Financial Accounting:
Tools for Business Decision Making
Kimmel, Weygandt, Kieso
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Chapter 9
Reporting and Analyzing Long-Lived Assets
After studying Chapter 9, you should be able to:
Describe how the cost principle applies to plant assets. Explain the concept of depreciation.
Compute periodic depreciation using the straight-line
method, and contrast its expense pattern with those of other methods.
Describe the procedure for revising periodic
After studying Chapter 9, you should be able to:
Explain how to account for the disposal of plant assets. Describe methods for evaluating the use of plant assets. Identify the basic issues related to reporting intangible
assets.
Indicate how long-lived assets are reported on the
balance sheet.
Chapter 9
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Plant Assets
Resources that:
have physical substance
are used in the operations of a business are not intended for sale to customers
Recorded at cost
Land - a building site Land improvements
driveway
parking lots
fences
underground sprinkler systems
Buildings Equipment
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Types of Expenditures
Revenue Expenditure
-immediately charged against revenue as an expense
Capital Expenditure
Cost is measured by:
the cash paid in a cash transaction, or
the cash equivalent price paid when noncash
assets are used in payment.
The cash equivalent price is equal to:
the fair market value of the asset given up, or the fair market value of the asset received,
whichever is more clearly determinable.
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Cost of Land Includes:
the cash purchase price
closing costs such as title and attorney's fees
real estate brokers commissions
Cost of Land
Improvements Include:
All expenditures necessary to make
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Cost of Buildings Include:
All necessary expenditures relating to the purchase or construction of a building.
When a building is purchased such costs include the:
purchase price
closing costs (attorney's fees, title
insurance)
Buildings
When a new building is constructed, its cost consists of:
the contract price architect's fees
building permits excavation cost
interest costs during
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Cost of Equipment Includes:
cash purchase price sales tax
freight charges and insurance
during transit paid by the purchaser
expenditures required in
assembling
Equipment
Two criteria apply in determining the cost of equipment:
the frequency of cost - one time or recurring
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Depreciation
Applies to three classes of plant assets: Land improvements
The revenue-producing ability of an asset declines during its useful life because of wear and tear.
Depreciable Assets
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Depreciation
The process of allocating to expense the cost of a plant asset over its useful life in a rational and systematic manner.
A process of cost allocation, not a process of asset valuation.
Land
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C
A
SH
Accumulated Depreciation
Factors in Computing
Depreciation
Cost - historical cost of the asset
Useful life - estimate of the expected productive life in terms of:
time
units of out activity or output
Factors in Computing
Depreciation
Depreciation Methods
Straight-line
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Affects of Depreciation
Depreciation affects the balance sheet through accumulated depreciation,
which is reported as a reduction from plant assets.
Depreciation affects the income
Straight-Line Method
The most
widely used method of depreciation
Depreciation is
the same for
each year of the asset's useful
life.
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Depreciable Cost*
The asset's useful life measured in years
Straight-Line
Depreciation Formula
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Partial Year Depreciation
If an asset is purchased during the
year rather than on January 1, the
annual depreciation is prorated
Declining-Balance Method
An accelerated
method
Accelerated methods
of depreciation result in more
depreciation in the early years of an asset's life and less depreciation in the later years.
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Units-of-Activity Method
The life of an asset is
expressed in
terms of the total units of
production or
the use expected from the asset.
Use of
Depreciation Methods in
Major U.S. Companies
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Depreciation and the IRS
The IRS allows corporate taxpayers to deduct depreciation when computing taxable income.
Depreciation and the IRS
Many large corporations use straight-line depreciation in their financial
statements to maximize net income. At the same time they use a special
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Depreciation and the IRS
For tax purposes:
the straight-line method or
a special accelerated-depreciation method called
the
Modified Accelerated Cost
Recovery System
The choice of depreciation method must be
Revising Periodic Depreciation
When a change in an estimate is required, the change is made in current and future years but not to prior periods.
Significant changes in estimates must be disclosed in the financial statements.
Extending an asset's estimated life reduces depreciation expense and increases net
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Ordinary Repairs
Expenditures to maintain the operating efficiency and
expected productive life of the asset.
Examples:
motor tune-ups oil changes
the painting of buildings
the replacing of worn-out gears
Ordinary repairs increase Repair
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Additions and Improvements
Costs incurred to increase the:
operating efficiency;
productive capacity; or
expected useful life of the plant asset.
Usually material in amount and occur
infrequently during the period of ownership
Impairment
A permanent decline in the
market value of an asset
Written down to the new market
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Plant Asset Disposals
The depreciation for the fraction of the year to the date of disposal must be recorded.
Depreciation Expense 8,000 Accumulated Depreciation 8,000
Compute Book Value:
Book Value =
Cost - Accumulated Depreciation
Sale of Plant Assets
In the sale of an asset, the book value of the asset is compared with the proceeds from the sale. If the proceeds exceed the book
value a gain on disposal occurs. Conversely, if proceeds from
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Retirement of Plant Assets
Recorded by decreasing Accumulated Depreciation for the full amount of
depreciation taken over the life of the asset.
The asset account is reduced for the original cost of the asset.
Analyzing Plant Assets
The three measures by which plant assets are evaluated are:
Average useful life;
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Average Useful Life
Useful life of an assets is chosen by a company
By selecting a longer estimated useful life:
A company spreads the cost of its plant assets
over a longer period of time;
The amount of expense reported in each period is
Average Useful Life
On the other hand, a shorter estimated useful live will result in a lower reported net income.
Average Useful Life of Plant Assets =
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Average Age of Plant Assets
Most companies use straight-line
depreciation for financial reporting.
Average age of plant assets =
Asset Turnover Ratio
There are two ways a company can increase its return on assets:
Increase profit per sale - measured by profit
margin ratio.
Increase its volume of sales - measured by
the asset turnover ratio =
Net Sales
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Intangible Assets
rights
privileges
competitive advantages that result from ownership of long-lived assets that do not possess physical
Amortization
Allocation of the cost of an intangible
asset to expense over the shorter of:
its useful (economic) life its legal life
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Types of Intangible Assets
Patents
Copyrights
Trademark or Trade Names
Franchises and Licenses
Goodwill
An exclusive right issued by the U.S.
Patent Office that enables the
recipient to manufacture, sell, or
control a patent for 17 years from the
date of grant.
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The initial cost of a patent is cash or cash equivalent price paid to acquire the patent.
Legal costs of protecting a patent in an infringement suit are added to the
Patent account and amortized over the remaining life of the patent.
Research and
Development Costs
Because of the uncertainty of
identifying the extent and timing of
future benefits, these costs are
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Copyrights
Copyrights are granted by the federal government giving the owner the
exclusive right to reproduce and sell artistic or published work.
Impressionist master Pierre Renoir died in
1919…
therefore, anyone can copy
A GIRL WITH A WATERING CAN
or his other paintings without receiving permission or paying
Trademarks/
Trade Names
A word, phrase,
jingle,or symbol that
distinguishes or
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Franchises
A franchise is a contractual agreement under which the franchiser grants the franchisee the right to:
sell certain products;
render specific services or to use certain
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Licenses
Operating rights granted by a government body permit the
enterprise to use public property in performing its service (i.e., the use of airwaves for radio or TV
Costs Associated with
Franchise or License
When costs can be identified with the acquisition of the franchise or license, an intangible asset should be
recognized.
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Goodwill
Goodwill represents the value of all favorable attributes that relate to a business enterprise, including:
exceptional management desirable location
Goodwill is recorded only when there is an exchange transaction that
involves the purchase of an entire business.
In other words, if you didn’t
buy it, it’s not on your balance
sheet.
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Goodwill
When an entire business is
purchased, goodwill is the excess of
cost over the fair market value of
Presentation Of
Long-Lived Assets
Plant assets are shown in the
financial statements under
Property, Plant, and Equipment.
Intangibles are shown separately under
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