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Chapter 8

Operating Assets:

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

Financial Accounting, Alternate 4e by Porter and Norton

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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

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Acquisition Cost of P,P&E

All costs necessary to acquire asset and prepare for intended use

PurchasePrice

+Taxes Installation

Costs

Transportation Charges

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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

75%

25%

% ofMarketValue

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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

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Depreciation of P,P & E

Match cost ofassets

with periodsbenefited

1 2 3

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

via

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$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

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Units-of-Production Method

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

depreciation =

per unit

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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

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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.

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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

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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

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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

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Units-of-Production Depreciation

Depreciation = Cost - Residual Valueper unit Life in Units

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

= $ 1.00

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Kemp’s depreciation in 2004:

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

Units-of-Production Depreciation

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Double-Declining-Balance Depreciation

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

= (100% / 5 years) x 2

= 40%

.40

Initiallyignore

residual value

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Double-Declining-Balance Depreciation

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

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Double-Declining-Balance Depreciation

Year 2 Depreciation = Beginning book value x rate

= $12,000 x 40%

= $4,800Beginning Ending

Year Rate Book Value Depreciation Book Value

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

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

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Double-Declining-Balance Depreciation

Beginning Ending

Year Rate Book Value Depreciation Book Value

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

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Straight-Line vs. DDB Depreciation

$0

$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

DDB

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Reasons for Choosing Straight-Line Depreciation

Simplicity Reporting to

stockholders Comparability Bonus plans

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Reasons for Choosing Accelerated Methods

Technological rate of change and competitiveness

Minimize taxable income Comparability

Income Taxes

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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

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Capital vs. Revenue Expenditures

IncomeStatement

Revenue Expenditure» Expense immediately

BalanceSheet

Capital Expenditure» Treat as asset addition to

be depreciated over a period of time

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Capital vs. Revenue Expenditures

Capitalize

Capitalize

Expense

Expense

General Guidelines:

» Increase asset life

» Increase asset productivity

» Normal maintenance

» Material expenditures

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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

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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

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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

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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

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Natural Resources

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

production

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(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

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Patents

Intangible Assets

Long-term assets with no physical properties

Goodwill

Trademarks

Copyrights

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Intangible Assets

Includes cost to acquire and prepare for intended use

+Purchase Price

Acquisition Costs

(i.e. legal fees, registration

fees, etc.)

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Research & Development

Must be expensed in period incurred

Difficult to identify future benefits

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Amortization of Intangibles

Normally recorded using straight-line method

Reported net of accumulated amortization

Amortized over legal or useful life, whichever is shorter

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Amortization of Intangibles

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:

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Amortization of Intangibles

ML Company’s annual amortization:

Patent approval costs $10,000

Divide by:

Lesser of legal or useful life 5 years

Annual amortization $ 2,000

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Amortization of Intangibles

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

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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

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Analyzing Long-term Assets

Average Life = Property, Plant & Equipment

Depreciation Expense

What is the average

depreciable period (or life) of

the company’s assets?

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Analyzing Long-term Assets

Average Age = Accumulated Depreciation Depreciation Expense

Are assets old or new?

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Analyzing Long-term Assets

Asset Turnover = Net Sales

Average Total Assets

How productive are the company’s

assets?

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End of Chapter 8