Accounting for Long-Term Operational

Assets

Chapter Eight

Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

8-2

Tangible Long-Term Assets

1.1. Property, Plant, and EquipmentProperty, Plant, and Equipment – Sometimes called plant assets or fixed assets. We depreciate these assets over their useful life.

2.2. Natural ResourcesNatural Resources – Mineral deposits, oil and gas reserves, timber stands, coal mines, and stone quarries are some examples of natural resources. We deplete these assets over their useful life.

3.3. LandLand – Has an infinite life and is not subject to depreciation.

8-3

Cost of Long-Term Assets

Buildings Buildings •Purchase pricePurchase price•Sales taxesSales taxes•Title search and transfer document Title search and transfer document costscosts•Realtor’s and attorney’s feesRealtor’s and attorney’s fees•Remodeling costsRemodeling costs

Buildings Buildings •Purchase pricePurchase price•Sales taxesSales taxes•Title search and transfer document Title search and transfer document costscosts•Realtor’s and attorney’s feesRealtor’s and attorney’s fees•Remodeling costsRemodeling costsEquipment Equipment •Purchase price (less Purchase price (less discounts)discounts)•Sales taxesSales taxes•Delivery costsDelivery costs•Installation costsInstallation costs•Costs to adapt to intended Costs to adapt to intended useuse

Equipment Equipment •Purchase price (less Purchase price (less discounts)discounts)•Sales taxesSales taxes•Delivery costsDelivery costs•Installation costsInstallation costs•Costs to adapt to intended Costs to adapt to intended useuse

Land Land •Purchase pricePurchase price•Sales taxesSales taxes•Title search and transfer Title search and transfer document costsdocument costs•Realtor’s and attorney’s Realtor’s and attorney’s feesfees•Costs of removal of old Costs of removal of old buildingsbuildings•Grading costsGrading costs

Land Land •Purchase pricePurchase price•Sales taxesSales taxes•Title search and transfer Title search and transfer document costsdocument costs•Realtor’s and attorney’s Realtor’s and attorney’s feesfees•Costs of removal of old Costs of removal of old buildingsbuildings•Grading costsGrading costs

8-4

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%

Fair market value of land 90,000 25%

Total fair market value 360,000$ 100%

Cost % AllocationAssign to building 240,000$ 75% 180,000$ Assign to land 240,000 25% 60,000

100% 240,000$

8-5

Depreciation Methods

1.1. Straight-line methodStraight-line method - the same amount - the same amount is depreciated each accounting period.is depreciated each accounting period.

2.2. Double-declining-balance Double-declining-balance – produces – produces more depreciation expense in the early more depreciation expense in the early years of an asset’s life, with a declining years of an asset’s life, with a declining amount of expense in later years.amount of expense in later years.

3.3. Units-of-ProductionUnits-of-Production – produces varying – produces varying amounts of depreciation in different amounts of depreciation in different accounting periods depending upon the accounting periods depending upon the number of units produced.number of units produced.

1.1. Straight-line methodStraight-line method - the same amount - the same amount is depreciated each accounting period.is depreciated each accounting period.

2.2. Double-declining-balance Double-declining-balance – produces – produces more depreciation expense in the early more depreciation expense in the early years of an asset’s life, with a declining years of an asset’s life, with a declining amount of expense in later years.amount of expense in later years.

3.3. Units-of-ProductionUnits-of-Production – produces varying – produces varying amounts of depreciation in different amounts of depreciation in different accounting periods depending upon the accounting periods depending upon the number of units produced.number of units produced.

8-6

Straight-Line Depreciation

Life Cycle Phase 1Acquire $25,000 cash from the sale of common stock to purchase the van.

= Rev. – Exp. = Net Inc. Cash Flow

Cash + Van AccDep = Com. Stk. Ret. Earn.25,000 NA = NA = 25,000 NA NA – NA = NA 25,000 FA

EquityAssets

Account Title Debit CreditCash 25,000 Common stock 25,000

8-7

Straight-Line Depreciation

Life Cycle Phase 2Purchase the van on January 1, 2011, for a net cost of $24,000.

= Rev. – Exp. = Net Inc. Cash Flow

Cash + Van AccDep = Com. Stk. Ret. Earn.(24,000) 24,000 = NA = NA NA NA – NA = NA (24,000) IA

EquityAssets

Account Title Debit CreditVan 24,000 Cash 24,000

8-8

Straight-Line Depreciation

Life Cycle Phase 3Use the van to generate $8,000 revenue for the period. Depreciation expense calculated under straight-line is determined as followed:

(Asset Cost – Salvage Value) (Asset Cost – Salvage Value) ÷ Useful Life÷ Useful Life(Asset Cost – Salvage Value) (Asset Cost – Salvage Value) ÷ Useful Life÷ Useful Life

($24,000 – $4,000) ($24,000 – $4,000) ÷ 4 = $5,000 depreciation÷ 4 = $5,000 depreciation($24,000 – $4,000) ($24,000 – $4,000) ÷ 4 = $5,000 depreciation÷ 4 = $5,000 depreciation

= Liab. + Equity Rev. – Exp. = Net Inc. Cash Flow

Cash + Book Value of Van8,000 NA = NA + 8,000 8,000 – NA = 8,000 8,000 OA

NA (5,000) NA (5,000) NA – 5,000 (5,000) NA

Assets

8-9

Straight-Line Depreciation

Life Cycle Phase 3Use the van to generate $8,000 revenue for the period. Depreciation expense calculated under straight-line is determined as followed:

= Liab. + Equity Rev. – Exp. = Net Inc. Cash Flow

Cash + Book Value of Van8,000 NA = NA + 8,000 8,000 – NA = 8,000 8,000 OA

NA (5,000) NA (5,000) NA – 5,000 (5,000) NA

Assets

Cash 8,000 Service revenue 8,000 Depreciation expense 5,000 Accumulated depreciation 5,000

8-10

Straight-Line Depreciation

= Liab. + Equity Gain – Exp. = Net Inc. Cash Flow

Cash + Book Value of Van Ret. Earn.4,500 (4,000) = NA + 500 500 – - = 500 4,500 IA

Assets

Life Cycle Phase 4On January 1, 2015, the van is sold for $4,500 cash.

Cost of Asset 24,000$ Accumulated Depreciation 20,000 ($5,000 × 4 years)Book Value 4,000 Cash Proceeds 4,500 Gain on disposal 500$

Account Title Debit CreditCash 4,500 Accumulated depreciation 20,000 Van 24,000 Gain on sale of van 500

8-11

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. Determine the straight-line rate of depreciation.

2. Multiply the straight-line rate times two.

3. Multiply the double-declining rate by the book value of the asset at the beginning of the period.

1. Determine the straight-line rate of depreciation.

2. Multiply the straight-line rate times two.

3. Multiply the double-declining rate by the book value of the asset at the beginning of the period.

8-12

Double-Declining-Balance Method

See how double-declining-balance depreciation works

(1 ÷ 4) = (25% straight-line rate × 2) = 50%(1 ÷ 4) = (25% straight-line rate × 2) = 50%

YearBook Value at

Beginning of Year

Double the Straight-Line

Rate

Annual Depreciation

Expense2008 ($24,000 – $ 0) 50% 12,000$ 2009 ($24,000 – $12,000) 50% 6,000 2010 ($24,000 – $18,000) 50% 2,000 2,0002011 ($24,000 - $20,000) 50% 2,000 0

22,000$

8-13

Units-of-Production Depreciation

Cost – Salvage valueTotal estimated units of production

=Depreciation charge per unitof production

Depreciation charge per unitof production

×Units of production in current accounting period

=PeriodicDepreciation Expense

8-14

Units-of-Production Depreciation

Here is the depreciation charge per mile driven in our van:

$24,000 – $4,000100,000 miles

= $0.20 per mile

Here is the calculation of depreciation expense based on miles driven:

Depreciation Charge Per

MileMiles

DrivenDepreciation

Expense0.20$ × 40,000 = 8,000$ 0.20 × 20,000 = 4,000 0.20 × 30,000 = 6,000 0.20 × 15,000 = 3,000 2,000

105,000 21,000$

8-15

Natural Resources

Cost – Salvage valueTotal estimated units recoverable

=Depletion charge per unitof resource

Depletion charge per unitof resource

×Number of units extracted and sold this period

=PeriodicDepletion Expense

8-16

Intangible Assets

1.1. Intangible Assets with Intangible Assets with IdentifiableIdentifiable Useful Lives Useful Lives – patents and copyrights.

• amortize the cost of each over its useful life.

2.2. Intangible Assets with Intangible Assets with IndefiniteIndefinite Useful Lives 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.