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Chapter 9
Long-Term
Assets
Skyline College
Lecture Notes
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92Copyright Houghton Mifflin Company. All rights reserved.
Long-Term Assets
Useful life of more than one yearUsed in the operation of a business
Not intended for resale
Long-term assets might include:
Equipment
Vehicles Property
Trademarks
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93Copyright Houghton Mifflin Company. All rights reserved.
Carrying Value
The unexpired cost of an asset(also called book value)
Unexpired Cost = Cost Accumulated Depreciation
On the Balance Sheet:
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94Copyright Houghton Mifflin Company. All rights reserved.
ClassificationofLong-Term Assets andMethods of Accounting for Them
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95Copyright Houghton Mifflin Company. All rights reserved.
Asset Impairment
When is an asset
deemed impaired?
When a long-term
asset loses some or allof its potential to
generate revenue
before the end of its
useful life
Asset Impairment
The carrying value of a
long-term asset exceeds
its fair value
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96Copyright Houghton Mifflin Company. All rights reserved.
AcquiringLong-Term Assets
How do companies make the decision toacquire long-term assets?
Capital Budgeting
Methodof Evaluation
Net Present Value Method
Evaluates the purchase based on the net presentvalue of acquisition cost, net annual savings in
cash flows, and disposal price
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97Copyright Houghton Mifflin Company. All rights reserved.
Apple Computer is considering the purchase of a $50,000 customerrelations software package. Management estimates that the company will
save $20,000 in net cash flows per year for four years, the usual life of the
software. The software should be worth $10,000 at the end of that period.
The interest rate is 10 percent compounded annually.
20x5 20x6 20x7 20x8Acquisition cost ($50,000)
Net annual savings in cash flows $20,000 $20,000 $20,000 $20,000
Disposal price 10,000
Net cash flows ($30
,000
) $20
,000
$20
,000
$30
,000
Cash flows related to the purchase of the computer would be as follows:
Net Present Value Method
Present value Tables 3 and 4 can now be used to place the
cash flows on a comparable basis.
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98Copyright Houghton Mifflin Company. All rights reserved.
Net annual savings in cashflows
Present value factor = 3.170Table 4: 4 periods, 10%3.170 x $20,000
63,400
Disposal price Present value factor = .683Table 3: 4 periods, 10%
.683 x $10,000
6,830
Net present value $20,230
20 5 20 6 20 7 20 8Acquisition cost ($50,000)
et annual savings in cash lo s $20,000 $20,000 $20,000 $20,000isposal price 10,000
et cash lo s ($30,000) $20,000 $20,000 $30,000
Acquisition cost Present value factor = 1.0001.000 x $50,000
($50,000)
As long as the net present value is
positive, Apple will earn a return of
at least 10 percent.
The return is greater than 10 percent on
the investment. Based on this analysis,
Apple should purchase the software.
Example of Net Present Value Method(contd)
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99Copyright Houghton Mifflin Company. All rights reserved.
FinancingLong-Term Assets
Financing
alternatives:
Use cash flow from
operationsIssue common stock
Issue long-term notes
Issue bonds
Investors may investigate
whether a company has
free cash flow to finance
long-term assets.
Free cash flow is cash that remains after deducting fundscommitted to operations at current levels
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910Copyright Houghton Mifflin Company. All rights reserved.
The Matching Rule andLong-Term Assets
When a company purchases an asset, it may choose tocapitalize it, thus deferring an expense to a later period
Favorably impacts profitability for that current period
Management uses ethical judgments in resolving two issues:
1. How much of the cost of a long-term asset shouldbe allocated to expense in the current period?
2. How much should be retained on the balance sheet
as an asset that will benefit future periods?
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911Copyright Houghton Mifflin Company. All rights reserved.
Long-Term AssetAccounting Policies
Each company must determine how it will
treat long-term assets:
1. What is the cost of the long-term asset?
2. How should the expired portion of the cost of theasset be allocated against revenues over time?
3. How should subsequent expenditures, such as
repairs and additions, be treated?4. How should disposal of the long-term asset be
recorded?
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912Copyright Houghton Mifflin Company. All rights reserved.
Discussion: Ethics on the Job
Brattman Company purchases a building and theland on which it is located for a lump sum. Theaccountant must allocate the purchase price betweenthe building and the land. The accountant decides to
allocate a larger portion of the price to the landsince this will improve net income. (If he allocatedmore of the price to the building, depreciationexpense would be higher, thus decreasing netincome.)
Q. Is this decision ethical? What must the accountant
base his decision on?
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913Copyright Houghton Mifflin Company. All rights reserved.
What Are Expenditures?
Payments or obligations to make a futurepayment for an asset or for a service
CapitalExpenditure
RevenueExpenditure
Expenditure for the
purchase or
expansion of a long-
term asset
Expenditure for the
repair, maintenance,
and operation of a
long-term asset
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914Copyright Houghton Mifflin Company. All rights reserved.
Capital Expenditures
Outlays for plant assets, natural resources, and
intangible assets
Additions, which are enlargements to the
physical layout of a plant assetBetterments, which are improvements to a plant
asset but that do not add to the plants physical
layout
Extraordinary repairs, which are repairs thatsignificantly enhance a plant assets estimated
useful life or residual value
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915Copyright Houghton Mifflin Company. All rights reserved.
Acquisition Costs
Includes all expenditures reasonable and necessary toget an asset in place and ready for use
Installation costs
FreightInsurance while in transit
Testing and setup
Are these items considered
acquisition costs?Repair costs
Interest charges on purchase
No
No
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916Copyright Houghton Mifflin Company. All rights reserved.
AcquiringLand
Costs that should be debited tothe Land account include:
Purchase price
Agent commissions
Legal feesAccrued taxes paid by
purchaser
Grading
Land preparation feesAssessments for local
improvements
Landscaping
Sample
Acquisition of Land
Net purchase price $170,000
Brokerage fees 6,000
Legal fees 2,000Tearing down old building $10,000
Less salvage 4,000 6,000
Grading 1,000
Total cost $185,000
Improvements to real estate like fences,driveways, or parking lots have a limited
life. They should be recorded in an account
called Land Improvements, not the Land
account.
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918Copyright Houghton Mifflin Company. All rights reserved.
Leasehold Improvements
Improvements to leased property that become theproperty of the lessor at the end of the lease
Classified as tangible assets in property, plant,
and equipment section of the balance sheet
Costs of leasehold improvements aredepreciated or amortized over the remainingterm of the lease or the useful life of the
improvement, whichever is shorter.
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919Copyright Houghton Mifflin Company. All rights reserved.
Acquiring Equipment
Acquisition costs include:
Purchase price (less cash discounts)
All expenditures connected with purchasing the
equipment and preparing it for use Freight
Insurance in transit
Excise taxes and tariffs
Buying expenses Installation costs
Cost of test runs
Equipment is subject
to depreciation
because it has alimited useful life
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920Copyright Houghton Mifflin Company. All rights reserved.
Group Purchases
Land and other assets may sometimes be purchasedfor a lump sum
Because buildings are
depreciable and land is not,the purchase price must be
allocated to each asset
Appraisal Percentage Apportionment
L , ( , , ) 8, ( 8 , )B il i 9 , 9 ( 9 , , ) , ( 8 , 9 )T t ls , 8 ,
ABC Co. buys a building and
the land on which it is situated
for a lump sum of $85,000.
Assume that appraisals yield
estimates of $10,000 for the
land and $90,000 for the
building if purchased separately.
Allocate as follows:
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921Copyright Houghton Mifflin Company. All rights reserved.
What Is Depreciation?
The periodic allocation of the cost of a tangibleasset (other than land and natural resources)over the assets estimated useful life
All tangible assets except land have a limited useful life(physical deterioration and obsolescence limit useful life)
Depreciation refers to the allocation of the cost of a plant
asset to the periods that benefit from the asset, not to the
assets physical deterioration or decrease in market value
Depreciation is not a process of valuation; it is a process
of allocation
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922Copyright Houghton Mifflin Company. All rights reserved.
Four Factors That Affect theComputationofDepreciation
1. Cost Net purchase price of an asset plus allreasonable and necessary expenditures
to get it in place and ready for use
2
. Residualvalue
Estimated scrap, salvage, or trade-in
value on the estimated date of itsdisposal
3. Depreciable
cost
Cost less residual value
4. Estimateduseful life
Total number of service units expectedfrom a long-term asset
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923Copyright Houghton Mifflin Company. All rights reserved.
Depreciation Expense, Asset Name xxxAccumulated Depreciation, Asset Name xxx
To record depreciation for the period
Accounting for Depreciation
Depreciation is recorded at the end of theaccounting period by an adjusting entry
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924Copyright Houghton Mifflin Company. All rights reserved.
Methods of Accounting forDepreciation
Accelerated method of depreciation
that results in larger amounts ofdepreciation in earlier years of the
assets life and smaller amounts in
later years
Spreads the depreciable cost evenly
over the estimated useful life of the
asset
Based on the assumption that
depreciation is solely the result of use
and that passage of time plays no role
in the depreciation process
Declining-balance
method
Straight-line
method
Production method
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925Copyright Houghton Mifflin Company. All rights reserved.
ifeUsefulstimated
alueesidualCostonepreciatiYearly !
yearper$1,800
years5
$1,000$10,000 !!
A delivery truck costs $10,000 and has an estimated
residual value of $1,000 at the end of its estimated
useful life of5 years.
Straight-Line Method Illustrated
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926Copyright Houghton Mifflin Company. All rights reserved.
Cost
YearlyDepreciation
AccumulatedDepreciation
CarryingValue
Date of purchase $10,000 $10,000End of first year 10,000 $1,800 $1,800 8,200End of second year 10,000 1,800 3,600 6,400End of third year 10,000 1,800 5,400 4,600End of fourth year 10,000 1,800 7,200 2,800End of fifth year 10,000 1,800 9,000 1,000
Theamountof
depreciationisthesameeachyear
Accumulated
depreciationincreasesuniformly
Thecarryingvalue
decreasesuniformlyuntilitreachestheestimated
residualvalue
DepreciationSchedule,Straight-Line Method
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927Copyright Houghton Mifflin Company. All rights reserved.
A delivery truck costs $10,000 and has an estimated residual value of
$1,000 at the end of its estimated useful life of five years. Assume the
truck was driven 20,000 miles during year 1; 30,000 miles during year2;
10,000 miles during year3; 20,000 miles during year4; and 10,000 miles
during year5.
ifeUsefulofUnitsstimated
alueesidualCostCostonepreciati !
mileper$0.10miles90,000$1,
000$1
0,000
!!
The unit of output
or use should be
appropriate for
that asset
Production Method
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928Copyright Houghton Mifflin Company. All rights reserved.
Cost Miles
YearlyDepreciation
AccumulatedDepreciation
CarryingValue
Date of purc ase $10,000 $10,000End of first year 10,000 20,000 $2,000 $2,000 8,000End ofsecond year 10,000 30,000 3,000 5,000 5,000End of third year 10,000 10,000 1,000 6,000 4,000
End of fourth year 10,000 20,000 2,000 8,000 2,000End of fifth year 10,000 10,000 1,000 9,000 1,000
Thereisadirectrelation
betweentheamountof
depreciationeachyear
andtheunitsofoutput
oruse.
Accumulated
depreciationincreases
eachyearindirect
relationtounitsof
outputoruse.
Thecarryingvalue
decreaseseachyearin
directrelationtounitsof
outputoruseuntilthe
estimatedresidualvalueis
reached.
DepreciationSchedule,Production Method
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929Copyright Houghton Mifflin Company. All rights reserved.
Declining-Balance Method
Based on the passage of time
Assumes that many kinds of plant assetsare most efficient when new
Is consistent with the matching rule
Any fixed rate can be used
Most common rate is twice the straight-line depreciation percentage (calleddouble-declining-balance method)
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930Copyright Houghton Mifflin Company. All rights reserved.
Double-Declining-BalanceMethod Illustrated
A delivery truck costs $10,000 and has an estimated residual
value of $1,000. Its estimated useful life is 5 years.
Under the straight-line method, the depreciation rate for each
year is 20 percent:
percent20years5percent100 !z
Under the double-declining-balance method, the depreciation
rate for each year is 40 percent:
percent40percent202 !v
This fixed rate is applied to the remaining carrying value
at the end of each year.
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932Copyright Houghton Mifflin Company. All rights reserved.
Graphic ComparisonofThree MethodsofDeterminingDepreciation
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933Copyright Houghton Mifflin Company. All rights reserved.
RevisingDepreciation Rates
Sometimes a company must revise its estimateof an assets useful life or its residual value
The periodic depreciation expense will increase or
decrease depending on the adjustment
The remaining depreciable cost of the asset should
be spread over the remaining years of useful life
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934Copyright Houghton Mifflin Company. All rights reserved.
Methods ofDisposal
Discard
Sell for cash
Exchange for another asset
When plant
assets are no
longerusefu
1. Record depreciation for the partial year up to the date
of disposal
2. Remove the carrying value of the asset
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935Copyright Houghton Mifflin Company. All rights reserved.
MGC Company purchased a machine on January 2, 20x2, for $6,500 and
planned to depreciate it on a straight-line basis over its estimated useful life
(8 years). Its residual value at the end of8 years was estimated to be $500.
On December31, 20x7, the balances of the relevant accounts were:
Machi ry ccumulat r ciati , Machi ry
6,500 4,650
On January 2, 20x8, management disposed of the asset.
Disposal of a Depreciable Asset
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936Copyright Houghton Mifflin Company. All rights reserved.
Disposal of a Plant Asset
Remove the carrying value of the asset Carrying value is computed by subtracting accumulated
depreciation from the acquisition cost of the asset If the asset is fully depreciated, the carrying value is zero If the asset is not fully depreciated, a loss is recorded
Jan. 2 Accumulated epreciation, Machiner 4,650
oss on isposal of Machiner 1, 50Machiner 6,500
iscarded machine no longerused in business
Accum. r ciati , Machi ry
4,650
Machi ry
6,500 4,6506,500
al. -0- al. -0-
Gains and losses on disposal of plant assets are classified as other
revenues and expenses on the income statement.
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937Copyright Houghton Mifflin Company. All rights reserved.
Selling a Plant Asset for Cash
In addition to removing the carrying value of the
asset, you will also record the cash received
If cash received = carrying value, no gain or loss is
recorded
If cash received < carrying value, loss
is recorded
If cash received > carrying value, gain
is recorded
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938Copyright Houghton Mifflin Company. All rights reserved.
Selling an Asset for CashCash Received = Carrying Value
Received $1,850 cash for sale of machinery.
Remove the carrying value of the asset and record receipt of cash:
Jan. Cas ,8Acc lat D r ciati n, ac inery ,
ac inery ,Sale f ac inery f r carryingal e;nogainor loss
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939Copyright Houghton Mifflin Company. All rights reserved.
Selling an Asset for CashCash Received < Carrying Value
Received $1,000 cash for sale of machinery.
Jan. Cas ,Acc lated Depreciation, ac inery ,Loss on Saleof ac inery 8
ac inery ,Saleof ac inery at less t an carryingal e; loss of 8 recorded
( ,8 , )
Remove the carrying value of the asset and record receipt of cash:
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940Copyright Houghton Mifflin Company. All rights reserved.
Selling an Asset for CashCash Received > Carrying Value
Received $2,000 cash for sale of machinery.
Jan. 2 ash 2,000Accumulated epreciation, Machiner 4,650
Gain on ale of Machiner 150Machiner 6,500
ale of machiner at more than carr ingvalue; gain of $150 recorded($2,000 $1, 50)
Remove the carrying value of the asset and record receipt of cash:
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941Copyright Houghton Mifflin Company. All rights reserved.
Exchanges of Plant Assets
May involvesimilar assets
May involvedissimilar assets
Old
machine
traded in
for newer
model
Cement
mixertraded in
for truck
Purchase price is reduced by the amount of the trade-in allowance
If trade allowance is greater than assets carrying value, gain realized.
If trade allowance is less than assets carrying value, loss realized.
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942Copyright Houghton Mifflin Company. All rights reserved.
What Are Natural Resources?
Assets that are converted to inventory bycutting, pumping, mining, or other extractionmethods
Timberlands
Oil and Gas Reserves
Mineral Deposits
Record at acquisition
cost and show on the
balance sheet as
long-term assets
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943Copyright Houghton Mifflin Company. All rights reserved.
AvailableUnitsofumberstimated
alueesidual-esourceaturalofCostper UnitCostepletion !
Depletionof Natural Resources
(1) The exhaustion of a natural resource and(2) The proportional allocation of the cost of a
natural resource to the units extracted
Costs are allocated
much like the
production method
of depreciation
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944Copyright Houghton Mifflin Company. All rights reserved.
RecordingDepletion Expense
A mine that cost $1,800,000 has an estimated 1,500,000 tons of coal.The estimated residual value of the mine is $300,000. During the first
year, 115,000 tons of coal are mined and sold.
AvailableUnitsofumberstimated
alueesidual-esourceaturalofCostper UnitCostDepletion !
per ton$1tons1,500,000
$300,000-$1,800,000 !!
Dec. 31 Depletion Expense, Coal Deposits 115,000Accumulated Depletion, Coal Deposits 115,000
To record depletion of coal mine: $1per ton, 115,000 tons mined and sold
Natural resources that have been extracted but not sold are considered inventory
and are not recorded as an expense until the year sold.
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945Copyright Houghton Mifflin Company. All rights reserved.
Development and Exploration Costsin the Oil andGas Industry
Use one of these two accounting methods:
Successful
efforts method
Cost recorded as an asset and depleted over the
estimated life of the resource. For an unsuccessful
effort, write off immediately as a loss.
Full-costing
method
All costs, including costs of dry wells, are
recorded as assets and depleted over the estimated
life of the producing resources. Improves earnings
performance in the early years.
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946Copyright Houghton Mifflin Company. All rights reserved.
What Is an Intangible Asset?
GoodwillTrademarks
Brand names
Copyrights
Patents
Leaseholds
Software
Customer Lists
Long-term, nonphysicalasset whose value comes
from the rights or
advantages afforded its
owner
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947Copyright Houghton Mifflin Company. All rights reserved.
Importance of Intangibles
For some companies, intangible assets make up asubstantial portion of total assets
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948Copyright Houghton Mifflin Company. All rights reserved.
Accounting for Intangible Assets
Intangibles developed
by a firm for its own
benefit
Intangibles acquired
from others
Record as expense Record as asset; amortizeover the shorter of useful
life or legal life (not to
exceed 40 years)
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949Copyright Houghton Mifflin Company. All rights reserved.
Difficult Issues WhenAccounting for Intangibles
How to account for the initial carrying value?
How to account for that amount under normal
business conditions (periodic write-off or
amortization)?
How to account for the amount if the value
declines substantially and permanently?
How to estimate an intangible assets value
and useful life?
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950Copyright Houghton Mifflin Company. All rights reserved.
Intangible Assets Illustrated
Soda Bottling Company purchases a patent on a unique bottle cap for$18,000. The patent will last for20 years, but the product using the cap
will be sold only for the next six years.
Patents 8,000ash 8,000
ecord rchaseof ottlecappatent
Recordthepurchaseofthepatent:
Amortization xpense 3,000Patents
3,000orecordamortizationexpensefor
patent ($ 8,000 6 years)
Recordtheannualamortizationexpense:
NoticethatthePatentsaccount isdirectly reduced y theamountofamortizationexpense, whereasdepreciationordepletion isaccumulated inseparatecontraaccountsforotherlong-term assets.
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951Copyright Houghton Mifflin Company. All rights reserved.
Intangible Assets Illustrated(contd)
The patent becomes worthless after only 1 year. Record the write-off:
If the patent becomes worthless before it is fully amortized, theremaining carrying value is written off as a loss by removing it from
the Patents account.
Loss on Patent 15,000
Patents 15,000
To record the write -off of aworthless patent($18,000$3,000)
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952Copyright Houghton Mifflin Company. All rights reserved.
Research andDevelopment Costs
The FASB requires that all R&D costs be treated as
revenue expenditures and charged to expense in the
period in which they are incurred.
Why? Too difficult to trace specific costs to specific profitable
developments
Costs of R&D are continuous and necessary for thesuccess of a business and are treated as current expenses
Studies show that 30 to 90 percent of all new products fail
and 75 percent of new-product expenses are unsuccessful
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953Copyright Houghton Mifflin Company. All rights reserved.
Computer Software Costs
Costs incurred in developingcomputer software for sale or
lease or for a firms internal use
are research and development
costs until the product hasproved technologically feasible
Costs incurred beforetechnologically feasible
should be charged to expense
as incurred
Once a working program is
ready, all costs are recordedas assets
Amortize over theestimated economic life
using the straight-line
method
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954Copyright Houghton Mifflin Company All rights reserved
Goodwill
A companys good reputationCustomer satisfaction
Good management
Manufacturing efficiency
Good location
Goodwill exists when a purchaser pays more for a business
than the fair market value of the businesss net assets
Goodwill should not be recorded unless it is paid for in connection with
the purchase of a whole business
Goodwill = Purchase price FMV of identifiable net assets