9-1. 9-2 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin...

9-1

9-2

Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

Chapter 9

Reporting and InterpretingLong-Lived Tangible and

Intangible Assets

9-3

Tangible

PhysicalSubstance

Intangible

No PhysicalSubstance

Will not be used up within the next year

Actively Used in Operations

Defining and ClassifyingLong-Lived Assets

9-4

Tangible

PhysicalSubstance



Land Assets subject to depreciation

Buildings and equipmentFurniture and fixtures

Examples


9-5


Tangible

PhysicalSubstance

Intangible

No PhysicalSubstance



Value represented by rights that produce benefits. Intangibles with a limited life, such as patents and copyrights, are subject to amortization. Intangibles with an unlimited (or indefinite) life, such as goodwill and trademarks, are not amortized.

9-6

Acquisition of Tangible Assets

Acquisition cost includes the purchase price and all expenditures needed to prepare the asset for

its intended use.

Acquisition cost does not includefinancing charges.

Recording costs as assets is calledcapitalizing the costs.

Acquisition cost includes the purchase price and all expenditures needed to prepare the asset for

its intended use.

Acquisition cost does not includefinancing charges.

Recording costs as assets is calledcapitalizing the costs.

9-7

Purchase price

Construction costs

Legal fees

Appraisal fees

Architectural fees

Purchase price

Construction costs

Legal fees

Appraisal fees

Architectural fees

Acquisition CostBuildings

9-8

Purchase price Sales taxes Transportation costs Installation costs

Purchase price Sales taxes Transportation costs Installation costs

Acquisition CostEquipment

9-9

Purchase price Legal fees Surveying fees Broker’s Commissions

Purchase price Legal fees Surveying fees Broker’s Commissions

Land is not depreciable.Land is not depreciable.

Acquisition CostLand

9-10

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?

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.

The total cost of a combined purchase of land and building is allocated in proportion to their relative market values.

Acquisition CostBasket Purchase

9-11

Appraised % of Purchase ApportionedAsset 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%

Acquisition CostBasket Purchase

9-12

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.

AcquisitionCash Purchase

Debit CreditAccounts

9-13

AcquisitionCash 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.

Debit CreditRides and equipment (+A) 25,750,000

Cash (-A) 25,750,000

Accounts

$26,000,000 - $1,000,000 + $125,000 + $625,000

9-14

AcquisitionCredit Purchase

Cedar Fair purchased on credit a new ride for $26,000,000 less a $1,000,000 discount. Cedar Fair paid $125,000 cash for transportation and $625,000

cash for installation of the ride.Prepare the journal entry for the acquisition assuming

Cedar Fair issued a note payable for the new ride.


9-15

Debit CreditRides and equipment (+A) 25,750,000

Cash (-A) 750,000 Note payable (+L) 25,000,000

Accounts

$26,000,000 - $1,000,000 + $125,000 + $625,000

AcquisitionCredit Purchase

Cedar Fair purchased on credit a new ride for $26,000,000 less a $1,000,000 discount. Cedar Fair paid $125,000 cash for transportation and $625,000

cash for installation of the ride.Prepare the journal entry for the acquisition assuming

Cedar Fair issued a note payable for the new ride.

9-16

Self- Constructed Tangible Assets

Asset cost includes:Asset cost includes:

All materials andlabor traceable tothe construction.

A reasonableamount ofoverhead.

Interest on debtincurred during

the construction.

9-17

Maintenance Costs IncurredDuring Time of Use

Type of AccountingExpenditure Identifying Characteristics Treatment

Ordinary 1. Maintains normal operating condition Expenserepairs and 2. Does not increase productivity

maintenance 3. Does not extend life beyond original estimate

Extraordinary 1. Major overhauls or partial Capitalizerepairs replacements

2. Extends life beyond original estimate

Additions 1. Increases productivity Capitalize2. May extend useful life3. Improvements or expansions

9-18

Depreciation is a cost allocation process that systematically and rationally matches

acquisition costs of operational assets with periods benefited by their use.

Depreciation is a cost allocation process that systematically and rationally matches

acquisition costs of operational assets with periods benefited by their use.

Cost

Allocation

(Unused)

Balance Sheet

(Used)

Income Statement

Expense

Depreciation

AcquisitionCost

9-19

Depreciation

DepreciationExpense

Income

Statement

Balance

SheetAccumulatedDepreciation

Depreciation for

the current year

Total of depreciation

to date on an asset

9-20

Book Values

Buildings and Equipment Buildings 19,843$ Less: Accumulated depreciation 7,487 12,356$

Equipment 7,698 Less: Accumulated depreciation 3,256$ 4,442

Total 16,798

Book value = Market valueBook value = Market value/

Depreciation on a Balance Sheet

9-21

Depreciation calculations require three amounts for each asset:

Acquisition cost.

Estimated useful life.

Estimated residual value.

Depreciation calculations require three amounts for each asset:

Acquisition cost.

Estimated useful life.

Estimated residual value.

Depreciation Calculations

9-22

Alternative Depreciation Methods

Straight-line

Units-of-production

Accelerated Method: Declining balance

Straight-line

Units-of-production

Accelerated Method: Declining balance

9-23

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.

Cost - Residual Value

Life in Years

Depreciation

Expense per Year=

Straight-Line Method

SL

9-24

Depreciation

Expense per Year=

Depreciation

Expense per Year= $20,000

$62,500 - $2,500

3 years


Cost - Residual Value

Life in Years

Depreciation

Expense per Year=

SL

9-25

Depreciation Accumulated Accumulated UndepreciatedExpense Depreciation Depreciation Balance

Year (debit) (credit) Balance (book value)62,500$

1 20,000$ 20,000$ 20,000$ 42,500 2 20,000 20,000 40,000 22,500 3 20,000 20,000 60,000 2,500

60,000$ 60,000$

Residual Value


About 84 percent of companies use thestraight-line method for some or all of their

assets disclosed in financial reports.SL

9-26

Units-of-Production Method

Depreciation Rate

= Cost - Residual Value Life in Units of Production

Step 1:

Step 2:

Depreciation Expense =

Depreciation Rate

×Number of

Units Producedfor the Year

9-27


At the beginning of the year, Cedar Fair purchased a new Go-Cart ride for $62,500

cash. The ride has a 100,000 mile useful life and an estimated residual value of $2,500.

If the ride is used 30,000 miles in the first year, what is the amount of depreciation expense?

At the beginning of the year, Cedar Fair purchased a new Go-Cart ride for $62,500

cash. The ride has a 100,000 mile useful life and an estimated residual value of $2,500.

If the ride is used 30,000 miles in the first year, what is the amount of depreciation expense?

9-28


$62,500 - $2,500 100,000 miles

= $.60 per mileDepreciation Rate

=

Step 1:

Step 2:

$.60 per mile × 30,000 miles = $18,000

Depreciation Expense =

9-29


Accumulated UndepreciatedDepreciation Depreciation Balance

Year Miles Expense Balance (book value)62,500$

1 30,000 18,000$ 18,000$ 44,500 2 50,000 3 20,000

100,000

9-30

Accumulated UndepreciatedDepreciation Depreciation Balance

Year Miles Expense Balance (book value)62,500$

1 30,000 18,000$ 18,000$ 44,500 2 50,000 30,000 48,000 14,500 3 20,000 12,000 60,000 2,500

100,000 60,000$

Residual Value


9-31

Declining-Balance Method

Depreciation RepairExpense Expense

Early Years High Low

Later Years Low High

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.

9-32

Double-Declining-Balance Method

AnnualDepreciation

Expense

NetBookValue

( )Useful Life in Years 2

= ×

Cost – Accumulated Depreciation

Declining balance rate of 2 isdouble-declining-balance (DDB) rate.

Annual computation ignores residual value.Annual computation ignores residual value.

9-33

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.


9-34

AnnualDepreciation

expense

NetBookValue

( )Useful Life in Years 2

= ×

( ) $62,500 × 3 years 2

= $41,667

( ) ($62,500 – $41,667) × 3 years 2

= $13,889


Year 1 Depreciation:

Year 2 Depreciation:

9-35

Depreciation Accumulated UndepreciatedExpense Depreciation Balance

Year (debit) Balance (book value)62,500$

1 41,667$ 41,667$ 20,833 2 13,889 55,556 6,944 3 4,629 60,185 2,315

60,185$

( ) ($62,500 – $55,556) × 3 years 2

= $4,629

Below residual value


9-36

Depreciation expense is limited to the amount thatreduces book value to the estimated residual value.

Depreciation Accumulated UndepreciatedExpense 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$


9-37

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.

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.

Tax Depreciation

9-38

Asset Impairment Losses

Impairment is the loss of a significant portionof the utility of an asset through . . .

Casualty. Obsolescence. Lack of demand for the asset’s services.

A loss should be recognized when anasset suffers a permanent impairment.

9-39

Update depreciation to the date of disposal.

Writing off accumulateddepreciation (debit).

Writing off the asset cost (credit).

Record the disposal by:

Recording cashreceived (debit)or paid (credit).

Recording again (credit)

or loss (debit).

Disposal of Tangible Assets

9-40

If Cash > BV, record a gain (credit).

If Cash < BV, record a loss (debit).

If Cash = BV, no gain or loss.


9-41

Cedar Fair sold a hotel for $5,000,000 cash in the middle of its 17th year of use. The

hotel originally cost $20,000,000, and was depreciated using the straight-line

method with zero salvage valueand a useful life of 20 years.

Cedar Fair sold a hotel for $5,000,000 cash in the middle of its 17th year of use. The

hotel originally cost $20,000,000, and was depreciated using the straight-line

method with zero salvage valueand a useful life of 20 years.


9-42

The amount of depreciation recorded for the first half of the 17th

year to bring depreciation up to date is:

a. $0.

b. $500,000.

c. $1,000,000.

d. $2,000,000.



a. $0.

b. $500,000.

c. $1,000,000.

d. $2,000,000.


9-43



a. $0.

b. $500,000.

c. $1,000,000.

d. $2,000,000.



a. $0.

b. $500,000.

c. $1,000,000.

d. $2,000,000.

Annual Depreciation:

($20,000,000 - $0) ÷ 20 Years

= $1,000,000 per year

$1,000,000 × ½ year = $500,000


9-44

After updating the depreciation,the equipment’s book value at date

of sale is:

a. $3,500,000.

b. $3,000,000.

c. $17,000,000.

d. $16,500,000.


of sale is:

a. $3,500,000.

b. $3,000,000.

c. $17,000,000.

d. $16,500,000.


9-45


of sale is:

a. $3,500,000.

b. $3,000,000.

c. $17,000,000.

d. $16,500,000.


of sale is:

a. $3,500,000.

b. $3,000,000.

c. $17,000,000.

d. $16,500,000.

Accumulated Depreciation =

(16½ yrs. × $1,000,000) = $16,500,000

BV = Cost - Accumulated Depreciation

BV = $20,000,000 - $16,500,000 = $3,500,000


9-46


The equipment’s sale resulted in:

a. a gain of $1,500,000.

b. a gain of $3,000,000.

c. a gain of $3,500,000.

d. a loss of $5,000,000.


a. a gain of $1,500,000.

b. a gain of $3,000,000.

c. a gain of $3,500,000.

d. a loss of $5,000,000.

9-47


a. a gain of $1,500,000.

b. a gain of $3,000,000.

c. a gain of $3,500,000.

d. a loss of $5,000,000.


a. a gain of $1,500,000.

b. a gain of $3,000,000.

c. a gain of $3,500,000.

d. a loss of $5,000,000.

Gain = Cash Received - Book ValueGain = $5,000,000 - $3,500,000 = $1,500,000


9-48

Prepare the journal entry to record Cedar Fair’s sale of the hotel in the 17th year.



9-49


Debit CreditCash (+A) 5,000,000 Accumulated depreciation (-xA, +A) 16,500,000

Buildings (-A) 20,000,000 Gain on sale of building (+R, +SE) 1,500,000

Accounts

Prepare the journal entry to record Cedar Fair’s sale of the hotel in the 17th year.

9-50

Intangible Assets

Noncurrent assetswithout physical

substance.

Noncurrent assetswithout physical

substance.

Useful life isoften difficultto determine.

Useful life isoften difficultto determine.

Usually acquired for operational

use.

Usually acquired for operational

use.

Often provideexclusive rights

or privileges.

Often provideexclusive rights

or privileges.

IntangibleAssets

9-51

Trademarks Copyrights Patents Licensing Rights Technology Franchises Goodwill

Record at current cash equivalent cost, including purchase price, legal fees, and

filing fees.

Intangible Assets

9-52

Amortize intangible assets with limited lives over the shorter of their economic lives or legal lives, subject to rules specified by GAAP.

Use straight-line method.

Research and development costs are normally expensed as incurred.

Amortize intangible assets with limited lives over the shorter of their economic lives or legal lives, subject to rules specified by GAAP.

Use straight-line method.

Research and development costs are normally expensed as incurred.

Intangible Assets

9-53

A symbol, design, or logo associated with a business.

A symbol, design, or logo associated with a business.

Purchasedtrademarks

are recordedat cost.

Internallydevelopedtrademarks

have norecorded

asset cost.

Intangible AssetsTrademarks

9-54

Intangible AssetsCopyrights

Exclusive right granted by the federal government to protect

artistic or intellectual properties.

Exclusive right granted by the federal government to protect

artistic or intellectual properties.

Amortize costover the period

benefited.

Amortize costover the period

benefited.

Legal life islife of creatorplus 70 years.

Legal life islife of creatorplus 70 years.

9-55

Intangible AssetsPatents

Exclusive right grantedby federal government to sell or

manufacture an invention.

Exclusive right grantedby federal government to sell or

manufacture an invention.

Cost is purchaseprice plus legalcost to defend.

Cost is purchaseprice plus legalcost to defend.

Amortize costover the shorter of

useful life or 20 years.

Amortize costover the shorter of

useful life or 20 years.

9-56

Intangible AssetsLicensing Rights

Limited permissions to use a product or service according to specific terms and conditions.

You may be using computersoftware that is made

available to you through acampus licensing agreement.

9-57

Intangible AssetsTechnology

A category of intangible assets that includes a company’s website and any computer programs written by its employees.

A category of intangible assets that includes a company’s website and any computer programs written by its employees.

9-58

Legally protected right to sell products or provide services purchased by franchisee from

franchisor.

Legally protected right to sell products or provide services purchased by franchisee from

franchisor.

Purchase price is an intangibleasset that is amortized.

Purchase price is an intangibleasset that is amortized.

Intangible AssetsFranchises

9-59

Occurs when onecompany buys

another company.

The amount by which thepurchase price exceeds the fair

market value of net assets acquired.

Only purchased goodwill is an

intangible asset.

Intangible AssetsGoodwill

Goodwill

9-60

Not amortized.Not amortized.Subject to assessment

for impairmentvalue and may be

written down.

Subject to assessment for impairment

value and may bewritten down.

Goodwill

Intangible AssetsGoodwill

9-61

Intangible Assets Goodwill

Eddy Company paid $1,000,000 to purchaseall of James Company’s assets and assumed liabilities of $200,000. The acquired assets were appraised at a fair value of $900,000.

9-62

What amount of goodwill should be recorded on Eddy Company books?

a. $100,000

b. $200,000

c. $300,000

d. $400,000


a. $100,000

b. $200,000

c. $300,000

d. $400,000


9-63


a. $100,000

b. $200,000

c. $300,000

d. $400,000


a. $100,000

b. $200,000

c. $300,000

d. $400,000

FMV of Assets 900,000$ Debt Assumed 200,000

FMV of Net Assets 700,000$ Purchase Price 1,000,000

Goodwill 300,000$


9-64

Summary of Accounting Rulesfor Long-Lived Assets

Stage Subject Tangible Assets Intangible AssetsAcquisition Purchased Asset Capitalize all related costs Capitalize all related costs

Self-constructed Asset Capitalize all related costs Expense all related costs(unless software products)

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-productiondeclining-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

Stage Subject Tangible Assets Intangible AssetsAcquisition Purchased Asset Capitalize all related costs Capitalize all related costs

Self-constructed Asset Capitalize all related costs Expense all related costs(unless software products)

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-productiondeclining-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

9-65

Optimal Level of Investment

How much is enough?

Insufficient capacity results

in lost sales.

Costly excesscapacity reduces

profits.

9-66

Evaluating the Use of Long-Lived Tangible Assets

FixedAsset

Turnover

Net Sales Revenue

Average Net Fixed Assets=

This ratio measures the sales dollars generated by each dollar

invested in fixed assets.

This ratio measures the sales dollars generated by each dollar

invested in fixed assets.

For the year 2003, Cedar Fair had $509,976 ofrevenue. End-of-year fixed assets were $777,039and beginning-of-year fixed assets were $781,502.

(All numbers in millions.)

For the year 2003, Cedar Fair had $509,976 ofrevenue. End-of-year fixed assets were $777,039and beginning-of-year fixed assets were $781,502.

(All numbers in millions.)

9-67

Fixed Asset Turnover

FixedAsset

Turnover

$509,976

($777,039 + $781,502) ÷ 2= = 0.65

FixedAsset

Turnover

Net Sales Revenue

Average Net Fixed Assets=

Yahoo! Six Flags Cedar Fair3.96 0.45 0.65

2003 Fixed Asset Turnover Comparisons

9-68

The 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.

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.

9-69

End of Chapter 9

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