2. Learning Objectives
1. Define, classify, and explain the nature of long-lived
assets.
2. Apply the cost principle to the acquisition of long-lived
assets.
3. Apply various depreciation methods as economic benefits
are used up over time.
4. Explain the effect of asset impairment on the financial
statements.
5. Analyze the disposal of long-lived tangible assets.
6. Analyze the acquisition, use, and disposal of long-lived
intangible assets.
7. Interpret the fixed asset turnover ratio.
8. Describe factors to consider when comparing companies’
long-lived assets.
3. Definition and Classification
Actively Used in Operations
Value represented by rights
that produce benefits.
Will not be used up within the next year
Intangibles with a limited
life, such as patents and
copyrights, are subject to Examples
amortization. Land
Tangible Intangible
Intangibles with an Assets subject to depreciation
unlimited (or indefinite) Buildings and equipment
Physical No Physical
life, such as goodwill andFurniture and fixtures
Substance are not
trademarks,
Substance
amortized.
4. Long-term Tangible Assets
Use
Acquisition 2. Allocate cost to periods Disposal
1. Compute cost. benefited. 4. Record disposal.
3. Account for subsequent
expenditures.
5. Acquisition of Tangible Assets
Acquisition cost includes:
1. purchase price; and
2. all necessary expenditures needed to
prepare the asset for its intended use.
Recording costs as assets is called
capitalizing the costs.
Principle
Historical cost: Cash equivalent cost given up
is the basis for the initial recording of elements.
7. Cash Purchase
Cedar Fair purchased a new ride for $26,000,000 less a
$1,000,000 discount. Cedar Fair paid $125,000 for
transportation and $625,000 for installation of the ride.
Prepare the journal entry for the acquisition assuming Cedar
Fair paid cash for the new ride.
1 Analyze
2 Record
8. Credit Purchase
Instead of paying cash, assume that Cedar Fair
issued a note for the new ride, but paid cash for
the transportation and installation of the ride.
Prepare the journal entry for the acquisition.
1 Analyze
2 Record
9. Acquisition Cost of Realty
Martin Co. purchased land as a factory site for
$400,000. The process of tearing down an old
building on the site and constructing the factory
required 6 months. The company paid $42,000 to
raze the old building and $1,850 for legal fees. It
also paid $68,000 for drawing the factory plan. The
construction of factory costs Martin $28,000,000.
Land value to be capitalized
Land purchase price 400,000
Land preparation 42,000
Legal fees 1,850
Total Land value 443,850
Building value to be capitalized
Construction costs 28,000,000
Architectural fees 68,000
Total Building value 28,068,000
10. Acquisition Cost of Realty
Total Land value = $443,850
Total Building value = $28,068,000
Accounts Debit Credit
Land (+A) 443,850
Building (+A) 28,068,000
Cash (-A) 28,511,850
11. Quick check
1. Starbucks paid
1) $150,000 cash to acquire land for a retail store.
2) This land had an old service garage that was removed at
a cost of $15,000, and salvaged materials were sold for
$2,000.
3) Additional closing cost (brokerage fee and transfer fee)
total $10,000.
Calculate the cost of this land to Starbucks.
2. S Co. purchased a machine for $32,000 with terms 2/15,
n/60, and paid $400 in shipping charges. Experts were hired
to install the machine at a cost of $1,000; In moving the
machine, paid $500 in damages occurred. Once the machine
was installed several test runs were made to calibrate the
settings – material and labor associated with the testing
totaled $600. Assuming the firm paid within the discount
period, what cost should be recorded for the machine?
12. Acquisition Cost - Basket Purchase
On January 1, Jones purchased land and
building for $400,000 cash. The appraised
values are building, $325,000, and land,
$175,000.
How much of the $400,000 purchase price
will be charged to the building and land
accounts?
The total cost of a combined purchase of land
and building is allocated in proportion to their
relative market values.
13. Acquisition Cost - Basket Purchase
Appraised % of Purchase Apportioned
Asset Value Value Price Cost
a b* c b × c
Land $ 175,000 35% × $ 400,000 = $ 140,000
Building 325,000 65% × 400,000 = 260,000
Total $ 500,000 100% $ 400,000
* $175,000 ÷ $500,000 = 35%
$325,000 ÷ $500,000 = 65%
14. Additional Expenditures
After a company acquires a plant asset
and puts it into service, it often makes
additional expenditures for that asset’s
operation:
General maintenance
Repair
Upgrade and improvement
Capitalize them or Expense them?
Capitalize: charge the amount to an asset
account
Expense: charged to current period income as
an expense
15. Additional Expenditures
Type of Accounting
Expenditure Identifying Characteristics Treatment
Ordinary 1. Maintains normal operating condition Expense
repairs and 2. Does not increase productivity
maintenance 3. Does not extend life beyond original
estimate
Extraordinary 1. Major overhauls or partial Capitalize
repairs replacements
2. Extends life beyond original estimate
Additions 1. Increases productivity Capitalize
2. May extend useful life
3. Improvements or expansions
16. Additional Expenditures
Financial Statement Effect
Current Current
Treatment Statement Expense Income Taxes
Capitalize Balance sheet
account debited Deferred Higher Higher
Expense Income statement Currently
account debited recognized Lower Lower
If the amounts involved are not material,
most companies expense the item.
17. Additional Expenditures
Kelly Co. owns machine that has net book value of
30,000. In Mar. 2007, Kelly paid $13,000 to
rearrange and reinstall machinery, which will
enhance productivity of the machine. In Apr. 2007,
it paid $200 for regular maintenance of the
machine. Prepare journal entries for the above
transactions.
Dr. Cr.
Machine (+A) 13,000
Cash (-A) 13,000
Maintenance Expense (+E,-SE) 200
Cash (-A) 200
18. Depreciation
Depreciation is the process of allocating the
cost of a plant asset to expense in the
accounting periods benefiting from its use.
Balance Sheet Income Statement
Acquisition Cost
Expense
Cost Allocation
(Unused) (Used)
19. Rules of the Game
As depreciation is recognized it is charged
to income as depreciation expense and
aggregated as the contra asset account
“accumulated depreciation”
The book value (or net book value) of a
depreciable asset equals the historical cost
minus the accumulated depreciation
The depreciation method selected
determines the periodic expense amount.
20. Depreciation on Delta’s
2000 Balance Sheet
Property and Equipment:
Flight equipment $ 27,000
Less: Accumulated depreciation 5,000 $ 22,000
Ground property and equipment 4,500
Less: Accumulated depreciation $ 2,300 2,200
Total property and equipment, net $ 24,200
Book Values
/
Book value = Market value
21. Factors in Computing Depreciation
The calculation of depreciation requires
three amounts for each asset:
Cost
Salvage Value Do we know these with
Useful Life absolute certainty?
23. Depreciation Methods
Straight-line
Units-of-production
Declining balance
We will use the following information to illustrate
the three methods of depreciation:
At the beginning of the year, Cedar Fair purchased
a new Go-Cart Ride for $62,500 cash. The ride
has an estimated useful life of 3 years and an
estimated residual value of $2,500.
25. Units-of-Production Method
The ride has a 100,000-mile estimated
useful life. If the ride is used 30,000 miles
in the first year, what is the amount of
depreciation expense?
($62,500 - $2,500) × 30,000 = $18,000
100,000
27. Declining-Balance Method
The declining-balance method matches higher
depreciation expense with higher revenues
in the early years of an asset’s useful life when
the asset is more efficient.
Depreciation
Expense
Early Years High
Later Years Low
28. Double-Declining-Balance Method
Declining balance rate of 2 is
double-declining-balance (DDB) rate.
Annual Net 2
Depreciation =
Expense
Book
Value
× ( Useful Life in Years )
Cost – Accumulated Depreciation
Annual computation ignores residual value.
29. Double-Declining-Balance Method
At the beginning of the year, Cedar Fair
purchased a new Go-Cart Ride for $62,500
cash. The ride has an estimated useful
life of 3 years and an estimated residual
value of $2,500.
Calculate the depreciation expense
for the first two years.
30. Double-Declining-Balance Method
Annual Net 2
Depreciation = Book
expense Value
× ( Useful Life in Years )
Year 1 Depreciation:
2
$62,500 × ( 3 years ) = $41,667
Year 2 Depreciation:
2
($62,500 – $41,667) × ( 3 years ) = $13,889
32. Double-Declining-Balance Method
Depreciation Accumulated Undepreciated
Expense Depreciation Balance
Year (debit) Balance (book value)
$ 62,500
1 $ 41,667 $ 41,667 20,833
2 13,889 55,556 6,944
3 4,444 60,000 2,500
$ 60,000
We usually must force depreciation expense in the
last year so that book value equals salvage value.
Depreciation expense is limited to the amount that
reduces book value to the estimated residual value.
33. Partial-Year Depreciation
When a plant asset is acquired during the
year, depreciation is calculated for the
fraction of the year the asset is owned.
Calculate the straight-line depreciation on December
31, 2007, for equipment purchased on June 30, 2007.
The equipment cost $75,000, has a useful life of 10
years, and an estimated salvage value of $5,000.
(Straight-Line method)
Depreciation = ($75,000 - $5,000) ÷ 10
= $7,000 for all 2007
Depreciation = $7,000 × 6/12 = $3,500
35. Tax Depreciation
For tax purposes, most corporations use
the Modified Accelerated Cost
Recovery System (MACRS).
MACRS depreciation provides for rapid
write-off of an asset’s cost in order to
stimulate new investment.
36. Asset Impairment Losses
Impairment is the loss of a significant portion of the utility of an
asset through . . .
Casualty.
Obsolescence.
Lack of demand for the asset’s services.
A loss should be recognized when an asset suffers a permanent
impairment.
Cedar Fair recorded a write-down of $3,200,000 on equipment.
1 Analyze
2 Record
37. Accounting for Asset Disposals
1. Recognize any unrecorded depreciation expense
2. Remove the historical cost of the asset and the
accumulated depreciation associated with the
asset from books
3. Record the cash receipts (or payment)
4. Recognize any difference between value of asset
received and book value of asset given up as a
gain or loss
38. Disposal of Tangible Assets
Update depreciation
If Cash > BV, record a gain (credit).
to the date of disposal.
If Cash < BV, record a loss (debit).
If Cash = BV, no gain or loss.
Recording a
gain (credit)
or loss (debit).
BV is equal to cost less accumulated depreciation.
39. Disposal of Tangible Assets
On December 31, 2007, Evans Company sells a machine
that originally cost $100,000 for $60,000 cash. The
machine was placed in service on January 1, 2004. It
was depreciated using the straight-line method with an
estimated salvage value of $20,000 and a useful life of
10 years.
Annual Depreciation:
($100,000 - $20,000) ÷ 10 Yrs. = $8,000
40. Update Depreciation to Date of
Disposal
Dr. Cr.
Dec. 31 Depreciation expense 8,000
Accumulated Depreciation - Machine 8,000
To update depreciation to date of disposal
Cost $ 100,000
Accumulated Depreciation:
4 yrs. × $8,000 = 32,000
Book Value $ 68,000
41. Determine Gain or Loss on Disposal
If Cash > BV, record a gain (credit).
If Cash < BV, record a loss (debit).
If Cash = BV, no gain or loss.
Cost $ 100,000
Accumulated depreciation 32,000
Book Value 68,000
Cash Received 60,000
Loss on disposal $ (8,000)
42. Record the Disposal in the Journal
Dr. Cr.
Dec. 31 Cash 60,000
Loss on Disposal of Asset 8,000
BV Accumulated Depreciation - Machine 32,000
Machine 100,000
To record disposal of equipment
Question: what if the company sells the machine for $80,000
Dr. Cr.
Dec. 31 Cash 80,000
Accumulated Depreciation - Machine 32,000
BV
Machine 100,000
Gain on Disposal of Asset 12,000
To record disposal of equipment
43. Classifying Long-Lived Assets
Actively Used in Operations
Examples
Value represented by rights
Expected to Benefit Future Periods
that produce benefits
Patents
Copyrights
Trademarks
Tangible
Franchises Intangible
Goodwill
Physical No Physical
Substance
Subject to amortization Substance
44. Intangible Assets
Noncurrent assets Often provide
without physical exclusive rights
substance. or privileges.
Intangible
Assets
Useful life is Usually acquired
often difficult for operational
to determine. use.
45. Cost Determination and Amortization
Record at
current cash Patents
equivalent cost,
including Copyrights
purchase price, Franchises
legal fees, and Trademarks
filing fees. Goodwill
46. Trademarks and Copyrights
A trademark is a symbol, design,
or logo associated with a business.
Internally developed
trademarks have no Purchased trademarks
are recorded at cost.
recorded asset cost.
A copyright is an exclusive right granted by the federal
government to protect artistic or intellectual properties.
Legal life is Amortize cost
life of creator over the period
plus 70 years. benefited.
47. Patents and Licensing Rights
A patent is an exclusive right granted by the 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 20 years.
Licensing rights grant limited permission to use a product
or service according to specific terms and conditions.
You may be using computer
software that is made
available to you through a
campus licensing agreement.
48. Franchises
A franchise provides legally protected rights
to sell products or provide services purchased
by a franchisee from the franchisor.
49. Goodwill
Purchase Price > Fair Market Value of Net Assets Acquired
Occurs when one Only purchased
company buys goodwill is an
another company. intangible asset.
Is impairment
Is not amortized. tested and may be
written down.
50. Amortization of Limited Life Intangible
Asset
Assume Cedar Fair purchased a patent for an uphill water-
coaster for $800,000 and intends to use it for 20 years. Each
year, the company would record $40,000 in Amortization
Expense ($800,000 ÷ 20 years).
1 Analyze
Assets = Liabilities + Stockholders' Equity
Patent (-A) $40,000 Amortization Expense
(+E, -SE) -40,000
2 Record
dr Amortization Expense (+E, -SE) 40,000
cr Patent (-A) 40,000
51. Summary of Accounting Rules
for Long-Lived Assets
Stage Subject Tangible Assets Intangible Assets
Acquisition Purchased Asset Capitalize all related costs Capitalize all related costs
Use Repairs/maintenance
Ordinary Expense related costs Not applicable
Extraordinary Capitalize related costs Not applicable
Depreciation/ amortization
Limited life straight-line Typically use straight line only
units-of-production
declining-balance
Unlimited life Do not depreciate land Do not amortize
Impairment test Write-down if necessary Write-down if necessary
Disposal Report gain or (loss) when . . . Receive more (less) on Receive more (less) on
disposal than book value disposal than book value
52. Turnover Analysis
Fixed Net Sales Revenue
Asset =
Average Net Fixed Assets
Turnover
This ratio measures the sales
dollars generated by each dollar
invested in fixed assets.
For the year 2008, Cedar Fair had $1,000,000 of
revenue. End-of-year fixed assets were $1,800,000
and beginning-of-year fixed assets were $1,940,000.
(All numbers in millions.)
53. Turnover Analysis
Fixed
Asset Net Sales Revenue
=
Turnover Average Net Fixed Assets
Fixed
Asset $1,000,000
= = 0.53
Turnover ($1,800,000 + $1,940,000) ÷ 2
2008 Fixed Asset Turnover Comparisons
Yahoo! Six Flags Cedar Fair
5.68 0.64 0.53
54. Impact of Depreciation Differences
Accelerated depreciation, in the early years of an asset’s
useful life, results in higher depreciation expense, lower
net income, and lower book value than would result using
straight-line depreciation.
Selling an asset with a low book value, resulting from
accelerated depreciation, might result in a gain.
Selling the same asset with a higher book value,
resulting from straight-line depreciation, might result in
a loss.
55. In-class exercise problem #1
On January 1, Manning Co. purchases a new
knitting machine costing $300,000, the shipping
cost was 1,000 and installs it at a cost of $23,000.
Estimates
The useful life of the equipment is 5 years
Salvage value of $24,000 at the end of 5 years
Total production of 1,500,000 pairs of socks
Actual production is as follows:
Year 1 350,000
Year 2 320,000
Year 3 300,000
How much depreciation will be recognized in each
year using (a) straight-line depreciation and (b)
units of production depreciation
56. In-class exercise problem #2
City Corp. owns machinery that cost
$20,000 when purchased on January 1,
2004. It sold the machinery on July 31,
2008 for $10,500 cash. On the day of sale,
the updated accumulated depreciation for
the machinery was $10,000. Determine
gain (loss) from the sale and prepare a
journal entry for the sale transaction.
57. In-class exercise problem #3
On December 31, 2007, Travis Inc. had a machine with a book
value of $940,000. The original cost and related
accumulated depreciation at this date are as follows:
12/31/2007
Machine $1,300,000
Accumulated depreciation 360,000
Book Value $ 940,000
The machine has expected useful life of 10 years and will have
$100,000 salvage value at the end of its useful life. Travis
has been depreciating the machine using a straight-line
method.
Required:
Assume that Travis Inc. sold the machine for $920,000 on
January 1, 2008. Determine Gain (Loss) from the sale of the
machine and prepare journal entries to record the disposal
transaction.
Assume that Travis Inc. sold the machine on Dec 31, 2008
for $920,000. Determine Gain (Loss) from the sale of the
machine and prepare journal entries to record the disposal
transaction.
