LONG-LIVED ASSETS AND DEPRECIATION Chapter 7 12-1 © 2005 McGraw-Hill Ryerson Limited

LONG-LIVED ASSETS AND LONG-LIVED ASSETS AND DEPRECIATIONDEPRECIATION

Chapter 7Chapter 7

12-1 © 2005 McGraw-Hill Ryerson Limited.

Characteristics: Used in the operations of a company. Have a useful life greater than one

accounting period. May be classified as Tangible or

Intangible.

Capital AssetsCapital Assets

© 2007 McGraw-Hill Ryerson Ltd.

Also referred to as Property, Plant and Equipment or as Fixed Assets.

Examples: buildings, land, equipment, leasehold improvements, vehicles, and natural resources.

Tangible Capital AssetsTangible Capital Assets


Lack physical substance. Examples: patents, trademarks, and

copyrights. Goodwill is also an intangible capital asset

but it is shown separately on the balance sheet.

Intangible Capital AssetsIntangible Capital Assets


Capital assets are recorded at cost which, includes all normal and reasonable expenditures necessary to get the asset in place and ready for its intended use.

Cost of Capital AssetsCost of Capital Assets


CapitalizeCapitalize

A cost that is added to an asset account, A cost that is added to an asset account, as distinguished from being expensed as distinguished from being expensed immediately.immediately.


An expenditure to make a capital asset more efficient or productive and/or extend the useful life of the capital asset beyond original expectations.

Examples: major overhauls of machinery, roof replacements, and plant expansions.

BettermentsBetterments


Is not subject to amortization. Cost of land includes:

Purchase price Legal fees Real estate commissions Accrued property taxes Payments for surveying, grading, draining,

and clearing the land Assessments by local governments

LandLand


Assets that increase the usefulness of the land but have a limited life.

Costs are charged to a separate asset account.

Costs are amortized over the period they benefit.

Land ImprovementsLand Improvements


Costs include all expenditures to make the building ready for its intended use.

Costs are amortized over the period they benefit.

BuildingsBuildings


Costs of alterations or improvements to leased property.

Costs are amortized over the life of the improvements or the life of the lease, whichever is shorter.

Examples include flooring, painting, storefronts, and partitions.

Leasehold ImprovementsLeasehold Improvements


Costs include all expenditures normal and necessary to purchase it and prepare it for its intended use.

Costs are amortized over the periods they benefit.

Machinery and EquipmentMachinery and Equipment


A process of systematically allocating the cost of a capital asset to expense over its estimated useful life.

Depreciation does not measure the decline in value or deterioration of an asset.

Depreciation begins to be recorded when the asset is put into use.

DepreciationDepreciation


Capital assets help the organization earn revenues over several accounting periods.

The cost of these assets is depreciated (spread out) over these same periods.

Cost

Useful life



Factors relevant in determining amortization:

1. Cost

2. Residual value

3. Useful life



The most commonly used methods are:

1. Straight-line

2. Units-of-production

3. Double-declining balance

Depreciation MethodsDepreciation Methods


The same amount is expensed each period of the asset’s useful life.

Straight-line depreciationexpense

=Cost – Estimated residual value

Estimated useful life

Straight-Line MethodStraight-Line Method


A piece of shoe-inspection machinery is purchased on January 1, 2011.

The relevant data is as follows:

Cost $10,000Estimated residual value -1,000Cost to be amortized $9,000Estimated useful life:Accounting periods 5 yearsUnits inspected 36,000 shoes

Illustration


Straight-line amortization expense

=Cost – Estimated salvage value


Illustration: Straight-Line Method

$10,000 – $1,000

5 years=

= $1,800/ year


Illustration: Straight-Line Method

The annual adjusting entry to record amortization on this equipment would be:

Amortization Expense, equipment 1,800

Accumulated Amortization, –equipment 1,800

20112011 20122012 20132013 20142014 20152015

EquipmentEquipment $10,000$10,000 $10,000$10,000 $10,000$10,000 $10,000$10,000 $10,000$10,000

Less: Acc. Amort.Less: Acc. Amort. 1,8001,800 3,6003,600 5,4005,400 7,2007,200 9,0009,000

Book ValueBook Value $8,200$8,200 $6,400$6,400 $4,600$4,600 $2,800$2,800 $1,000$1,000


Amortization per unit =

Cost – Estimated residual value

Total estimated units of production

This method is employed when the use of an asset varies greatly from one period to the next.

The amount charged to expense is based on the usage of the asset.

Annual amortization

expense=

Actual production x Amortization per unit

Units-of-Production MethodUnits-of-Production Method


Amortization per unit (shoe)

Illustration: Units-of-Production Method

$10,000 – $1,000

36,000 units (shoes)=

$.25/shoe

Assume actual production is as follows:Assume actual production is as follows:

2011 2012 2013 2014 20152011 2012 2013 2014 2015

Units (shoes) 7,000 8,000 9,000 7,000 6,000

x.25 x.25 x.25 x.25 x.25

Amortization $1,750 $2,000 $2,250 $1,750 $1,250*

=

*Maximum amortization allowed since 36,000 units have been produced.


Illustration: Units-of-Production Method

20112011 20122012 20132013 20142014 20152015





This method yields larger amortization expenses This method yields larger amortization expenses in the early years of an asset’s life and smaller in the early years of an asset’s life and smaller charges in later years.charges in later years.

A constant rate, up to twice the straight-line rate, A constant rate, up to twice the straight-line rate, is applied to the asset’s beginning of the period is applied to the asset’s beginning of the period book value.book value.

Declining-Balance MethodDeclining-Balance Method


Steps:Steps:

1.1. Compute the double-declining balance rate.*Compute the double-declining balance rate.*

rate = 2 / (estimated life in years)rate = 2 / (estimated life in years)

2.2. Multiply the rate by the asset’s opening book Multiply the rate by the asset’s opening book value.value.

amortization expense = rate x book valueamortization expense = rate x book value

**Note: Salvage value is not used in this calculation.Note: Salvage value is not used in this calculation.

Double-Declining Balance MethodDouble-Declining Balance Method


Illustration: Double-Declining-Balance MethodRate = 2 / 5 years x 100%

= 40% per year

YearYear Book Value atBook Value at

start of periodstart of period

Amortization Amortization ExpenseExpense

Accumulated Accumulated AmortizationAmortization

Book Value atBook Value at

end of periodend of period

20112011 $10,000$10,000 40% x 10,000 40% x 10,000

= $4,000= $4,000

$4,000$4,000 $6,000$6,000

20122012 6,0006,000 40% x 6,00040% x 6,000

= 2,400= 2,400

6,4006,400 3,6003,600

20132013 3,6003,600 40% x 3,60040% x 3,600

= 1,440= 1,440

7,8407,840 2,1602,160

20142014 2,1602,160 40% x 2,16040% x 2,160

= 864= 864

8,7048,704 1,2961,296

20152015 1,2961,296 296 296 (maximum)(maximum)

9,0009,000 1,0001,000

(salvage value)(salvage value)


Illustration: Double Declining Balance Method

20112011 20122012 20132013 20142014 20152015





PeriodPeriod Straight-Straight-lineline

Units-of-Units-of-productionproduction

Double-Double-Declining Declining BalanceBalance

20112011 $1,800$1,800 $1,750$1,750 $4,000$4,000

20122012 1,8001,800 2,0002,000 2,4002,400

20132013 1,8001,800 2,2502,250 1,4401,440

20142014 1,8001,800 1,7501,750 864864

20152015 1,800 1,800 1,2501,250 296296

$9,000$9,000 $9,000$9,000 $9,000$9,000

Comparison of MethodsComparison of Methods


Assets may be purchased or disposed of at any Assets may be purchased or disposed of at any time during the year.time during the year.

Amortization for a partial year is recorded when Amortization for a partial year is recorded when the purchase or disposal is made at a time other the purchase or disposal is made at a time other than the beginning or end of the accounting than the beginning or end of the accounting period.period.

Partial-Year AmortizationPartial-Year Amortization


Methods:Methods:

1.1. Nearest whole monthNearest whole month If the asset is in use for If the asset is in use for moremore than half of the month, than half of the month,

amortization is calculatedamortization is calculated for the whole month. for the whole month. If the asset is in use for If the asset is in use for lessless than half of the month, than half of the month,

amortization is not calculatedamortization is not calculated for the month. for the month.

2.2. Half-year ruleHalf-year rule Six months’ amortization is recorded regardless Six months’ amortization is recorded regardless

when an asset is acquired or disposed of.when an asset is acquired or disposed of.

Partial-Year AmortizationPartial-Year Amortization


Mini-QuizMini-Quiz

Gamma Company purchased a computer costing $4,000 on April 16. It is expected to last for three years and then sell for $400.

Calculate amortization for the first year using the:

1. Straight-line method.

2. Double declining balance method.


Mini-QuizMini-Quiz


Straight-line amortization expense

=Cost – Estimated residual value


=$4,000 – $400

3 yearsX 8/12 year

= $800

XPortion of

year


Mini-QuizMini-Quiz


DDB amortization

expense=

=

= $1778 (rounded)

DDB rate x Cost x Portion of year

(2 x 1/3) x $4,000 x 8/12


Amortization rates for current and future Amortization rates for current and future periods may be revised if there is a periods may be revised if there is a change in an asset’s:change in an asset’s:

1.1. Estimated residual value and/or useful life.Estimated residual value and/or useful life.oror

2.2. Cost due to betterments.Cost due to betterments.

Revising Amortization RatesRevising Amortization Rates


The unamortized cost of the asset is amortized (spread) over the remaining life of the asset.

This is considered to be a change in an accounting estimate and not an error.

Changes in Estimated Useful Life Changes in Estimated Useful Life and/or Estimated Salvage Valueand/or Estimated Salvage Value


Example: Straight-line Method

Revised amortization for remaining years

=

Remaining book value

Revised residual value

Revised remaining useful life

Changes in Estimated Useful Life Changes in Estimated Useful Life and/or Estimated residual Valueand/or Estimated residual Value


Capital assets may be disposed of for a Capital assets may be disposed of for a variety of reasons such as:variety of reasons such as:

1.1. ObsolescenceObsolescence

2.2. Wear and tearWear and tear

3.3. DamageDamage

4.4. Changing business plansChanging business plans

Disposal of Capital AssetsDisposal of Capital Assets


Accounting for disposal involves:Accounting for disposal involves:1.1. Recording of amortization up to date of Recording of amortization up to date of

disposal.disposal.

2.2. Removal of asset and associated Removal of asset and associated accumulated amortization from the accumulated amortization from the accounts.accounts.

3.3. Recording any cash received or paid in the Recording any cash received or paid in the disposal.disposal.

4.4. Recording any gain or loss on disposal.Recording any gain or loss on disposal.

Disposal of Capital AssetsDisposal of Capital Assets


Tangible capital assets such as standing Tangible capital assets such as standing timber, mineral deposits, and oil fields.timber, mineral deposits, and oil fields.

Are recorded at cost, which includes all Are recorded at cost, which includes all expenditures necessary to acquire and expenditures necessary to acquire and prepare the resource for use.prepare the resource for use.

Natural ResourcesNatural Resources


Amortization per unit =

Cost – Estimated residual value

Total units of capacity

Amortization expense = Units

extractedx Amortization per unit

Natural resources are amortized based on units extracted or depleted.

Natural ResourcesNatural Resources


Have no physical substance.Have no physical substance. Are used in operations.Are used in operations. Are recorded at cost when purchased.Are recorded at cost when purchased. Are amortized over their estimated useful Are amortized over their estimated useful

life.life. Examples include patents, trademarks, Examples include patents, trademarks,

and copyrights.and copyrights.

Intangible AssetsIntangible Assets


AmortizationAmortization Estimated useful life may be affected by Estimated useful life may be affected by

legal, regulatory, competitive, or other legal, regulatory, competitive, or other factors.factors.

Only the straight-line method is used.Only the straight-line method is used.

Intangible AssetsIntangible Assets


PatentsPatents

Grants given by the federal government to Grants given by the federal government to an inventor (U.S.) bestowing the exclusive an inventor (U.S.) bestowing the exclusive right to produce and sell the invention for right to produce and sell the invention for 17 years.17 years.

Depreciation is calculated on its useful life Depreciation is calculated on its useful life for the 17 years, whichever is shortest.for the 17 years, whichever is shortest.


CopyrightsCopyrights

Exclusive right to reproduce and sell a Exclusive right to reproduce and sell a book, musical composition, film and similar book, musical composition, film and similar items for 75 years. (U.S.)items for 75 years. (U.S.)

Amortization is the shorter of the 75 years Amortization is the shorter of the 75 years or the economic life. or the economic life.


TrademarksTrademarks

Distinctive identification of a manufactured Distinctive identification of a manufactured product or of a service taking the form of product or of a service taking the form of a name, a slogan, a sign, a logo, or an a name, a slogan, a sign, a logo, or an emblem.emblem.


FranchiseFranchise

Privileges granted by a government, Privileges granted by a government, manufacturer, or distributor to sell a manufacturer, or distributor to sell a product or service in accordance with product or service in accordance with specified conditions.specified conditions.


LeaseholdsLeaseholds

The right to use a fixed asset for a The right to use a fixed asset for a specified period of time, typically beyond 1 specified period of time, typically beyond 1 year. year.

Sometimes included with plant and Sometimes included with plant and equipment assets.equipment assets.


Leasehold ImprovementsLeasehold Improvements

Tenant spends money to improve the Tenant spends money to improve the leased property. leased property.

Not permitted to be removed from the Not permitted to be removed from the premises when a lease expires.premises when a lease expires.

EX. Panels, walls, air conditioning, EX. Panels, walls, air conditioning, storefronts, flooringstorefronts, flooring


End of ChapterEnd of Chapter


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LONG-LIVED ASSETS AND DEPRECIATION Chapter 7 12-1 © 2005 McGraw-Hill Ryerson Limited