Acct 2210 Chapter 8 Accounting for Long-Term Operational

Acct 2210 Chapter 8 Accounting for Long-Term Operational

Acct 2210 Chapter 8 Accounting for Long-Term Operational Assets McGraw-Hill/Irwin McGraw-Hill/Irwin Copyright 2013 by The McGraw-Hill Companies, Inc. All rights reserved. LO 1 Identify different types of long-term operational assets. 8-2 Tangible versus Intangible Assets Tangible assets have a physical presence; they can be seen and touched. Intangible assets are rights or privileges. They cannot be seen or touched. 8-3 Tangible Long-Term Assets 1. Property, Plant, and Equipment Sometimes

called plant assets or fixed assets. We depreciate (allocate the cost of) these assets over their useful life. 2. Natural Resources Mineral deposits, oil and gas reserves, timber, coal mines, and stone quarries are examples of natural resources. We deplete (allocate the cost of) these assets over their useful life. 3. Land Has an infinite life and is not subject to depreciation (they stopped making it a long time ago!). 8-4 Intangible Assets 1. Intangible Assets with Identifiable Useful Lives patents and copyrights. Amortize the cost of each over its useful life. 2. Intangible Assets with Indefinite Useful Lives renewable franchises, trademarks, and goodwill. The cost of these assets is not expensed unless it can be shown that there has been an impairment in value. 8-5 LO 2 Determine the cost of longterm

operational assets. 8-6 Cost of Long-Term Assets Buildings Buildings Purchase Purchase price price Sales Sales taxes taxes Title Title search search and and transfer transfer document document costs costs Realtors Realtors and and attorneys attorneys fees fees Remodeling Remodeling costs costs Equipment Equipment Purchase

Purchase price price (less (less discounts) discounts) Sales Sales taxes taxes Delivery Delivery costs costs Installation Installation costs costs Costs Costs to to adapt adapt to to intended intended use use 8-7 Cost of Long-Term Assets Land Land Purchase Purchase price price Sales Sales taxes taxes Title

Title search search and and transfer transfer document document costs costs Realtors Realtors and and attorneys attorneys fees fees Costs Costs of of removal removal of of old old buildings buildings Grading Grading costs costs 8-8 Basket Purchase Allocation Beatty Co. purchased land and a building for $240,000 cash. An appraiser estimated that the land has a fair market value of $90,000, and the building has a fair market value of $270,000. How will we assign the $240,000 cost between the land and building? Amount

Fair market value of building $ 270,000 75% 90,000 25% 360,000 100% Fair market value of land Total fair market value Assign to building Assign to land $ $ Cost 240,000 240,000 % %

75% 25% 100% Allocation $ 180,000 60,000 $ 240,000 8-9 Life Cycle of Operational Assets 8-10 LO 3 Explain how different depreciation methods affect financial statements. 8-11 Depreciation Methods 1. 1. Straight-line Straight-line method method -- the the same same amount amount is

is depreciated depreciated each each accounting accounting period. period. 2. 2. Double-declining-balance Double-declining-balance produces produces more more depreciation depreciation expense expense in in the the early early years years of of an an assets assets life, life, with with aa declining declining amount amount of of expense expense in in later later years. years. 3.

3. Units-of-production Units-of-production produces produces varying varying amounts amounts of of depreciation depreciation in in different different accounting accounting periods periods depending depending upon upon the the number number of of units units produced. produced. 8-12 Asset to be Depreciated List price of van $ 23,500 Cash discount (2,350) Transportation cost 250 Cost of customization 2,600 Cost of van

$ 24,000 The van has a salvage value of $4,000, and an estimated useful life of four years. 8-13 Straight-Line Depreciation Life Cycle Phase 1 Acquire $25,000 cash from the sale of common stock to purchase the van. Assets Cash + Van 25,000 NA = Equity Rev. Exp. = Net Inc. AccDep = Com. Stk. Ret. Earn. = NA = 25,000 NA NA Account Title Cash Common stock Debit

25,000 NA = NA Cash Flow 25,000 FA Credit 25,000 8-14 Straight-Line Depreciation Life Cycle Phase 2 Purchase the van on January 1, 2013, for a net cost of $24,000. Assets Cash + Van AccDep (24,000) 24,000 = NA Account Title Van Cash = Equity

= Com. Stk. = NA Ret. Earn. NA Rev. Exp. = Net Inc. Cash Flow NA (24,000) IA NA Debit 24,000 = NA Credit 24,000 8-15 Straight-Line Depreciation Life Cycle Phase 3 Use the van to generate $8,000 revenue for the period. Depreciation expense calculated under straight-line is determined as followed: (Asset Cost Salvage Value) Useful Life

($24,000 $4,000) 4 = $5,000 depreciation Assets = Liab. Cash + Book Value of Van 8,000 NA = NA NA (5,000) NA + Equity + 8,000 (5,000) Rev. 8,000 NA Exp. = NA

= 5,000 Net Inc. 8,000 (5,000) Cash Flow 8,000 OA NA 8-16 Straight-Line Depreciation Life Cycle Phase 3 Use the van to generate $8,000 revenue for the period. Depreciation expense calculated under straight-line is determined as followed: Assets = Liab. Cash + Book Value of Van 8,000 NA = NA NA (5,000) NA + Equity +

8,000 (5,000) Cash Rent revenue Depreciation expense Accumulated depreciation Rev. 8,000 NA Exp. = NA = 5,000 Net Inc. 8,000 (5,000) Cash Flow 8,000 OA NA

8,000 8,000 5,000 5,000 8-17 LO 4 Determine how gains and losses on disposals of long-term operational assets affect financial statements. 8-18 Straight-Line Depreciation Life Cycle Phase 4 On January 1, 2017, the van is sold for $4,500 $ 24,000 cash.Cost of Asset Accumulated Depreciation Book Value Cash Proceeds Gain on disposal Assets = Liab. Cash + Book Value of Van 4,500 (4,000) = NA

20,000 4,000 4,500 $ 500 + Equity + Ret. Earn. 500 Account Title Cash Accumulated depreciation Van Gain on sale of van ($5,000 4 years) Gain Exp. 500 Debit 4,500 20,000 -

= Net Inc. = 500 Cash Flow 4,500 IA Credit 24,000 500 8-19 Double-Declining-Balance Method The double-declining-balance method is called an accelerated depreciation method because more depreciation expense is recorded in the early years than in later years. Determining the amount of depreciation expense in any year is the result of a three-step process. 1. 1. Determine Determine the the straight-line straight-line rate rate of of depreciation. depreciation. 2. 2. Multiply Multiply the the straight-line straight-line rate

rate times times two. two. 3. 3. Multiply Multiply the the double-declining double-declining rate rate by by the the book book value value of of the the asset asset at at the the beginning beginning of of the the (each) (each) period. period. 8-20 Double-Declining-Balance Method See how double-declining-balance depreciation works (1 (1 4) 4) == (25% (25% straight-line

straight-line rate rate 2) 2) == 50% 50% Year 2013 2014 2015 2016 Book Value at Beginning of Year ($24,000 $ 0) ($24,000 $12,000) ($24,000 $18,000) ($24,000 - $20,000) Double the Straight-Line Rate 50% 50% 50% 50% Annual Depreciation Expense $ 12,000 6,000

2,000 2,000 $ 22,000 2,000 0 8-21 Units-of-Production Depreciation Cost Salvage value Total estimated units of production Depreciation = charge per unit of production Depreciation Units of production in Periodic charge per unit current accounting = Depreciation of production period Expense 8-22 Units-of-Production Depreciation Here is the depreciation charge per mile driven in our van: $24,000 $4,000 = $0.20 per mile 100,000 miles

Here is the calculation of depreciation expense based on miles driven: Depreciation Charge Per Mile $ 0.20 0.20 0.20 0.20 Miles Driven 40,000 20,000 30,000 15,000 105,000 = = = = Depreciation Expense $ 8,000

4,000 6,000 3,000 $ 2,000 21,000 8-23 Graph of Depreciation Expense 8-24 LO 5 Identify some of the tax issues which affect long-term operational assets. 8-25 Income Tax (IRS) Considerations The maximum depreciation currently allowed by tax law is computed using the modified accelerated cost recovery system (MACRS). The rate of depreciation depends on the class life of the asset and the period in which we are calculating depreciation. There are currently six categories for property, excluding real estate. They are 3-year, 5-year, 7-year, 10-year, 15-year, and 20-year property.

8-26 Income Tax Considerations Here are the tax rates for 5-year and 7-year property: Year 1 2 3 4 5 6 7 8 5-Year Property % 20.00% 32.00% 19.20% 11.52% 11.52% 5.76% 100.00% 7-Year Property % 14.29% 24.49% 17.49% 12.49% 8.93%

8.92% 8.93% 4.46% 100.00% Lets assume our van is classified as 5-year property and calculate depreciation for our tax return. 8-27 Income Tax Considerations Lets assume our van is classified as 5-year property and calculate depreciation for our tax return. Year 1 2 3 4 5 6 5-Year Property % 20.00% 32.00% 19.20% 11.52% 11.52% 5.76% 100.00% Cost of Van $ 24,000

24,000 24,000 24,000 24,000 24,000 Depreciation Expense $ 4,800 7,680 4,608 2,765 2,765 1,382 $ 24,000 8-28 LO 6 (students are not responsible for this material) Show how revising estimates affects financial statements. 8-29 Revision of Estimates (OMIT) Estimates are revised when new information surfaces. Assume we purchased equipment on January 1, 2013, for $50,000 cash and estimated salvage value was $3,000. The equipment has an estimated useful life of

eight years, and we use straight-line depreciation. ($50,000 $3,000) 8 = $5,875 depreciation per year On January 1, 2017, after four years of depreciation, it was determined that the machine has a useful life of fourteen years. ($26,500 $3,000) 10 = $2,350 depreciation per year 8-30 LO 7 Explain how continuing expenditures for operational assets affect financial statements. 8-31 Continuing Expenditures for Plant Assets Costs That Are Expensed (in the current period) The cost of routine maintenance and minor repairs that are incurred to keep an asset in good working order are expensed as incurred. Assume the company spent $500 cash for routine maintenance on machinery. Assets = Liab. Cash (500) = NA

+ Equity Ret. Earn. + (500) Account Title Repairs Expense Cash Rev. NA Exp. 500 = Net Inc. = Debit 500 Cash Flow (500) (500) OA Credit

500 8-32 Continuing Expenditures for Plant Assets Costs That Are Capitalized (shown as assets) Expenditures that improve the quality of an asset are capitalized as part of the cost of that asset. Assume the company spent $4,000 cash for a major overall of equipment to improve efficiency. Assets Cash + Equip. (4,000) 4,000 A. Depr NA Account Title Equipment Cash = Liab. + Equity Rev. Exp. = Net Inc.

Cash Flow = NA + NA NA NA = NA (4,000) IA Debit 4,000 Credit 4,000 8-33 Continuing Expenditures for Plant Assets Costs That Extend the Life of an Asset The amount of the expenditure should reduce the balance in the accumulated depreciation account. Assume the company spent $4,000 cash for improvements that extended the life of equipment four years. Assets Cash + Equip. (4,000) NA

= Liab. - A. Depr (4,000) = NA + Equity Rev. Exp. = Net Inc. + NA NA NA = NA Account Title Accumulated Depreciation - Equipment Cash Debit 4,000 Cash Flow (4,000) IA

Credit 4,000 8-34 LO 8 Explain how expense recognition for natural resources (depletion) affects financial statements. 8-35 Natural Resources Cost Salvage value Total estimated units recoverable Depletion Number of units charge per unit extracted and sold of resource this period Depletion = charge per unit of resource Periodic = Depletion Expense

8-36 Natural Resources Apex Coal Mining paid $4,000,000 cash to purchase a mine expected to yield 16,000,000 tons of coal. After all coal is extracted the mine is not expected to have any salvage value. During the year, the company extracted and sold 360,000 tons of coal. $4,000,000 $0 16,000,000 tons = $0.25 per ton extracted and sold 8-37 Natural Resources Apex Coal Mining paid $4,000,000 cash to purchase a mine expected to yield 16,000,000 tons of coal. After all coal is extracted the mine is not expected to have any salvage value. During the year, the company extracted and sold 360,000 tons of coal. Assets Cash = Liab. + Coal Mine (4,000,000) 4,000,000 = NA (90,000)

NA NA + Equity + Account Title Coal Mine Cash Depletion Expense Coal Mine NA (90,000) Rev. NA NA Exp. Debit 4,000,000 = Net Inc. NA = 90,000 NA (90,000)

Cash Flow (4,000,000) IA NA Credit 4,000,000 90,000 90,000 8-38 LO 9 Explain how expense recognition for intangible assets (amortization) affects financial statements. 8-39 Intangible Assets Trademarks Trademarks A A name name or or symbol symbol that

that identifies identifies aa company company or or aa product. product. The The cost cost of of aa trademark trademark may may include include design, design, purchase, purchase, or or defense defense of of the the trademark. trademark. Patents Patents The The exclusive exclusive legal legal right right to to

produce produce and and sell sell aa product product that that has has one one or or more more unique unique features. features. The The legal legal life life of of aa patent patent is is 20 20 years. years. 8-40 Intangible Assets Copyrights Copyrights Protection Protection of of writings,

writings, musical musical composition, composition, work work of of art, art, or or other other intellectual intellectual property. property. The The protection protection extends extends for for the the life life of of the the creator creator plus plus 70 70 years. years. Franchise Franchise The The exclusive

exclusive right right to to sell sell products products or or perform perform services services in in certain certain geographic geographic areas. areas. 8-41 Intangible Assets Goodwill Goodwill The The excess excess of of cost cost over over fair fair value value of of net net tangible tangible assets

assets acquired acquired in in aa business business acquisition. acquisition. Assume that your company is willing to pay $450,000 cash to acquire Seller Company. Lets look at the accounting. Seller Company Balance Sheet At December 31, 2013 Assets $ 500,000 Liabilities Stockholders' Equity Total $ $ 100,000 400,000 500,000 8-42 Goodwill

Assume that your company is willing to pay $450,000 cash to acquire Seller Company. Lets look at the accounting. Seller Company Balance Sheet At December 31, 2013 Assets $ 500,000 Liabilities Stockholders' Equity Total Assets Cash + Seller Assets (450,000) 500,000 = Liab. $ $ + Equity Goodwill Seller Liab. 50,000 = 100,000 + NA 100,000 400,000 500,000 Rev.

NA Exp. = Net Inc. Cash Flow = (450,000) IA NA NA 8-43 Goodwill Assume that your company is willing to pay $450,000 cash to acquire Seller Company. Lets look at the accounting. Seller Company Balance Sheet At December 31, 2013 Assets $ 500,000 Liabilities Stockholders' Equity Total

$ $ 100,000 400,000 500,000 Account Title Seller Assets Goodwill Seller Liabilities Cash Debit 500,000 50,000 Credit 100,000 450,000 8-44 Expensing Intangible Assets An asset with an identifiable useful life is amortized using the straight-line method over the intangibles legal life or its useful life. Assume we purchased a patent that has a 11-year legal and useful life for $44,000 cash. Assets = Liab. + Patent (44,000)

44,000 = NA (4,000) + Equity Rev. Exp. = Net Inc. Cash Flow Cash NA NA + NA (4,000) Account Title Patent Cash Amortization Expense - Patent Patent NA NA

NA = 4,000 Debit 44,000 NA (4,000) (44,000) IA NA Credit 44,000 4,000 4,000 8-45 Impairment of Intangible Asset Intangible Intangible assets assets with with indefinite indefinite useful useful lives lives must must be

be tested tested for for impairment impairment annually. annually. IfIf the the fair fair value value of of the the intangible intangible asset asset is is less less than than its its book book value, value, an an impairment impairment loss loss is is recognized. recognized. Assume that at the end of 2014, we determine that goodwill has suffered a $10,000 impairment in value. Assets = Liab. Goodwill

(10,000) = NA + Equity + (10,000) Account Title Impairment Loss Goodwill Rev. NA Exp. = Net Inc. 10,000 = Debit 10,000 Cash Flow (10,000) NA Credit

10,000 8-46 Balance Sheet Presentation 8-47 End of Chapter Eight 8-48

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