, and ¥2,000) are included in the cost of the truck (¥166,000) The payments for insurance and the license are operating costs and therefore are expensed Copyright ©2019 John Wiley & Son, Inc. 17 Learning Objective 2 Apply Depreciation Methods to Plant Assets Copyright ©2019 John Wiley & Sons, Inc. 18 Depreciation Methods Depreciation Process of allocating to expense the cost of a plant asset over its useful life in a rational and systematic manner. Process of cost allocation, not asset valuation Applies to land improvements, buildings, and equipment, not land Depreciable, because the revenue-producing ability of asset will decline over the asset’s useful life Copyright ©2019 John Wiley & Sons, Inc. 19 Factors in Computing Depreciation Depreciation expense is reported on the income statement. Accumulated depreciation is reported on the balance sheet as a deduction from plant assets. Copyright ©2019 John Wiley & Sons, Inc. 20 Depreciation Methods (1 of 2) Management selects the method it believes best measures an asset’s contribution to revenue over its useful life. Examples include: 1) Straight-line method. 2) Units-of-activity method. 3) Declining-balance method. Copyright ©2019 John Wiley & Sons, Inc. 21 Depreciation Methods (2 of 2) Illustration: Barb’s Florists purchased a small delivery truck on January 1, 2020. Cost €13,000 Expected salvage value € 1,000 Estimated useful life in years 5 Estimated useful life in miles 100,000 Required: Compute depreciation using the following. (a) Straight-Line (b) Units-of-Activity (c) Declining Balance Copyright ©2019 John Wiley & Son, Inc. 22 Straight-Line Method (1 of 3) Expense is same amount for each year Depreciable cost = Cost less residual value Residual Depreciable Cost - Value = Cost €13,000 - €1,000 = €12,000 Annual Depreciable Useful Life Depreciation Cost ÷ (in years) = Expense €12,000 ÷ 5 = €2,400 Copyright ©2019 John Wiley & Son, Inc. 23  Straight-Line Method (2 of 3) Computations End of Year Depreciable Annual Accumulated Book Year Cost x Rate = Expense Depreciation Value 2020 $12,000 x 20% = € 2,400 € 2,400 €10,600* 2021 12,000 x 20 = 2,400 4,800 8,200 2022 12,000 x 20 = 2,400 7,200 5,800 2023 12,000 x 20 = 2,400 9,600 3,400 2024 12,000 x 20 = 2,400 12,000 1,000 €12,000 Journal Entry 2020 Depreciation Expense 2,400 *€13,000 − €2,400 Accumulated Depreciation 2,400 Copyright ©2019 John Wiley & Sons, Inc. 24 Straight-Line Method (3 of 3) Assume the delivery truck was purchased on April 1, 2020. Computations End of Year Depreciable Annual Partial Depreciation Accum. Year Cost x Rate = Expense x Year = Expense Deprec. 2020 €12,000 x 20% = € 2,400 x 9/12 = € 1,800 €1,800 2021 12,000 x 20 = 2,400 x = 2,400 4,200 2022 12,000 x 20 = 2,400 x = 2,400 6,600 2023 12,000 x 20 = 2,400 x = 2,400 9,000 2024 12,000 x 20 = 2,400 x = 2,400 11,400 2025 12,000 x 20 = 2,400 x 3/12 = 600 12,000 €12,000 Copyright ©2019 John Wiley & Sons, Inc. 25 Do It! 2a: Straight-Line Depreciation On January 1, 2020, Iron Mountain Ski Corporation purchased a new snow-grooming machine for €50,000. The machine is estimated to have a 10-year life with a €2,000 residual value. What journal entry would Iron Mountain Ski Corporation make at December 31, 2020, if it uses the straight-line method of depreciation? Residual Annual Year Cost - Value ÷ Rate = Expense 2020 €50,000 - €2,000 ÷ 10% = €4,800 Depreciation Expense 4,800 Accumulated Depreciation 4,800 Copyright ©2019 John Wiley & Sons, Inc. 26 Units-of-Activity Method (1 of 2) Companies estimate total units of activity to calculate depreciation cost per unit Expense varies based on units of activity Depreciable cost is cost less salvage value Often referred to as units-of-production method Depreciable Total Units Depreciable Cost Cost ÷ of Activity = per Unit €12,000 ÷ 100,000 miles = €0.12 Copyright ©2019 John Wiley & Sons, Inc. 27  Units-of-Activity Method (2 of 2) Computations End of Year Units of Annual Accumulated Book Year Activity x Rate = Expense Depreciation Value 2020 15,000 x €.012 = € 1,800 € 1,800 €11,200* 2021 30,000 x.012 = 3,600 5,400 7,600 2022 20,000 x.012 = 2,400 7,800 5,200 2023 25,000 x.012 = 3,000 10,800 2,200 2024 10,000 x.012 = 1,200 12,000 1,000 Journal Entry 2020 Depreciation Expense 1,800 *€13,000 − €1,800 Accumulated Depreciation 1,800 Copyright ©2019 John Wiley & Sons, Inc. 28 Declining-Balance Method (1 of 3) Accelerated method Decreasing annual depreciation expense over asset’s useful life Double declining-balance rate is double the straight- line rate Rate applied to book value Copyright ©2019 John Wiley & Sons, Inc. 29 Declining-Balance Method (2 of 3) Computations End of Year Beginning Annual Accumulated Book Year Book Value x Rate = Expense Depreciation Value 2020 €13,000 x 40% = € 5,200 € 5,200 €7,800 (a) 2021 7,800 x 40 = 3,120 8,320 4,680 2022 4,680 x 40 = 1,872 10,192 2,808 2023 2,808 x 40 = 1,123 11,315 1,685 2024 1,685 x 40 = 685 (b) 12,000 1,000 (a) €13,000 − €5,200 (b) €1,685 x 40% = €674, expense adjusted to €685 to result in residual value of €1,000. Copyright ©2019 John Wiley & Sons, Inc. 30 Declining-Balance Method (3 of 3) Assume the delivery truck was purchased on April 1, 2020. Computations End of Year Beginning Annual Partial Depreciation Accum. Year Book Value x Rate = Expense x Year = Expense Deprec. 2020 €13,000 x 40% = € 5,200 x 9/12 = € 3,900 €3,900 2021 9,100 x 40 = 3,640 x = 3,640 7,540 2022 5,460 x 40 = 2,184 x = 2,184 9,724 2023 3,276 x 40 = 1,310 x = 1,310 11,034 2024 1,966 x 40 = 786 x = 786 11,820 2025 1,180 x 40 = 472 x = 180 (a) 12,000 (a) Expense adjusted to €180 to result in residual value of €1,000. Copyright ©2019 John Wiley & Sons, Inc. 31 Comparison of Methods (1 of 2) Straight- Declining- Units-of- Year Line Balance Activity 2020 € 2,400 € 5,200 € 1,800 2021 2,400 3,120 3,600 2022 2,400 1,872 2,400 2023 2,400 1,123 3,000 2024 2,400 685 1,200 €12,000 €12,000 €12,000 Annual depreciation expense varies, but total depreciation expense is the same (€12,000) for the five-year period. Copyright ©2019 John Wiley & Sons, Inc. 32 Comparison of Methods (2 of 2) Copyright ©2019 John Wiley & Sons, Inc. 33 Component Depreciation (1 of 2) IFRS requires component depreciation for plant assets Any significant parts of a plant asset that have significantly different estimated useful lives should be separately depreciated Copyright ©2019 John Wiley & Sons, Inc. 34 Component Depreciation (2 of 2) Illustration: Lexure Construction builds an office building for HK$4,000,000, not including the cost of the land. If the HK$4,000,000 is allocated over the 40-year useful life of the building, Lexure reports HK$100,000 (HK$4,000,000 ÷ 40) of depreciation per year, assuming straight-line depreciation and no residual value. However, assume that HK$320,000 of the cost of the building relates to a heating, ventilation, and air conditioning (HVAC) system and HK$600,000 relates to flooring. Because the HVAC system has a depreciable life of five years and the flooring has a depreciable life of 10 years, Lexure must use component depreciation. It must reclassify HK$320,000 of the cost of the building to the HVAC system and HK$600,000 to the cost of flooring. Copyright ©2019 John Wiley & Sons, Inc. 35 Component Depreciation (2 of 2) Assuming that Lexure uses straight-line depreciation, the following shows the computation of component depreciation for the first year of the office building. Building cost adjusted (HK$4,000,000 − HK$320,000 − HK$600,000) HK$3,080,000 Building cost depreciation per year (HK$3,080,000 ÷ 40) HK$ 77,000 Personal HVAC system depreciation (HK$320,000 ÷ 5) 64,000 Flooring depreciation (HK$600,000 ÷ 10) 60,000 Total component depreciation in first year HK$ 201,000 Copyright ©2019 John Wiley & Sons, Inc. 36 Depreciation and Income Taxes Tax laws do not require taxpayer to use the same depreciation method on the tax return that is used in preparing financial statements. Many companies use straight-line in their financial statements to maximize net income. They also use an accelerated depreciation method on their tax returns to minimize their income taxes. Copyright ©2019 John Wiley & Son, Inc. 37 Revaluation of Plant Assets (1 of 5) IFRS allows companies to revalue plant assets to fair value at the reporting date Must be applied to all assets in a class of assets Assets that are experiencing rapid price changes must be revalued on an annual basis Copyright ©2019 John Wiley & Sons, Inc. 38 Revaluation of Plant Assets (2 of 5) Gain Situation Illustration: Pernice Ltd. applies revaluation to equipment purchased on January 1, 2020, for HK$1,000,000. The equipment has a useful life of five years and no residual value. On December 31, 2020, Pernice makes the following journal entry to record depreciation expense, assuming straight-line depreciation. Depreciation Expense 200,000 Accumulated Depreciation—Equipment 200,000 Copyright ©2019 John Wiley & Sons, Inc. 39 Revaluation of Plant Assets (3 of 5) At the end of 2020, independent appraisers determine that the asset has a fair value of HK$850,000. To report the equipment at its fair value of HK$850,000 on December 31, 2020, Pernice eliminates the Accumulated Depreciation— Equipment account, reduces Equipment to its fair value of HK$850,000, and records Revaluation Surplus of HK$50,000. The entry to record the revaluation is as follows. Accumulated Depreciation—Equipment 200,000 Equipment 150,000 Revaluation Surplus 50,000 Copyright ©2019 John Wiley & Sons, Inc. 40 Revaluation of Plant Assets (4 of 5) Pernice reports Depreciation expense of HK$200,000 in the income statement HK$50,000 in other comprehensive income HK$850,000 is the new basis of the asset Assuming no change in the total useful life, depreciation in 2021 will be HK$212,500 (HK$850,000 ÷ 4). Copyright ©2019 John Wiley & Sons, Inc. 41 Revaluation of Plant Assets (5 of 4) Loss Situation Illustration: Pernice’s equipment has a carrying amount of HK$800,000 (HK$1,000,000 − HK$200,000). However, at the end of 2020, independent appraisers determine that the asset has a fair value of HK$775,000, which results in an impairment loss of HK$25,000 (HK$800,000 − HK$775,000). The entry to record the equipment and report the impairment loss is as follows. Accumulated Depreciation—Equipment 200,000 Impairment Loss 25,000 Equipment 225,000 Copyright ©2019 John Wiley & Sons, Inc. 42 Revising Periodic Depreciation (1 of 4) Accounted for in period of change and future periods (Change in Estimate) No change in depreciation reported for prior years Not considered an error Use a step-by-step approach: 1. determine new depreciable cost 2. divide by remaining useful life Copyright ©2019 John Wiley & Son, Inc. 43 Revising Periodic Depreciation (2 of 4) Illustration: Barb’s Florists decides on January 1, 2023, to extend the useful life of the truck by one year (a total life of six years) and increase its residual value to €2,200. The company has used the straight-line method to depreciate the asset to date. Depreciation for the first 3 years is as follows. Equipment cost €13,000 Residual value − 1,000 Depreciable base 12,000 Useful life (original) ÷ 5 years Annual depreciation € 2,400 × 3 years = €7,200 Copyright ©2019 John Wiley & Sons, Inc. 44 Revising Periodic Depreciation (3 of 4) Net book value at date of change in estimate (after 3 years). Plant Assets: Equipment €13,000 Accumulated depreciation 7,200 Net book value € 5,800 Copyright ©2019 John Wiley & Sons, Inc. 45 Revising Periodic Depreciation (4 of 4) Calculation of depreciation expense for 2023, year 4. Net book value after year 3 €5,800 Residual value (revised) − 2,200 Depreciable base 3,600 Remaining life ÷ 3 years Revised Annual depreciation €1,200 Journal entry for 2023 and future years. Depreciation Expense 1,200 Accumulated Depreciation 1,200 Copyright ©2019 John Wiley & Sons, Inc. 46 Do It! 2b: Revised Depreciation (1 of 3) Chambers Corporation purchased a piece of equipment for £36,000. It estimated a 6-year life and £6,000 salvage value. Thus, straight-line depreciation was £5,000 per year [(£36,000 − £6,000) ÷ 6]. At the end of year three (before the depreciation adjustment), it estimated the new total life to be 10 years and the new salvage value to be £2,000. Compute the revised depreciation. Copyright ©2019 John Wiley & Sons, Inc. 47 Do It! 2b: Revised Depreciation (2 of 3) Calculation of depreciation expense for first 2 years. Equipment cost £36,000 Salvage value − 6,000 Depreciable base 30,000 Useful life (original) ÷ 6 years Annual depreciation £ 5,000 × 2 years = £10,000 Net book value at date of change in estimate (after 2 years). Plant Assets: Equipment £36,000 Accumulated depreciation 10,000 Net book value £26,000 Copyright ©2019 John Wiley & Sons, Inc. 48 Do It! 2b: Revised Depreciation (3 of 3) Calculation of revised depreciation expense for remaining years. Net book value after year 2 £26,000 Salvage value (revised) − 2,000 Depreciable base 24,000 Remaining life ÷ 8 years Annual depreciation £ 3,000 Journal entry for remaining years. Depreciation Expense 3,000 Accumulated Depreciation 3,000 Copyright ©2019 John Wiley & Sons, Inc. 49 Learning Objective 3 Explain How to Account for the Disposal of Plant Assets Copyright ©2019 John Wiley & Sons, Inc. 50 Plant Asset Disposals Companies dispose of plant assets in three ways — 1. Retirement: Equipment is scrapped or discarded 2. Sale: Equipment is sold to another party 3. Exchange: Equipment is traded for new equipment Record depreciation up to the date of disposal. Eliminate asset by (1) debiting Accumulated Depreciation, and (2) crediting the asset account. Copyright ©2019 John Wiley & Son, Inc. 51 Retirement of Plant Assets (1 of 3) No cash is received Decrease (debit) Accumulated Depreciation for full amount of depreciation taken over life of asset Decrease (credit) asset account for original cost of asset Copyright ©2019 John Wiley & Sons, Inc. 52 Retirement of Plant Assets (2 of 3) Illustration: Hobart Publishing retires its computer printers, which cost €32,000. The accumulated depreciation on these printers is €32,000. Prepare the entry to record this retirement. Accumulated Depreciation—Equipment 32,000 Equipment 32,000 Question: What happens if a fully depreciated plant asset is still useful to the company? Copyright ©2019 John Wiley & Son, Inc. 53 Retirement of Plant Assets (3 of 3) Illustration: Sunset Company discards delivery equipment that cost €18,000 and has accumulated depreciation of €14,000. The journal entry is? Accumulated Depreciation—Equipment 14,000 Loss on Disposal of Plant Assets 4,000 Equipment 18,000 Companies report a loss on disposal in the “Other income and expense” section of the income statement. Copyright ©2019 John Wiley & Son, Inc. 54 Sale of Plant Assets (1 of 4) Compare the book value of the asset with the proceeds received from the sale. If proceeds exceed the book value, a gain on disposal occurs If proceeds are less than the book value, a loss on disposal occurs Copyright ©2019 John Wiley & Sons, Inc. 55 Sale of Plant Assets (2 of 4) Illustration: On July 1, 2020, Wright Interiors sells office furniture for €16,000 cash. The office furniture originally cost €60,000. As of January 1, 2020, it had accumulated depreciation of €41,000. Depreciation for the first six months of 2020 is €8,000. Prepare the journal entry to record depreciation expense up to the date of sale. Depreciation Expense 8,000 Accumulated Depreciation—Equipment 8,000 Copyright ©2019 John Wiley & Sons, Inc. 56 Sale of Plant Assets (3 of 4) Cost of office furniture €60,000 Less: Accumulated depreciation (€41, 000 + €8,000) 49,000 Book value at date of disposal 11,000 Proceeds from sale 16,000 Gain on disposal of plant asset € 5,000 Wright records the sale as follows on July 1. Cash 16,000 Accumulated Depreciation—Equipment 49,000 Equipment 60,000 Gain on Disposal of Plant Assets 5,000 Copyright ©2019 John Wiley & Sons, Inc. 57 Sale of Plant Assets (4 of 4) Illustration: Assume that instead of selling the office furniture for €16,000, Wright sells it for €9,000. Cost of office furniture €60,000 Less: Accumulated depreciation (€41, 000 + €8,000) 49,000 Book value at date of disposal 11,000 Proceeds from sale 9,000 Loss on disposal of plant asset € 2,000 Cash 9,000 Accumulated Depreciation—Equipment 49,000 Loss on Disposal of Plant Assets 2,000 Equipment 60,000 Copyright ©2019 John Wiley & Sons, Inc. 58 Do It! 3: Plant Asset Disposal (1 of 2) Overland Trucking has decided to sell an old truck that cost £30,000 and which has accumulated depreciation of £16,000. (a) What entry would Overland Trucking make to record the sale of the truck for £17,000 cash? Cash 17,000 Accumulated Depreciation—Equipment 16,000 Equipment 30,000 Gain on Disposal of Plant Assets 3,000 Copyright ©2019 John Wiley & Sons, Inc. 59 Do It! 3: Plant Asset Disposal (2 of 2) Overland Trucking has decided to sell an old truck that cost £30,000 and which has accumulated depreciation of £16,000. (b) What entry would Overland Trucking make to record the sale of the truck for £10,000 cash? Cash 10,000 Accumulated Depreciation—Equipment 16,000 Loss on Disposal of Plant Assets 4,000 Equipment 30,000 Copyright ©2019 John Wiley & Sons, Inc. 60 Learning Objective 4 Describe How to Account for Natural Resources and Intangible Assets Copyright ©2019 John Wiley & Sons, Inc. 61 Natural Resources and Intangible Assets Natural resources consist of standing timber and underground deposits of oil, gas, and minerals. Distinguishing characteristics: Physically extracted in operations Replaceable only by an act of nature Cost is the price needed to acquire the resource and prepare it for its intended use. Copyright ©2019 John Wiley & Son, Inc. 62 Depletion (1 of 3) The allocation of the cost to expense in a rational and systematic manner over the resource’s useful life. Companies generally use units-of-activity method Depletion generally is a function of the units extracted Total Cost - Residual Value Depletion Cost = Total Estimated Units Available per Unit Copyright ©2019 John Wiley & Son, Inc. 63 Depletion (2 of 3) Illustration: Lane Coal Company invests HK$50 million in a mine estimated to have 10 million tons of coal and no residual value. Compute the depletion cost per unit. Total Cost - Residual Value Depletion Cost = Total Estimated Units Available per Unit HK$50,000,000 = HK$5.00 per ton 10,000,000 Copyright ©2019 John Wiley & Son, Inc. 64 Depletion (3 of 3) Illustration: Lane Coal Company invests HK$50 million in a mine estimated to have 10 million tons of coal and no residual value. In the first year, Lane extracts and sells 250,000 tons of coal. Lane computes the depletion as follows: HK$50,000,000 ÷ 10,000,000 = HK$5.00 depletion cost per ton HK$5.00 x 250,000 = HK$1,250,000 annual depletion Journal entry: Inventory (coal) 1,250,000 Accumulated Depletion 1,250,000 Copyright ©2019 John Wiley & Son, Inc. 65 Intangible Assets Rights, privileges, and competitive advantages that result from ownership of long-lived assets that do not possess physical substance. Limited life or an indefinite life. Common types of intangibles: Patents Trademarks Copyrights Trade names Franchises and Licenses Goodwill Copyright ©2019 John Wiley & Sons, Inc. 66 Accounting for Intangible Assets (1 of 8) Limited-Life Intangibles: Amortize to expense Credit asset account or accumulated amortization Indefinite-Life Intangibles: No foreseeable limit on time asset is expected to provide cash flow No amortization Copyright ©2019 John Wiley & Sons, Inc. 67 Accounting for Intangible Assets (2 of 8) Patents Amortize to expense Exclusive right to manufacture, sell, or otherwise control an invention for 20 years from date of grant Capitalize costs of purchasing a patent and amortize over 20-year life or its useful life, whichever is shorter Expense any R&D costs in developing a patent Legal fees incurred successfully defending a patent are capitalized to Patents account Copyright ©2019 John Wiley & Son, Inc. 68 Accounting for Intangible Assets (4 of 8) Illustration: National Labs purchases a patent at a cost of NT$720,000. National estimates the useful life to be eight years. Prepare the journal entry to record the annual amortization for the year ended December 31. Cost NT$720,000 Useful life ÷ 8 Amortization NT$ 90,000 Dec. 31 Amortization Expense 90,000 Patents 90,000 Copyright ©2019 John Wiley & Sons, Inc. 69 Accounting for Intangible Assets (5 of 8) Copyrights Gives owner exclusive right to reproduce and sell an artistic or published work Granted for life of creator plus 70 years Capitalize costs of acquiring and defending Amortized to expense over useful life Copyright ©2019 John Wiley & Sons, Inc. 70 Accounting for Intangible Assets (6 of 8) Trademarks and Trade Names Word, phrase, jingle, or symbol that distinguishes or identifies a particular enterprise or product  Big Mac, Coca-Cola, and Jetta Legal protection for indefinite number of 20 year renewal periods Capitalize acquisition costs No amortization Copyright ©2019 John Wiley & Sons, Inc. 71 Accounting for Intangible Assets (7 of 8) Franchises Contractual arrangement between a franchisor and a franchisee  CPC, Subway, and Europcar are franchises Franchise (or license) with a limited life should be amortized to expense over its useful life If life is indefinite, cost is not amortized Copyright ©2019 John Wiley & Son, Inc. 72 Accounting for Intangible Assets (8 of 8) Goodwill Includes exceptional management, desirable location, good customer relations, skilled employees, high- quality products, etc. Only recorded when an entire business is purchased Goodwill is recorded as excess of purchase price over fair value of net assets acquired Not amortized Copyright ©2019 John Wiley & Son, Inc. 73 Research and Development Costs Expenditures that may lead to patents copyrights new processes new products All R & D costs are expensed when incurred Not intangible assets Copyright ©2019 John Wiley & Son, Inc. 74 Do It! 4: Classification Concepts (1 of 3) Match the term most directly associated with each statement. Copyrights Depletion Intangible assets Franchises Research costs 1. The allocation of the cost of a natural Depletion resource in a rational and systematic manner. 2. Rights, privileges, and competitive advantages that result from the ownership Intangible of long-lived assets that do not possess assets physical substance. Copyright ©2019 John Wiley & Sons, Inc. 75 Do It! 4: Classification Concepts (2 of 3) Match the term most directly associated with each statement. Copyrights Depletion Intangible assets Franchises Research costs 3. An exclusive right granted by the government to reproduce and sell an artistic or published Copyrights work. 4. A right to sell certain products or services or to use certain trademarks or trade names Franchises within a designated geographic area. Copyright ©2019 John Wiley & Sons, Inc. 76 Do It! 4: Classification Concepts (3 of 3) Match the term most directly associated with each statement. Copyrights Depletion Intangible assets Franchises Research costs 5. Costs incurred by a company that often lead to patents or new products. These Research costs must be expensed as incurred. costs Copyright ©2019 John Wiley & Sons, Inc. 77 Learning Objective 5 Discuss How Plant Assets, Natural Resources, and Intangible Assets are Reported and Analyzed Copyright ©2019 John Wiley & Sons, Inc. 78 Statement Presentation and Analysis Presentation Usually, companies combine plant assets and natural resources under “Property, plant, and equipment” in the statement of financial position. Intangible assets are shown separately Copyright ©2019 John Wiley & Son, Inc. 79  Statement Presentation Artex Enterprises Statement of Financial Position (partial) (in billions) Property, plant, and equipment Gold mine ¥ 530 Less: Accumulated depletion 210 ¥ 320 Land 600 Buildings 7,600 Less: Accumulated depreciation—buildings 500 7,100 Equipment 3,870 Less: Accumulated depreciation— equipment 620 3,250 Total property, plant, and equipment ¥11,270 Intangible assets Patents 440 Trademarks 180 Goodwill 900 1,520 Total assets ¥12,790 Copyright ©2019 John Wiley & Son, Inc. 80 Analysis Illustration: LG’s net sales for a recent year were ₩58,140 billion. Its total ending assets were ₩35,528 billion, and beginning assets were ₩34,766 billion. Net Sales ÷ Average Total Assets = Asset Turnover ₩35,528 + ₩34,766 ₩58,140 ÷ = 1.65 Times 2 Each dollar invested in assets produced ₩1.65 in sales. If a company is using its assets efficiently, each investment in assets will create a high amount of sales. Copyright ©2019 John Wiley & Son, Inc. 81 DO IT! 5: Asset Turnover Paramour Company reported net income of $180,000, net sales of $420,000, and had total assets of $460,000 on January 1, 2020, and total assets on December 31, 2020, of $540,000 billion. Determine Paramour’s asset turnover for 2020. Solution Net Sales ÷ Average Total Assets = Asset Turnover $460,000 + $540,000 $420,000 ÷ =.84 Times 2 Copyright ©2019 John Wiley & Son, Inc. 82 Learning Objective 6 Explain How to Account for the Exchange of Plant Assets Copyright ©2019 John Wiley & Sons, Inc. 83 Appendix 9A Exchange of Plant Assets Ordinarily, companies record a gain or loss on exchange of plant assets Most exchanges have commercial substance Commercial substance if future cash flows change as a result of exchange Copyright ©2019 John Wiley & Son, Inc. 84 Loss Treatment Illustration: Roland NV exchanged old trucks (cost €64,000 less €22,000 accumulated depreciation) plus cash of €17,000 for a new semi-truck. The old trucks had a fair market value of €26,000. Cost of used trucks €64,000 Less: Accumulated depreciation 22,000 Book value 42,000 Fair market value of used trucks 26,000 Loss on disposal of plant assets €16,000 Fair market value of used trucks €26,000 Cash paid 17,000 Cost of new truck €43,000 Copyright ©2019 John Wiley & Son, Inc. 85 Loss Treatment Illustration: Roland NV exchanged old trucks (cost €64,000 less €22,000 accumulated depreciation) plus cash of €17,000 for a new semi-truck. The old trucks had a fair market value of €26,000. Prepare the entry to record the exchange of assets by Roland. Equipment (new) 43,000 Accumulated Depreciation—Equipment 22,000 Loss on Disposal of Plant Assets 16,000 Equipment (old) 64,000 Cash 17,000 Copyright ©2019 John Wiley & Son, Inc. 86 Gain Treatment Illustration: Mark Express trades its old delivery equipment (cost €40,000 less €28,000 accumulated depreciation) for new delivery equipment. The old equipment had a fair market value of €19,000. Mark also paid €3,000. Cost of old equipment €40,000 Less: Accumulated depreciation 28,000 Book value 12,000 Fair market value of old equipment 19,000 Gain on disposal of plant assets € 7,000 Fair market value of old equipment €19,000 Cash paid 3,000 Cost of new equipment €22,000 Copyright ©2019 John Wiley & Son, Inc. 87 Gain Treatment Illustration: Mark Express trades its old delivery equipment (cost €40,000 less €28,000 accumulated depreciation) for new delivery equipment. The old equipment had a fair market value of €19,000. Mark also paid €3,000. Equipment (new) 22,000 Accumulated Depreciation—Equipment 28,000 Equipment (old) 40,000 Gain on Disposal of Plant Assets 7,000 Cash 3,000 Copyright ©2019 John Wiley & Son, Inc. 88 Learning Objective 7 Compare the Accounting For Long-lived Assets Under I F R S and U.S. G A A P Copyright ©2019 John Wiley & Sons, Inc. 89 A Look at U.S. GAAP Key Points Similarities The definition for plant assets for both IFRS and GAAP is essentially the same. GAAP, like IFRS, capitalizes all direct costs in self-constructed assets such as raw materials and labor. IFRS does not address the capitalization of fixed overhead although in practice these costs are generally capitalized. GAAP also views depreciation as an allocation of cost over an asset’s useful life. GAAP permits the same depreciation methods (e.g., straight-line, accelerated, and units-of activity) as IFRS. Copyright ©2019 John Wiley & Son, Inc. 90 A Look at U.S. GAAP Key Points Similarities The accounting for subsequent expenditures (such as ordinary repairs and additions) are essentially the same under IFRS and GAAP. Under both GAAP and IFRS, changes in the depreciation method used and changes in useful life are handled in current and future periods. Prior periods are not affected. GAAP recently conformed to IFRS in the accounting for changes in depreciation methods. The accounting for plant asset disposals is essentially the same under IFRS and GAAP. Initial costs to acquire natural resources are essentially the same under IFRS and GAAP. Copyright ©2019 John Wiley & Son, Inc. 91 A Look at U.S. GAAP Key Points Similarities The definition of intangible assets is essentially the same under IFRS and GAAP. The accounting for exchanges of non-monetary assets has converged between IFRS and GAAP. GAAP now requires that gains on exchanges of non-monetary assets be recognized if the exchange has commercial substance. This is the same framework used in IFRS. Both IFRS and GAAP follow the historical cost principle when accounting for property, plant, and equipment at date of acquisition. Cost consists of all expenditures necessary to acquire the asset and make it ready for its intended use. Copyright ©2019 John Wiley & Son, Inc. 92 A Look at U.S. GAAP Key Points Similarities Under both IFRS and GAAP, interest costs incurred during construction are capitalized. Recently, IFRS converged to GAAP requirements in this area. Differences Under GAAP, an item of property, plant, and equipment with multiple parts is generally depreciated over the useful life of the total asset. Thus, component depreciation is generally not used. However, GAAP permits companies to use component depreciation. GAAP uses the term salvage value, rather than residual value, to refer to an owner’s estimate of an asset’s value at the end of its useful life for that owner. Copyright ©2019 John Wiley & Son, Inc. 93 A Look at U.S. GAAP Key Points Differences IFRS allows companies to revalue plant assets to fair value at the reporting date. As in IFRS, under GAAP 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. Under IFRS, however, costs in the development phase are capitalized as Development Costs once technological feasibility is achieved. IFRS permits revaluation of intangible assets (except for goodwill). GAAP prohibits revaluation of intangible assets. Copyright ©2019 John Wiley & Son, Inc. 94 A Look at U.S. GAAP Key Points Differences IFRS requires an impairment test at each reporting date for plant 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 or its value-in-use. Value-in-use is the future cash flows to be derived from the particular asset, discounted to present value. Under GAAP, impairment loss is measured as the excess of the carrying amount over the asset’s fair value. Copyright ©2019 John Wiley & Son, Inc. 95 A Look at U.S. GAAP Key Points Differences IFRS allows reversal of impairment losses when there has been a change in economic conditions or in the expected use of the asset. 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. Copyright ©2019 John Wiley & Son, Inc. 96 A Look at U.S. GAAP Looking to the Future 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 plant assets and intangibles. 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. The IASB and FASB have identified a project that would consider expanded recognition of internally generated intangible assets. 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 costs in GAAP. Copyright ©2019 John Wiley & Son, Inc. 97 Copyright Copyright © 2019 John Wiley & Sons, Inc. All rights reserved. Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States 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 ©2019 John Wiley & Sons, Inc. 98