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1
Chapter 10
Long-term Assets:
Property, Plant, and Equipment, Natural Resources,and Intangibles
Adapted from Financial Accounting 4e by Porter and Norton
2
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
3
Acquisition Cost of P,P&E
All costs necessary to acquire asset and prepare for intended use
PurchasePrice
+Taxes Installation
Costs
Transportation Charges
4
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
5
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
6
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 ofProduction
AcceleratedMethods
via
7
$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
8
Units-of-Production Method
Allocate asset cost based on number of units produced over its useful life
depreciation =
per unit
9
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
10
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.
11
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
12
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
13
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
14
Units-of-Production Depreciation
Depreciation = Cost - Residual Valueper unit Life in Units
= $20,000 - $2,000 18,000
= $ 1.00
15
Kemp’s depreciation in 2004:
4,000 units x $1/unit = $ 4,000
Units-of-Production Depreciation
16
Double-Declining-Balance Depreciation
DDB rate = (100% / useful life) x 2
= (100% / 5 years) x 2
= 40%
.40
Initiallyignore
residual value
17
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
18
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
19
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
20
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
21
Reasons for Choosing Straight-Line Depreciation
Simplicity Reporting to
stockholders Comparability Bonus plans
22
Reasons for Choosing Accelerated Methods
Technological rate of change and competitiveness
Minimize taxable income Comparability
Income Taxes
23
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
Yr. 1 Yr. 2 Yr. 3 Yr. 4
reviseestimate
$2,160 $2,160$3,600 $3,600
Example:
$2,160 $2,160 $2,160
Yr. 5 Yr. 6 Yr. 7
26
Capital vs. Revenue Expenditures
IncomeStatement
Revenue Expenditure» Expense immediately
BalanceSheet
Capital Expenditure» Treat as asset addition to
be depreciated over a period of time
27
Capital vs. Revenue Expenditures
Capitalize
Capitalize
Expense
Expense
General Guidelines:
» Increase asset life
» Increase asset productivity
» Normal maintenance
» Material expenditures
28
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
29
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
Yr. 5 Yr. 6 Yr. 7
30
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
31
Disposal of Operating Assets
Sell truck (cost $20,000; accumulated depreciation $9,000) for $12,400
Sale price $ 12,400 Less book value: Asset cost $20,000 Less: accumulated
depreciation 9,000 11,000 = Gain on sale $ 1,400
Example:
32Natural Resources
(in thousands)
Boise Cascade CorporationPartial Balance Sheet
Property and Equipment:Land and land improvements $ 68,482Buildings and improvements 675,905Machinery and equipment 4,606,102Less: accumulated depreciation (2,742,650)
2,607,839Timber, timberlands, and
timber deposits 322,132 $2,929,971
33
Natural Resources
Resource consumed as it is used Expense called depletion vs. depreciation Depletion method similar to units of
production
34
(in millions)
AOL Time Warner, Inc.Partial Balance Sheet
Operating Assets:Property, plant and equipment, net $ 12,684Music catalogues and copyrights 2,927Film library 3,363Cable television and sports franchises 27,109Brands, trademarks, and other 10,684Goodwill and other intangibles 128,338
Intangible
Assets
35
Patents
Intangible Assets
Long-term assets with no physical properties
Goodwill
Trademarks
Copyrights
36
Intangible Assets
Includes cost to acquire and prepare for intended use
+Purchase Price
Acquisition Costs
(i.e. legal fees, registration
fees, etc.)
37
Research & Development
Must be expensed in period incurred
Difficult to identify future benefits
38
Amortization of Intangibles
Normally recorded using straight-line method
Reported net of accumulated amortization
Amortized over legal or useful life, whichever is shorter
39
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:
40
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
41
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
42
Analyzing Long-term Assets
Average Life = Property, Plant & Equipment
Depreciation Expense
What is the average
depreciable period (or life) of
the company’s assets?
43
Analyzing Long-term Assets
Average Age = Accumulated Depreciation Depreciation Expense
Are assets old or new?
44
Analyzing Long-term Assets
Asset Turnover = Net Sales
Average Total Assets
How productive are the company’s
assets?
45
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