8-1 ©2006 Prentice Hall, Inc.. 8-2 ©2006 Prentice Hall, Inc. REPORTING & INTERPRETING L-T OPERATIONAL ASSETS (1 of 2) Learning objectives Learning objectives

8-1©2006 Prentice Hall, Inc.


REPORTING & REPORTING & INTERPRETING L-T INTERPRETING L-T

OPERATIONAL ASSETSOPERATIONAL ASSETS (1 of (1 of 2)2)

Learning objectivesAcquiring plant assetsUsing long-term tangible assets

— depreciation and depletionUsing intangible assets—amorti

zationChanges after the purchase of a

n asset


REPORTING & REPORTING & INTERPRETING L-T INTERPRETING L-T

OPERATIONAL ASSETSOPERATIONAL ASSETS (2 of (2 of 2)2)

Selling long-term assetsLong-term asset presentation o

n financial statementsFinancial statement analysisBusiness risk, control, and

ethics


Learning ObjectivesLearning Objectives(1 of 3)(1 of 3)

Explain how long-term assets are classified, how their cost is computed, and how they are reported

Explain and compute how tangible assets are written off over their useful lives and reported on the financial statements



Explain how decreases in value, repairs, changes in productive capacity, and changes in estimates of useful life and salvage value of assets are reported on the financial statements

Describe how long-term assets are reported on the financial statements



Describe how long-term assets are reported on the financial statements

Use return-on-assets (ROA) and the asset turnover ratio to help evaluate the firm’s performance

Recognize the risks associated with long-term assets and the controls that can minimize those risks


Acquiring Plant AssetsAcquiring Plant Assets(1 of 2)(1 of 2)

Long-term operational assetsAssets that last for more than one

accounting periodUsed to help a business generate

revenueDoes purchase of a plant asset

affect the income statement?


Acquiring Plant AssetsAcquiring Plant Assets(2 of 2)(2 of 2)

Types of long-lived assetsTangible assets

Property, plant, and equipmentIntangible assets

Trademarks, patents, copyrights, etc.

Acquisition costsBasket purchase allocation


Acquisition Costs(1 of 2)

Historical cost principle requires assets to be recorded at their costPlus cost of getting asset in place and

ready for useWhy aren’t most long-term assets

reported at their current market value?Why aren’t long-term assets

immediately expensed when purchased?

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©2006 Prentice Hall, Inc.

Acquisition Costs(2 of 2)

Which of the following are acquisition costs for a building and why?Real estate commissionsCost of tearing down an existing buildingConsultant’s fee to decide whether to

lease or purchase the buildingInstallation feesCost of land where building will be built

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Basket Purchase Allocation

Purchase of two or more assets for one price

Cost allocated to each asset based on their relative fair market valuesPercent of total FMV of the assetsHow do firm’s determine an asset’s

current fair market value?Basket purchase example

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Basket Purchase Example(1 of 2)

On July 1, Valdez Environmental purchased a tug boat and oil cleaning equipment for $7M

FMV of tug boat is $4MFMV of oil cleaning equipment is $6MHow much of the $7M will be

allocated to the tug boat and to the oil cleaning equipment?

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Basket Purchase Example(2 of 2)

Relative FMV

FMV

Tug BoatCleaning Equip

_

_

Total

AllocationTug Boat X $7M =Cleaning Equip

X $7M =

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Using L-T Tangible Using L-T Tangible Assets: Depreciation and Assets: Depreciation and

DepletionDepletion (1 of 3) (1 of 3)

Purchase of long-term tangible assets are capitalized (recorded as assets)

L-T tangible assets expensed by depreciating (or depleting) themDepreciation allocates the COST of an

asset to the periods that benefit from the use of the assetWhat accounting principle requires this (ch 2)?

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Depreciation terminologyAcquisition cost (cost)Estimated useful lifeSalvage value (residual value)

Estimated value of an asset at the end of its useful life

Depreciable base = cost - salvage valueBook value (carrying value)

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Depreciation methodsStraight-lineActivity (units of production)Declining balance

Depreciation exampleDepletion

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Estimated Useful Life

How long a company expects an asset to be productiveMay be expressed in years or

units of activity (e.g., miles, hours, # of units produced)

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Book Value

Book value equals cost less accumulated depreciation

The unexpensed portion of an asset

Book value bears NO relationship to FMV

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Straight line Depreciation

Equal amount of an asset are expensed each yearDepreciable base is constant (cost-

SV)Depreciation rate is constant (1/UL)

Depreciable cost (cost - SV)Useful life (in years)

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Activity (Units of Production) Depreciation

Amount of asset expensed each year depends on asset’s usageDepreciable base is constant (cost-SV)Depreciation rate is constant (1/UL)

Depreciable cost (cost - SV) Useful life in unitsAnnual depreciation expense

depr rate x actual level of activity for year

Depr Rate =

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Declining Balance Depreciation

(1 of 2)

Accelerated depreciation methodAnnual depreciation expense declines over

asset’s useful lifeDepreciable base changes (beg book value)Depreciation rate is constant (X/UL)

X = Depreciation rateMost common rate is 200%

Also called double-declining balance (DDB)Never depreciate below salvage value

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Declining Balance Depreciation

(2 of 2)

2 _UL

DDB Exp = x Book value (cost – A/D)

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Depreciation Example(1 of 5)

Photocopier purchased on 1/1/08Acquisition cost $14,000Useful life

5 years or300,000 copies

Estimated salvage value $2,000

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Straight-line method $14,000 - $2,000 5 years

Activity methodAssume 40,000 copies were made

$14,000 - $2,000 300,000 copies

=$2,400/year

x 40,000 =$1,600

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Double-declining balance methodYear 1

Year 2

2 _5 yrs

x $14,000 = $5,600

2 _5 yrs

x ($14,000 - $5,600) = $3,360

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SL DDBYr Exp A/D Exp A/D1 2,400 2,400 5,600 5,6002 2,400 4,800 3,360 8,960

3 2,400 7,200 2,016 10,97

6

4 2,400 9,600 1,024 12,00

0

5 2,400 12,00

0 - 12,00

0

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Which method (SL or DDB) produces the highest income in the earliest years?

Which method has the highest book value throughout the asset’s life?

Which method is best for income smoothing?

Which method produces the best asset turnover ratio over the asset’s life?

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Depletion

Used to expense natural resources as they are used upSame computation to activity depreciation

with zero salvage value Cost _ Useful life in unitsAnnual depletion expense

depl rate x actual level of activity for year

Depl rate =

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Using Intangible Assets:Using Intangible Assets:AmortizationAmortization (1 of 3) (1 of 3)

Rights, privileges, or benefits that have long-term value to the firm

Recorded at costAmortization

Same method of expensing as straight-line depreciation with zero salvage value

Accumulated amortization calculated for each intangible asset

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Using Intangible Assets: Using Intangible Assets: AmortizationAmortization (2 of 3) (2 of 3)

CopyrightProvides U.S. legal protection for authors of

original workAmortized over shorter of legal or useful life

Patent A property right on inventionsAmortized over shorter of legal life (20

years) or useful life (often around 10 years)

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Using Intangible Assets: Using Intangible Assets: AmortizationAmortization (3 of 3) (3 of 3)

Trademarks10 years of protection; renewable

FranchiseAgreement that authorizes someone to sell

or distribute a company’s goods or services in a certain area

GoodwillResearch and development costs

Immediately expensed. Why?

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Goodwill

Excess of cost over FMV of net assets when one company purchases another companyWhy would a company pay more than the

FMV of the net assets for a company?Goodwill is not amortized

Loss recorded for decrease in valueReported in the notes to the financial

statements

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Changes After an Asset Changes After an Asset PurchasePurchase

(1 of 2)(1 of 2)

Asset impairmentPermanent reduction in market

value below book valueSimilar to LCM method for inventory

Capital expenditures to improve or extend an asset’s useful lifeCapitalize and depreciate

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Changes After an Asset Changes After an Asset PurchasePurchase

(2 of 2)(2 of 2)

At what point does a roof repair become a capital expenditure?

Revising estimates of useful life and salvage valueDepreciate remaining depreciable

cost over remaining useful lifeRevising estimate example

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Revising an Estimate Example

(1 of 2)

FactsAsset cost: $30,000Original useful life: 5 yearsOriginal salvage value: $8,000In the beginning of year 3, the

asset is determined to have 4 years of useful life remaining and a salvage value of $6,000

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Revising an Estimate Example

(2 of 2)

Depreciation expense for yr 1 & 2($30,000 - $8,000)/5 = $4,400/yr

Book value at beginning of year 3($30,000 - $8,800) = $21,200

Depreciation expense yr 3-6($21,200 - $6000)/4 = $3,800/yr

4 =remaining years of useful life

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Selling Long-term AssetsSelling Long-term Assets(1 of 2)(1 of 2)

Cash proceeds > BV = gainCash proceeds < BV = lossCash proceeds = BV = no gain/lossJournal entry

Increase cash (debit)Remove asset (credit)Remove A/D (debit)Record gain (credit) or loss (debit)

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Selling Long-term AssetsSelling Long-term Assets(2 of 2)(2 of 2)

Sold asset for $20,000 cashCost $35,000; A/D $18,000

Date Transaction Debit Credit

Assets = Liab. + Cont. Cap. + R/E

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Long-term Asset Long-term Asset Presentation on Financial Presentation on Financial

StatementsStatements

PP&E may be reported on the financial statements at book value or showing cost and A/D

How can you calculate the average age of depreciable assets when all you have is cost, A/D and depr exp?Could you do this if you did not know

A/D?

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Financial Statement Financial Statement AnalysisAnalysis

(1 of 3)(1 of 3)

Return on assets (ROA)Measures how well a company is

using its assets to generate revenueAnswers the following

Did the company invest wisely in its assets?

Net Income + Interest Expense Average Total Assets

Avg total assets = (Beg TA + End TA)/2

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(2 of 3)(2 of 3)

Interest expense results from financing with debt instead of equityWhy is interest expense added back to

net income to compute ROA?How can a company increase its ROA

without increasing its net income?Compare the ROA of a CPA firm to the

ROA of an auto manufacturer

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(3 of 3)(3 of 3)

Asset Turnover RatioMeasures how efficiently a company

uses its assets to generate sales

Net Sales _ Average Total AssetsExplain how a company can have a

high asset turnover and a low ROA

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Business Risk, Control, Business Risk, Control, and Ethicsand Ethics

(1 of 2)(1 of 2)

Risks associated with long-term assetsTheft, vandalism, natural disasters,

terrorist attacks, etc.Controls used to safeguard assets

Physical controlsComplete and reliable record

keeping

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Business Risk, Control, Business Risk, Control, and Ethicsand Ethics

(2 of 2)(2 of 2)

Controls used to safeguard assets (continued)Monitoring

Make sure that physical controls, separation of duties, and other policies and procedures related to protecting assets are operating properly

Who is responsible for monitoring function?

Comments or questions about PowerPoint Slides?Contact Dr. Richard Newmark atUniversity of Northern Colorado’s

Kenneth W. Monfort College of [email protected] 8-

45©2006 Prentice Hall, Inc.

Documents

8-1 ©2006 Prentice Hall, Inc.. 8-2 ©2006 Prentice Hall, Inc. REPORTING & INTERPRETING L-T OPERATIONAL ASSETS (1 of 2) Learning objectives Learning objectives