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PowerPoint PresentationMcGraw-Hill/Irwin
*
In this chapter, we will study the acquisition and depreciation of
productive assets used in a business. In addition, we will take a
quick look at accounting for natural resources and intangibles.
This chapter contains some challenging accounting procedures, so
let us get started.
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Conceptual Learning Objectives
C1: Describe property, plant and equipment and issues in accounting
for them
C2: Explain depreciation and the factors affecting its
computation
C3: Explain depreciation for partial years and changes in
estimates
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A1: Compare and analyze alternative depreciation methods
A2: Compute total asset turnover and apply it to analyze a
company’s use of assets
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Procedural Learning Objectives
P1: Apply the cost principle to compute the cost of property, plant
and equipment.
P2: Compute and record depreciation using the straight-line,
units-of-production, and declining-balance methods.
P3: Distinguish between revenue and capital expenditures, and
account for them.
P4: Account for asset disposal through discarding or selling an
asset.
P5: Account for natural resource assets and their depletion.
P6: Account for intangible assets.
P7: Appendix 8A: Account for asset exchanges
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Actively Used in Operations
*
Property, plant and equipment are tangible assets that are used
actively in the operations of the entity. We fully expect these
assets, sometimes referred to as plant assets or fixed assets to
benefit future periods.
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Use
benefited.
Disposal
*
When we acquire property, plant and equipment, they are recorded at
historical cost. We will see how cost is determined on the next
slide.
Once the asset is placed in service, we will allocate a portion of
the asset’s cost to depreciation expense as the asset becomes
older.
Finally, at the end of the asset’s useful life, we will dispose of
it and remove it from our books and records. The accounting for
property, plant and equipment usually covers several accounting
periods.
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Acquisition
Cost
cash discounts.
Cost Determination
P1
All expenditures needed to prepare the asset for its intended
use
Purchase
price
*
The cost includes the purchase price as well as all costs necessary
to get the asset in place and ready for its intended use. We record
the purchase price net of any cash discounts available.
Finance charges are not included in the cost of an asset. If we
elect to finance the purchase over a period of time, the interest
cost is charged as an expense when incurred.
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Land
P1
*
Land is not a depreciable asset. In addition to the purchase price,
there are many costs generally incurred in connection with the
acquisition. Many of these costs are related to obtaining legal
title to the land.
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Depreciate over useful life of improvements.
P1
Land improvements are depreciated over their useful life. Land
improvements include parking lots, driveways, fences, sidewalks,
landscaping, and any outdoor lighting systems.
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Brokerage
fees
Taxes
*
Whether we purchase or construct a building, the cost should
include the purchase price plus any attorney fees or title fees. If
we construct the building, the cost will include all the necessary
construction costs as well as the costs we have just
mentioned.
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Purchase
price
Installing,
*
Machinery and equipment is recorded at its purchase price less any
available cash discount. The company may have to pay delivery
charges on the truck; these costs are included in the cost of the
truck. If we need to install any special parts to make the
machinery or equipment ready for its intended use, we will include
these costs in the price of the assets.
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On January 1, Matrix, Inc. purchased land and building for $200,000
cash. The appraised values are building, $162,500, and land,
$87,500.
How much of the $200,000 purchase price will be charged to the
building and land accounts?
Lump-Sum Asset Purchase
The total cost of a combined purchase of land and building is
separated on the basis of their relative market values.
P1
*
It is not uncommon to have a lump-sum purchase of assets. The most
common example may be when purchasing a building and land.
Remember, the land is not depreciable but the building is. We must
assign a portion of the purchase price separately to the building
and to the land. When faced with this type of problem, accountants
normally divide the cost between the assets on the basis of
relative fair market values. Let’s see how this works.
Matrix, Incorporated purchased land with a building for two hundred
thousand dollars cash. The building was appraised at one hundred
sixty-two thousand five hundred dollars, and the land was appraised
at eighty-seven thousand five hundred dollars.
We must determine how to divide the two hundred thousand dollar
purchase price between the land and building.
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*
Begin by calculating the relative fair value as a percent of the
total fair value. The total fair value is two hundred fifty
thousand dollars. The land has an appraised value of eighty-seven
thousand five hundred dollars. So, land is valued at thirty-five
percent of the total. We get the percent by dividing eighty-seven
thousand five hundred dollars by the total fair value of two
hundred fifty thousand dollars. We do a similar calculation for the
building. Next, multiply the percentages we just calculated times
the purchase price of two hundred thousand dollars to determine the
amount assigned to each asset. In the case of land, we multiply
thirty-five percent times two hundred thousand dollars and assign
seventy thousand dollars to the land account. The remainder, or one
hundred thirty thousand dollars, is assigned to the building
account.
Sheet1
Appraised
% of
Purchase
Apportioned
Asset
Value
Value
Price
Cost
a
b*
c
McGraw-Hill/Irwin
Depreciation is the process of allocating the cost of an item of
property, plant and equipment to expense in the accounting periods
benefiting from its use.
Depreciation
C2
Cost
Allocation
Acquisition
Cost
(Unused)
*
Depreciation is a process of cost allocation. We allocate the cost
of the asset to expense over its useful life in some rational and
systematic manner. We do not want to confuse asset valuation, an
economic concept, with allocation.
The unused portion of the asset’s cost appears on the balance
sheet. We allocate a portion of the cost to expense on the income
statement each accounting period. Let’s look at some very common
methods of calculating depreciation expense.
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The calculation of depreciation requires three amounts for each
asset:
Cost
*
Regardless of the method used to calculate depreciation expense, we
must know three variables: the asset’s cost; the estimated salvage
value we expect to receive at the end of its useful life, and the
estimated useful life of the asset. Once these three amounts are
known, we select the depreciation method that we will use to
calculate depreciation expense.
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Straight-line
Units-of-production
Declining-balance
*
There are three popular methods of calculating depreciation
expense. The easiest and most widely used method is called
straight-line depreciation. In special circumstances, we may wish
to use the units-of-productions method. We would elect this method
if the life of the asset is generally measured in terms of units of
production. For example, airplanes keep highly detailed tracking of
the number of hours the engines run. The unit of production may be
the hours run by an aircraft. The third method is called the
declining-balance method. Under this method, we take more
depreciation expense in the early years of the asset’s life and
lower amounts of depreciation in later years. Several income-tax
depreciation calculations are based on the declining balance
method. Let’s begin by looking at straight-line depreciation.
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On January 1, 2007, equipment was purchased for $50,000 cash. The
equipment has an estimated useful life of five years and an
estimated residual value of $5,000.
Straight-Line Method
=
*
Depreciation expense for any given period is determined by taking
the asset’s cost less its estimated salvage value and dividing this
amount by the asset’s estimated useful life. If we calculate annual
depreciation, we would express the useful life in years. Or we may
want to calculate monthly depreciation. We will see how to do this
on a later slide. Here is our specific depreciation example. On
January first, 2007, a company purchased equipment for fifty
thousand dollars. The estimated useful life is five years and the
estimated salvage value is five thousand dollars. Can you calculate
the amount of annual depreciation?
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=
*
This calculation was relatively easy. Did you get the annual
depreciation of nine thousand dollars? Now let us make the journal
entry on December thirty first, to record depreciation expense for
the year. The proper adjusting journal entry is to debit, or
increase, depreciation expense and credit, or increase, the contra
account, accumulated depreciation dash equipment for nine thousand
dollars. Now let us look at depreciation for this asset for its
five-year life.
Larson
Dr.
Cr.
3,000
$ 275,000
Matrix, Inc.
1
30
90
McGraw-Hill/Irwin
*
Notice that depreciation expense is the same amount in each of the
five years. If we plot this amount on a graph, it would be a
straight line. That is how we got the name of the method.
Accumulated depreciation increases by nine thousand dollars each
year. The cost of the asset (fifty thousand dollars) less
accumulated depreciation at the end of any year is called book
value. Book value decreases by nine thousand dollars each year. The
ending book value is equal to the estimated salvage value at the
end of the asset’s useful life. We want this to be true regardless
of the method we use. It’s easy to calculate the rate of
depreciation—just divide one hundred percent by the useful life. In
this case the rate of depreciation is twenty percent. If we
multiply the asset’s cost less its salvage value of forty-five
thousand dollars times twenty percent, we get the annual
depreciation of nine thousand dollars.
Sheet1
Depreciation
Accumulated
Expense
Depreciation
Accumulated
Book
Year
(debit)
(credit)
Depreciation
Value
$ 50,000
2007
$ 9,000
$ 9,000
$ 9,000
41,000
2008
9,000
9,000
18,000
32,000
2009
9,000
9,000
27,000
23,000
2010
9,000
9,000
36,000
14,000
2011
9,000
9,000
45,000
5,000
$ 45,000
$ 45,000
Sheet2
Sheet3
McGraw-Hill/Irwin
P2
Income Statement.
Book Value
Book Value
*
In this graph of each year’s depreciation expense, you can clearly
see the straight-line nature of the method. Now we have a graph of
the asset’s book value at the end of each year. Once again, we have
a straight line that slopes down and to the left.
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*
Under the units-of-production method, the first step is to
calculate the depreciation expense per unit of production. Take the
asset’s cost less its salvage value and divide this amount by the
total estimated number of units that will be produced by the
assets. Once we complete the first step, we may calculate
depreciation expense for the period. Multiply the depreciation
expense per unit that we determined in step one by the number of
units produced in the current period. Let’s look at a specific
example.
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On December 31, 2007, equipment was purchased for $50,000 cash. The
equipment is expected to produce 100,000 units during its useful
life and has an estimated salvage value of $5,000.
If 22,000 units were produced in 2008, what
is the amount of depreciation expense?
Units-of-Production Method
*
At the end of December 2007, the company purchased equipment that
had a cost of fifty thousand dollars and estimated salvage value of
five thousand dollars. The equipment is expected to produce one
hundred thousand units during its useful life. During 2008, the
equipment was used to produce twenty-two thousand units. Let’s
follow our two-step method of calculating depreciation expense for
2008.
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Depreciation
*
First we calculate the depreciation expense per unit of production
of forty-five cents per unit. During 2008, the company produced
twenty-two thousand units, so we determine depreciation expense of
ninety-nine hundred dollars. Just multiply the twenty-two thousand
units times the forty-five cents per unit depreciation charge.
Let’s look at a table of depreciation expense for this equipment
over its five-year life. Remember that we need to know the units
produced in each year.
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Units-of-Production Method
*
In the second column we show the units produced in each of the five
years. In 2010, no units were produced, so there is no
depreciation. The depreciation expense amounts are all determined
by multiplying the units produced by forty-five cents per unit.
Finally, notice that the book value is equal to the estimated
salvage value of five thousand dollars at the end of the asset’s
estimated useful life. Now let us move on to the declining-balance
method.
Sheet1
Depreciation
Accumulated
Book
Year
Units
Expense
Depreciation
Value
$ 50,000
2008
22,000
$ 9,900
$ 9,900
40,100
2009
28,000
12,600
22,500
27,500
2010
- 0
- 0
22,500
27,500
2011
32,000
14,400
36,900
13,100
2012
18,000
8,100
45,000
5,000
100,000
$ 45,000
Sheet2
Sheet3
McGraw-Hill/Irwin
later years’ total expense.
*
One of the reasons to consider the declining-balance method is that
it is an attempt to match depreciation expense and repairs expense
to focus on the overall cost of ownership. In the early years of
the asset’s life, depreciation under the declining-balance method
is high and generally repair expenses are low. Conversely, in the
later years of an asset’s life, we take less depreciation expense
but repairs expense is usually higher. So, over the life of the
asset we attempt to smooth the total cost of ownership.
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*
Calculating depreciation expense under the double-declining-balance
method is a three-step process. The first step is the calculate the
straight-line depreciation rate. Recall that we do this by dividing
one hundred percent by the asset’s useful life. In our specific
case we divide one hundred percent by the five-year useful life to
get a straight-line rate of twenty percent. The second step is to
calculate the double-declining-balance rate. We do this by
multiplying the straight-line rate times two. In our case that
would be twenty percent times two, or forty percent. The third, and
final step is to determine depreciation expense. We multiply the
double-declining rate times the book value of the asset at the
beginning of the period. Under the double-declining-balance method
we ignore estimated salvage value. The beginning book value (cost
less accumulated depreciation), is fifty thousand dollars.
Depreciation expense for 2008 is twenty thousand dollars, forty
percent times fifty thousand dollars.
Don’t forget that salvage value is not used in the
double-declining-balance method.
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*
At the start of the second year the book value of the asset was
thirty thousand dollars (cost of fifty thousand dollars less
accumulated depreciation of twenty thousand dollars). To determine
depreciation expense, we multiply the book value of thirty thousand
dollars times our rate of forty percent to yield twelve thousand
dollars. Let’s look at a depreciation table for our asset.
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*
While we always want the book value to be equal to estimated
salvage value at the end of the asset’s useful life, it just will
not work properly using the double-declining-balance method. As you
can see, the book value of the asset is three thousand eight
hundred and eighty-eight dollars. We need for it to be equal to
five thousand dollars, the estimated salvage value. The only way we
can make this work is to force depreciation expense in the last
year to be the amount needed to bring book value down to salvage
value. In 2012, if we go by the table, we would record depreciation
expense of two thousand five hundred ninety-two dollars. But this
can’t be right since the book value can’t go below the salvage
value of five thousand dollars. Let’s look at a corrected
schedule.
Sheet1
Depreciation
Accumulated
Book
Year
Expense
Depreciation
Value
$ 50,000
2008
$ 20,000
$ 20,000
30,000
2009
12,000
32,000
18,000
2010
7,200
39,200
10,800
2011
4,320
43,520
6,480
2012
2,592
46,112
3,888
$ 46,112
Sheet2
Sheet3
McGraw-Hill/Irwin
last year so that book value equals salvage value.
*
If we force depreciation expense to be one thousand four hundred
and eighty dollars in 2012, accumulated depreciation will be
forty-five thousand dollars, and book value will be equal to
salvage value of five thousand dollars. Let’s summarize our three
depreciation methods by looking at some graphs.
Sheet1
Depreciation
Accumulated
Book
Year
Expense
Depreciation
Value
$ 50,000
2008
$ 20,000
$ 20,000
30,000
2009
12,000
32,000
18,000
2010
7,200
39,200
10,800
2011
4,320
43,520
6,480
2012
1,480
45,000
5,000
$ 45,000
Sheet2
Sheet3
McGraw-Hill/Irwin
*
The graph in the upper left corner is depreciation expense using
the straight-line method. We have a constant nine thousand dollar
expense each year.
In the upper right corner we have the graph of units-of-production
depreciation expense. This method does not follow any pattern
because it is dependent on the number of units produced each
period. Notice that in year three the equipment was idle so no
depreciation expense was recorded.
At the bottom of the screen is the depreciation expense under the
double-declining-balance method. Depreciation expense decreases
each year of the asset’s life.
The choice of the depreciation method to use is one that should be
carefully made by management. Depreciation expense impacts net
income in each period of the asset’s useful life.
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When an item of property, plant or equipment is acquired during the
year, depreciation is calculated for the fraction of the year the
asset is owned.
Partial-Year Depreciation
C 3
*
To this point we have discussed depreciation of an asset that was
purchased at the beginning of the year. Let’s see how we handle
depreciation expense for partial periods, that is, assets that are
purchased during the year.
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Calculate the straight-line depreciation on December 31, 2010, for
equipment purchased on June 30, 2010. The equipment cost $75,000,
has a useful life of 10 years, and an estimated salvage value of
$5,000.
Depreciation = ($75,000 - $5,000) ÷ 10
= $7,000 for all 2007
Depreciation = $7,000 × 6/12 = $3,500
*
In our example, a company purchased equipment for seventy-five
thousand dollars on June thirtieth, 2010. The equipment has a
useful life of ten years and estimated salvage value of five
thousand dollars. This company uses straight-line depreciation for
all its property, plant and equipment.
Let’s calculate depreciation expense for 2010. The depreciation
expense for the entire year 2010 would be seven thousand dollars.
We determine this amount by taking cost less salvage value of
seventy thousand dollars and dividing it by ten. The company had
the equipment in service for one-half of the year, so we multiply
the annual depreciation of seven thousand dollars times one-half,
or six twelfths. We use the same procedure for other partial
periods.
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useful life
Over the life of an asset, new information may come to light that
indicates the
original estimates were inaccurate.
C 3
*
You know that the salvage value and useful life of an item of
property, plant and equipment are both estimates. Like all
estimates, new information may come to light that will cause us to
revise our previous estimate. Let’s see how accountants handle the
revision of previous estimates.
© The McGraw-Hill Companies, Inc., 2010
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On January 1, 2008, equipment was purchased that cost $30,000, has
a useful life of 10 years, and no salvage value. During 2011, the
useful life was revised to eight years total (five years
remaining).
Calculate depreciation expense for the year
ended December 31, 2008, using the
straight-line method.
C 3
–
*
In our example, a company purchased equipment on January first,
2008 for thirty thousand cash. The equipment is estimated to have a
ten-year useful life and no salvage value at the end of its useful
life. The company uses the straight-line method for all plant
assets and begins recording depreciation on this equipment in 2008.
We continue our original computations for 2009 and 2010. During
2011, we learn new information about the equipment. This new
information causes us to revise our estimate of the equipment’s
useful life. We now believe the equipment will have a total useful
life of eight years. We already recorded depreciation expense for
three years (2008, 2009, and 2010), so there are five years
remaining in the equipment’s useful life. In this case, accountants
would take the book value at the date of revision of our estimate,
that is, 2011, and subtract any estimated salvage value at the time
of revision. This total is to be divided by the remaining useful
life of the asset at the date of revision. Let’s calculate the
proper depreciation expense for 2011.
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C 3
*
The asset had a cost of thirty thousand dollars and a ten-year
useful life with no salvage value. Under straight-line depreciation
we record three thousand dollars of expense in each of the years
2008, 2009, and 2010. Accumulated depreciation has a balance of
nine thousand dollars at the beginning of 2011. The remaining book
value is twenty-one thousand dollars and the remaining useful life
of the asset is five years, so depreciation for each of those five
years will be four thousand two hundred dollars. Let’s record
depreciation expense at December thirtieth, 2011.
We debit depreciation expense for forty-two hundred dollars and
credit accumulated depreciation dash equipment for the same
amount.
Sheet1
Depreciation
Accumulated
Undepreciated
Expense
Depreciation
Balance
Year
(debit)
Balance
9,000
Jul. 30
3,000
$ 275,000
2007
1
30
90
McGraw-Hill/Irwin
*
Total accumulated depreciation is subtracted for the total cost of
property, plant, and equipment.
Sheet1
Depreciation
Accumulated
Undepreciated
Expense
Depreciation
Balance
Year
(debit)
Balance
9,000
$ 453,000
McGraw-Hill/Irwin
Additional Expenditures
If the amounts involved are not material, most companies expense
the item.
P3
*
After a plant asset is purchased, the company may incur additional
expenditures on that asset. These expenditures may be for repairs
and maintenance, overhauls, upgrading the asset, and similar
expenditures.
One way to handle these types of expenditures is to treat them as a
Capital Expenditure and charge the amount to a balance sheet
account like the asset or accumulated depreciation. In some cases,
the expenditures may be treated as Revenue Expenditures and charged
to current period income as an expense. For each expenditure
subsequent to acquisition of a plant asset we must decide if the
expenditure is to be treated as a Capital or Revenue
expenditure.
Sheet1
$ 90,000
$ 40,000
$ (24,000)
26,000
Proceeds from issuance of debt
13,000
$ 15,000
$ 15,000
$ 15,000
Sheet2
McGraw-Hill/Irwin
*
Generally, subsequent expenditures for ordinary repairs are treated
as revenue expenditures and charged to current period income as an
expense. Subsequent expenditures that are for betterments are
classified as extraordinary repairs. These should be treated as
capital expenditures and charged to the asset account. Let’s look
at the proper accounting for the disposal of plant assets.
Sheet1
$ 90,000
$ 40,000
$ (24,000)
26,000
Proceeds from issuance of debt
13,000
$ 15,000
$ 15,000
$ 15,000
Sheet2
Repairs
3. Does not extend life beyond original
estimate.
replacements.
© The McGraw-Hill Companies, Inc., 2010
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Journalize disposal by:
P4
*
Whenever we dispose of an item of property, plant and equipment,
the first thing we do is update depreciation to the date of
disposal. After completing the update we can begin on the journal
entry. We start the journal entry by recording a debit to the cash
account, if cash was received, or credit the cash account, if cash
was paid by the company. In addition, we must determine whether a
gain or loss is associated with the disposal. A gain is recorded
with a credit, just like revenue, and a loss is recorded with a
debit, just like an expense account.
We complete the entry by removing the asset’s cost from our books
with a credit, and remove the related accumulated depreciation with
a debit.
Let’s see how we calculate the gain or loss associated with the
disposal.
© The McGraw-Hill Companies, Inc., 2010
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Journalize disposal by:
Recording cash
received (debit)
Recording a
gain (credit)
*
If the amount of cash received is greater than the book value of
the asset (cost less accumulated depreciation), a gain is
associated with the disposal.
If the cash received is less than the book value of the asset, a
loss will be recorded. When the amount of cash is exactly equal to
the book value of the asset, there will be no gain or loss in
connection with the disposal. Now let us look at a specific example
of disposal of a plant asset.
© The McGraw-Hill Companies, Inc., 2010
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On September 30, 2011, Evans Company sells a machine that
originally cost $100,000 for $60,000 cash. The machine was placed
in service on January 1, 2008. It was depreciated using the
straight-line method with an estimated salvage value of $20,000 and
a useful life of 10 years.
Selling Property, Plant and Equipment
P4
*
On September thirtieth, 2011, Evans Company sells a machine for
sixty thousand dollars cash. The machine was purchased on January
first, 2008, for one hundred thousand dollars, had an estimated
salvage value of twenty thousand dollars, and a useful life of ten
years. Evans uses straight-line depreciation.
© The McGraw-Hill Companies, Inc., 2010
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Annual Depreciation:
9/12 × $8,000 = $6,000
*
Annual depreciation is eight thousand dollars. For the nine months
ending September thirtieth, Evans will record six thousand dollars
in depreciation.
Next, we make the journal entry to bring the depreciation
up-to-date. The required journal entry is to debit depreciation
expense and credit accumulated depreciation dash machine. Now we
need to make the journal entry to record the disposal.
Larson
Dr.
Cr.
Jul. 30
3,000
$ 275,000
2007
1
30
90
McGraw-Hill/Irwin
P4
*
The balance in the accumulated depreciation account is thirty
thousand dollars at the date of disposal. We recorded three years
of depreciation at eight thousand dollars and the partial year
depreciation of six thousand dollars. Once we determine the book
value of the asset, we can calculate any gain or loss involved with
the disposal.
Sheet1
Cost
$ 100,000
McGraw-Hill/Irwin
P4
*
The book value of seventy thousand dollars is less than the cash
received of sixty thousand dollars, so this disposal involves a
loss of ten thousand dollars. Let’s record the journal entry.
Sheet1
Cost
$ 100,000
McGraw-Hill/Irwin
P4
*
We record the disposal with a debit to the cash account for sixty
thousand dollars, a debit to accumulated depreciation dash machine
for thirty thousand dollars (this eliminates the account balance),
and a debit to the loss on disposal account for ten thousand
dollars. Finally, we credit the asset account, machine, for one
hundred thousand dollars, the historical cost of the machine.
Larson
Dr.
Cr.
10,000
2005
3,000
$ 275,000
2006
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2007
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P5
*
Let’s change the subject away from disposals of plant assets and
discuss natural resources.
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McGraw-Hill/Irwin
*
Natural resources abound. We have accounting issues with oil, coal,
timber, gold, gravel, and a wide variety of other natural
resources. In general, natural resources can be thought of as
anything extracted from our natural environment. As accountants, we
report natural resources at their cost less accumulated depletion.
The depletion we will study in this text is very similar to
units-of-production depreciation. The cost of any natural resource
must include all exploration and development costs as well as
extraction costs. A portion of these total costs will be charged to
income each period through the depletion expense account. Let’s see
how this works.
© The McGraw-Hill Companies, Inc., 2010
McGraw-Hill/Irwin
Step 2:
*
We begin the process of calculating depletion expense by
determining the depletion expense per unit of natural resource. The
numerator of the equation contains the resource cost less any
estimated salvage value. The denominator of the equation is our
estimated total capacity of the natural resource we expect to
extract. For oil we express the denominator in terms of barrels,
for coal we use tons, for timber we use board feet, and the like
for other resources. The current period depletion expense is
determined by multiplying the depletion expense per unit,
determined in the first step, by the number of extracted units sold
during the period. Depletion expense is based on the number of
units sold, not the number of units extracted. Let’s go over a
specific example.
© The McGraw-Hill Companies, Inc., 2010
McGraw-Hill/Irwin
Apex Mining acquired a tract of land containing ore deposits. Total
costs of acquisition and development were $1,000,000 and Apex
estimates the land contained 40,000 tons of ore. During the first
year of operations Apex extracted and sold 13,000 tons of
ore.
Depletion of Natural Resources
*
Apex Mining paid one million dollars cash to acquire and develop an
ore site. The engineers at Apex estimate that the site will
eventually produce forty thousand tons of ore. During the first
year of operation, the company extracted and sold thirteen thousand
tons of ore. Let’s start by calculating the depletion charge per
ton of ore.
© The McGraw-Hill Companies, Inc., 2010
McGraw-Hill/Irwin
Step 1:
Depletion Expense
*
The depletion charge per ton of ore is twenty-five dollars. The
site has no residual value so we divide one million dollars by
forty thousand tons to get the twenty-five dollar per ton depletion
charge. Depletion expense for the first year will be three hundred
twenty-five thousand dollars. We extracted and sold thirteen
thousand tons of ore at twenty-five dollars per ton.
© The McGraw-Hill Companies, Inc., 2010
McGraw-Hill/Irwin
Property, Plant and Equipment Used in Extracting Natural
Resources
Specialized property, plant and equipment may be required to
extract the natural resource.
These assets are recorded in a separate account and
depreciated.
P5
*
The development and extraction of many types of natural resources
require highly specialized plant assets. Just think of the use of
off-shore drilling platforms for oil and gas production. These
specialized assets are recorded in a separate account from the
natural resource and depreciated over their useful lives.
© The McGraw-Hill Companies, Inc., 2010
McGraw-Hill/Irwin
P6
*
Now let us turn to the last major subject we will cover in the
presentations…intangible assets.
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McGraw-Hill/Irwin
*
Intangible assets lack physical substance and that makes it
difficult to determine the asset’s useful life or any residual
value. Many intangible assets involve exclusive rights or
privileges. We will review the major types of intangible assets and
related accounting on the remaining screens.
© The McGraw-Hill Companies, Inc., 2010
McGraw-Hill/Irwin
Patents
Copyrights
Leaseholds
Trademarks & Trade Names
Record at current cash equivalent cost, including purchase price,
legal fees, and filing fees.
Cost Determination and Amortization
*
We have provided you with a list of intangible assets that will be
discussed. Intangible assets are normally recorded at the purchase
price plus any legal or related fees.
© The McGraw-Hill Companies, Inc., 2010
McGraw-Hill/Irwin
Patents
The exclusive right granted to its owner to manufacture and sell a
patented item or use a process for 20 years. A patent is generally
amortized, using the straight-line method, over its useful life not
to exceed 20 years.
P6
*
A patent gives the holder the exclusive right to manufacture and
sell an item or process for twenty years. A patent is amortized (a
process just like depreciation) using the straight-line method over
its useful life, but never more than twenty years. Most companies
amortize patents over a very short period of time.
© The McGraw-Hill Companies, Inc., 2010
McGraw-Hill/Irwin
Patents
Matrix, Inc. purchased a patent for $10,000. The patent is expected
to have a useful life of 10 years.
P6
Part One
In our example, Matrix purchased a patent for ten thousand dollars
cash. The useful life of the patent is estimated at ten years.
Let’s prepare the journal entry to record the annual amortization
expense.
Part Two
We will debit amortization expense dash patents for one thousand
dollars (one-tenth of the ten thousand dollar cost), and credit
accumulated amortization dash patents for the same amount. This
entry will be made each year for the next nine years.
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Copyrights
The exclusive right to publish and sell a musical, literary, or
artistic work during the life of the creator plus 70 years.
P6
Leaseholds
*
A copyright grants to the holder the exclusive right to publish and
sell musical, literary, or artistic work for the life of the
creator plus seventy years. Most copyrights are amortized over a
short period of time using the straight-line method. A leasehold is
the right to the beneficial use of property owned by a lessor. The
lessee does not own the property but gets to use it over some
extended period of time.
© The McGraw-Hill Companies, Inc., 2010
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Leasehold Improvements
A lessee may pay for alterations or improvements to the leased
property such as partitions, painting, and storefronts. These costs
are usually amortized over the term of the lease.
P6
Franchises and Licenses
*
Leasehold improvements are any alterations or improvements to
leased property. Leasehold improvements are normally amortized
using the straight-line method over the term of the lease.
The holder of a franchise has the right to deliver a product or
service under conditions granted by the franchisor. You really
can’t drive down any major street without finding a number of
franchise operations. The accounting for franchises can become
quite complex. At this point it is sufficient to be able to define
the nature of a franchise.
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Trademarks and Trade Names
A symbol, name, phrase, or jingle identified with a company,
product, or service.
P6
*
A trademark or trade name is any symbol, name, phrase, or jingle
that is identified with a company, product or service. No other
party may use the trademark or trade name without the permission of
the holder. Many trademarks are extremely valuable. The name
“Mercedes-Benz” is quite valuable, or the name “Harley-Davidson.”
How about the phrase, “Coke is it.”
We normally amortize the cost of trademarks over a short period of
time using the straight-line method.
© The McGraw-Hill Companies, Inc., 2010
McGraw-Hill/Irwin
each year to determine if there has been
any impairment in carrying value.
Goodwill
*
An intangible asset called goodwill can be created when one company
buys another company. If the purchase price of the company is
greater than the fair value of the net assets and liabilities
acquired, we have goodwill associated with the transaction.
Goodwill is not amortized. Each year we must test to see if there
has been any impairment in the carrying value of the goodwill. If
an impairment is determined to exist, we will reduce the goodwill
account and recognize the loss in value.
© The McGraw-Hill Companies, Inc., 2010
McGraw-Hill/Irwin
efficiency in using its assets.
Total Asset Turnover
*
Total asset turnover is equal to the net sales for the period
divided by the average total assets. The average total assets is
computed by taking the beginning balance of total assets, adding
the ending balance, and dividing the result by two. Total asset
turnover provides us with information about how efficiently a
company uses its assets. For example, Dragon had an asset turnover
in 2010 of point 92. This means that for every dollar of assets
invested, the company generated ninety two cents in sales. You can
see that two companies in the same industry, like Dragon and
Phoenix, can have significantly different measures of total asset
turnover. The ratio should be interpreted in comparison to prior
years and also to its competitors.
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Exchanging Property, Plant and Equipment
Many property, plant and equipment are disposed of by exchanging
them for newer assets. The next few slides will explain how
exchanges are recorded.
P7
*
Many property, plant and equipment such as machinery, automobiles,
and office equipment, are disposed of by exchanging them for newer
assets. In a typical exchange of property, plant and equipment, a
trade-in allowance is received on the old asset and any remaining
balance is either paid in cash or financed. In the next few slides,
we will discuss how these exchanges are accounted for using
generally accepted accounting principles.
© The McGraw-Hill Companies, Inc., 2010
McGraw-Hill/Irwin
SIMILAR
Accounting for exchanges of similar assets depends on whether the
book value of the asset(s) given up is less or more than the market
value of the asset(s) received.
P7
*
We have special rules in accounting when we trade one plant asset
for a similar plant asset. The particular accounting we will follow
depends on whether there is a gain or loss involved in the
transaction.
© The McGraw-Hill Companies, Inc., 2010
McGraw-Hill/Irwin
Exchanging Property, Plant and Equipment
Accounting for exchanges of similar assets depends on whether the
transaction has commercial substance (i.e. whether company’s future
cash flows change).
A loss is recognized when the book value given up is more than the
market value received.
A gain is recognized when the book value given up is less than the
market value received.
P7
*
We know that a loss occurs when the book value of the asset or
assets given up is more than the market value of the asset or
assets received.
A gain exists when the book value of the asset given up is less
than the market value of the asset received.
© The McGraw-Hill Companies, Inc., 2010
McGraw-Hill/Irwin
On May 30, 2010, Matrix, Inc. exchanged a used bus and $35,000 cash
for a new European-style bus. The old bus originally cost $40,000,
had up-to-date accumulated depreciation of $30,000. The new bus had
a market value of $39,000.
Exchanging Property, Plant and Equipment
COMMERCIAL SUBSTANCE
*
Let’s look at a specific example of the exchange of similar plant
assets. On May thirtieth, 2010, Matrix exchanges a used bus and
thirty-five thousand dollars cash for a new similar bus that has a
fair market value of thirty-nine thousand dollars. The old bus
given up has a historical cost of forty thousand dollars and
accumulated depreciation to the date of exchange of thirty thousand
dollars.
The first thing we need to determine is whether a gain or loss will
result. Assume that this transaction has commercial
substance.
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McGraw-Hill/Irwin
P7
*
The book value of the bus given up is ten thousand dollars and the
cash paid is thirty-five thousand dollars, so Matrix gave up assets
with a book value of forty-five thousand dollars. We compare the
book value of the assets given up to the thirty-nine thousand
dollar market value of the bus received and see that this
transaction indicates a loss of six thousand dollars.
Let us prepare the journal entry to record the exchange.
We debit the Bus account for thirty-nine thousand dollars, the fair
value of the bus received. Next, we debit Accumulated Depreciation
dash Bus for thirty thousand dollars and Loss on Exchange for six
thousand dollars. The credits are to the old Bus asset account for
forty thousand dollars and to Cash for thirty-five thousand
dollars.
Sheet1
$ 39,000
10,000
Cash
35,000
45,000
3,000
$ 275,000
2006
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On May 30, 2010, Matrix, Inc. exchanged a used bus and $35,000 cash
for a new European-style bus. The old bus originally cost $40,000,
had up-to-date accumulated depreciation of $30,000. The new bus had
a market value of $49,000.
COMMERCIAL SUBSTANCE
P7
*
Now let us look at an example very similar to the one we just
completed. Once again we are exchanging similar plant assets. The
old bus has a cost basis of forty thousand dollars and accumulated
depreciation to the date of exchange of thirty thousand dollars. In
addition to exchanging the old bus, we are paying thirty-five
thousand dollars cash. In exchange we are receiving a new bus that
has a market value of forty-nine thousand dollars. Let’s look at
the accounting of this exchange.
© The McGraw-Hill Companies, Inc., 2010
McGraw-Hill/Irwin
P7
*
Unlike our last example, this transaction indicates that a gain
exists. Let us prepare the journal entry for this exchange. We
record the new bus at the market value. Next, we remove the old bus
and its accumulated depreciation from our books. To accomplish
this, we will debit the accumulated depreciation account and credit
the Bus asset account. Finally, we credit the Cash account for the
cash payment made in connection with the exchange, and record the
gain.
Sheet1
$ 49,000
10,000
Cash
35,000
45,000
3,000
$ 275,000
Gain
4,000
2006
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On May 30, 2010, Matrix, Inc. exchanged a used bus and $35,000 cash
for a new European-style bus. The old bus originally cost $40,000,
had up-to-date accumulated depreciation of $30,000. The new bus had
a market value of $49,000.
NO COMMERCIAL SUBSTANCE
P7
*
If we just change the assumption and treat this transaction with no
commercial substance, then the journal entry would be
different.
© The McGraw-Hill Companies, Inc., 2010
McGraw-Hill/Irwin
P7
$49,000 - $4,000 = $45,000
*
If the exchange transaction has no commercial substance, the gain
is not recognized. Instead, we record the asset received at the
book value of the asset given up. Let us prepare the journal entry
for this exchange. We record the new bus at the book value of the
assets given up. In our exchange, we gave up a bus with a book
value of ten thousand dollars and cash of thirty-five thousand
dollars. The cost basis of the new bus will be forty-five thousand
dollars. Next, we remove the old bus and its accumulated
depreciation from our books. To accomplish this, we will debit the
accumulated depreciation account and credit the Bus asset account.
Finally, we credit the Cash account for the cash payment made in
connection with the exchange. The same analysis and approach is
taken for a loss on an asset exchange with commercial
substance.
Sheet1
$ 49,000
10,000
Cash
35,000
45,000
3,000
$ 275,000
2006
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*
This chapter covered a great deal of new material related to
property, plant and equipment acquisition, depreciation and
disposal. We also covered accounting issues for intangible assets
and natural resources.
Appraised% ofPurchaseApportioned
Remaining book value21,000$
Revised annual depreciation4,200$
Property, plant, and equipment:
Financial Statement Effect
3. Does not extend life beyond original
estimate.
replacements.
Betterments
and
Extraordinary
Repairs
Dr.Cr.
Cost100,000$
Book Value70,000$
Machine100,000
Dr.Cr.
Cost of old bus40,000$
Cash35,000 45,000
Cost of old bus40,000$
Cash35,000 45,000