1 Chapter 8 Operating Assets: Property, Plant, and Equipment, Natural Resources, and Intangibles...

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Chapter 8

Operating Assets:

Property, Plant, and Equipment, Natural Resources,and Intangibles

Financial Accounting, Alternate 4e by Porter and Norton

Buildings and improvement $ 1,242.9Machinery and equipment 3,191.1Construction in progress 310.7

$ 4,744.7Land 223.8

$ 4,968.5Less accumulated depreciation

(2,588.7)Property, plant, and equipment (net) $ 2,379.8

Johnson Controls, Inc.Property, Plant, and Equipment

Book Value

AtCost

Acquisition Cost of P,P&E

All costs necessary to acquire asset and prepare for intended use

PurchasePrice

+Taxes Installation

Transportation Charges

Group Asset Purchases

Allocate cost of lump-sum purchase based on fair market values

Cost$100,000

$75,000

$25,000

AllocatedCost

Land = $30,000

Building = $90,000

Fair MarketValue

% ofMarketValue

Capitalization of Interest

Interest can be included as part of the cost of an asset if:» company constructs asset

over time, and» borrows money to finance

construction

Depreciation of P,P & E

Match cost ofassets

with periodsbenefited

4 5 6 7 8 9 10

11 12 13 14 15 16 17

18 19 20 21 22 23 24

25 26 28 29 30 3127

Straight-Line Units-of-Production

AcceleratedMethods

$9,0003-year life

Straight-Line Method

Allocates cost of asset evenly over its useful life

$3,000Year 1

$3,000Year 2

$3,000Year 3

Units-of-Production Method

Allocate asset cost based on number of units produced over its useful life

depreciation =

per unit

Double-Declining-Balance Method

Double the straight-line rate on a declining balance (book value)

Accelerated method - higher amount of depreciation in early years

Straight-LineRate

Depreciation Example

On January 1, Kemp Company purchases a machine for $20,000. The life of the machine is estimated at five years, after which it is expected to be sold for $2,000.

Depreciation Example

Calculate Kemp's depreciation of the machine for years 1 - 5 using the straight-line, units-of-production and double-declining-balance depreciation methods.

$20,000 cost - $2,000 residual value = $18,000 to be depreciated

Straight-Line Depreciation

Depreciation = Cost - Residual Value Life= $20,000 - $2,000

5 years= $3,600

$18,0005-year life

$3,600Year 1

$3,600Year 2

$3,600Year 3

$3,600Year 4

$3,600Year 5

Units-of-Production Depreciation

Kemp’s estimated machine production:Yr. 1 3,600 unitsYr. 2 3,600 unitsYr. 3 3,600 unitsYr. 4 3,600 unitsYr. 5 3,600 unitsTotal 18,000 units

Depreciation = Cost - Residual Valueper unit Life in Units

= $20,000 - $2,000 18,000

= $ 1.00

Kemp’s depreciation in 2004:

4,000 units x $1/unit = $ 4,000

Double-Declining-Balance Depreciation

DDB rate = (100% / useful life) x 2

= (100% / 5 years) x 2

Initiallyignore

residual value

Year 1 Depreciation = Beginning book value x rate

= $20,000 x 40%

= $8,000

Beginning Ending

Year Rate Book Value Depreciation Book Value

1 40% $20,000 $8,000 $12,000

Year 2 Depreciation = Beginning book value x rate

= $12,000 x 40%

= $4,800Beginning Ending

1 40% $20,000 $8,000 $12,000

2 40% $12,000 4,800 7,200

Beginning Ending

1 40% $20,000 $8,000 $12,000

2 40% 12,000 4,800 7,2003 40% 7,200 2,880 4,3204 40% 4,320 1,728 2,5925 40% 2,592 592 2,000

$18,000

Final year’s depreciation = amount needed to equate book

value with salvage value

= ResidualValue

Straight-Line vs. DDB Depreciation

$1,000

$2,000

$3,000

$4,000

$5,000

$6,000

$7,000

$8,000

Year 1 Year 2 Year 3 Year 4 Year 5

Straight-line

Reasons for Choosing Straight-Line Depreciation

Simplicity Reporting to

stockholders Comparability Bonus plans

Reasons for Choosing Accelerated Methods

Technological rate of change and competitiveness

Minimize taxable income Comparability

Income Taxes

Changes in Depreciation Estimates

Recompute depreciation schedule using new estimates

Record prospectively (i.e., change should affect current and future years only)

Useful life is 7 years vs. 5?

24Depreciation

Change in Estimate

$20,000 machine originally expected to be depreciated over 5 years. After 2 years, useful life is increased to 7 years.

$3,600

planned $3,600$3,600

Yr. 1 Yr. 2 Yr. 3

Example:

reviseestimate

Yr. 4 Yr. 5

25Depreciation

Change in Estimate

$12,800 remaining book value allocated prospectively over remaining life

reviseestimate

Example:

$2,160 $2,160$3,600 $3,600 $2,160 $2,160 $2,160

Yr. 1 Yr. 2 Yr. 3 Yr. 4 Yr. 5 Yr. 6 Yr. 7

Capital vs. Revenue Expenditures

IncomeStatement

Revenue Expenditure» Expense immediately

BalanceSheet

Capital Expenditure» Treat as asset addition to

be depreciated over a period of time

Capital vs. Revenue Expenditures

Capitalize

Expense

General Guidelines:

» Increase asset life

» Increase asset productivity

» Normal maintenance

» Material expenditures

Capital Expenditures

$20,000 machine originally expected to be depreciated over 5 years. After 2 years, overhaul machine at cost of $3,000. Machine life is increased by 3 years.

Example:

replaceengine

$3,600planned $3,600$3,600

Yr. 1 Yr. 2 Yr. 3 Yr. 4 Yr. 5

Capital Expenditures

$12,800 remaining book value + $3,000 capital expenditure depreciated prospectively over remaining life

replaceengine

Example:

Yr. 1 Yr. 2 Yr. 3 Yr. 4

$2,300 $2,300$3,600 $3,600 $2,300 $2,300 $2,300 $2,300

Yr. 5 Yr. 6 Yr. 7 Yr. 8

Disposal of Operating Assets

Record depreciation up to date of disposal

Compute gain or loss on disposal

Proceeds > Book Value = Gain Proceeds < Book Value = Loss

Disposal of Operating Assets

Sell truck (cost $20,000; accumulated depreciation $9,000) for $12,400

Asset cost $20,000Less: Accumulated depreciation 9,000Book value 11,000Sale price 12,400 Gain on sale of asset $ 1,400

Example:

32Natural Resources

(in thousands)

Boise Cascade CorporationPartial Balance Sheet

Property and Equipment:Land and land improvements $ 70,731Buildings and improvements 709,127Machinery and equipment 4,678,112Less: accumulated depreciation (2,915,940)

2,542,030Timber, timberlands, and

timber deposits 328,720 $2,870,750

Natural Resources

Resource consumed as it is used Expense called depletion vs. depreciation Depletion method similar to units of

production

(In millions)

Walt Disney and Co.Consolidated Balance Sheets (partial)

Operating assets:Parks, resorts and other property, at cost Attractions, buildings and equipment $ 18,917 Accumulated depreciation (8,133)

10,784 Projects in process 1,148 Land 848

12,780Intangible assets, net 2,776Goodwill 17,083

Intangible

Assets

Patents

Intangible Assets

Long-term assets with no physical properties

Goodwill

Trademarks

Copyrights

Intangible Assets

Includes cost to acquire and prepare for intended use

+Purchase Price

Acquisition Costs

(i.e. legal fees, registration

fees, etc.)

Research & Development

Must be expensed in period incurred

Difficult to identify future benefits

Amortization of Intangibles

Normally recorded using straight-line method

Reported net of accumulated amortization

Amortized over legal or useful life, whichever is shorter

ML Company developed a patent for $10,000. The patent’s legal life is 20 years, but its anticipated useful life is 5 years.

Example:

ML Company’s annual amortization:

Patent approval costs $10,000

Divide by:

Lesser of legal or useful life 5 years

Annual amortization $ 2,000

ML Company’s Balance Sheet Presentation:

Upon End ofacquisition Yr. 1 Yr. 5

Long-term Assets:

Intangible assets, net of accum.

amortization $10,000 $8,000 $ 0

Long-term Assets and the Statement of Cash Flows

Operating Activities Net income xxx Depreciation and amortization + Gain on sale of asset –

Loss on sale of asset + Investing Activities

Purchase of asset –Sale of asset +

Financing Activities

Analyzing Long-term Assets

Average Life = Property, Plant & Equipment

Depreciation Expense

What is the average

depreciable period (or life) of

the company’s assets?

Average Age = Accumulated Depreciation Depreciation Expense

Are assets old or new?

Asset Turnover = Net Sales

Average Total Assets

How productive are the company’s

assets?

End of Chapter 8

1 Chapter 8 Operating Assets: Property, Plant, and Equipment, Natural Resources, and Intangibles...

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