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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

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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 businessare not intended for sale to customers

Recorded at cost

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Land - a building siteLand improvements

driveway

parking lots

fences

underground sprinkler systems

BuildingsEquipment

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Types of Expenditures

Revenue Expenditure

-immediately charged against revenue as an expense

Capital Expenditure

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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

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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)

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Buildings

When a new building is constructed, its cost consists of:

the contract price architect's fees

building permitsexcavation cost

interest costs during

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Cost of Equipment Includes:

cash purchase pricesales tax

freight charges and insurance

during transit paid by the purchaser

expenditures required in

assembling

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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

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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.

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Land

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C

A

SH

Accumulated Depreciation

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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

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Factors in Computing

Depreciation

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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

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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

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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

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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.

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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.

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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 AcceleratedCost

RecoverySystem

The choice of depreciation method must be

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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.

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Examples:

motor tune-upsoil 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

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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

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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.

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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

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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 =

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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

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Amortization

Allocation of the cost of an intangible

asset to expense over the shorter of:

its useful (economic) lifeits legal life

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Types of Intangible Assets

Patents

Copyrights

Trademark or Trade Names

Franchises and Licenses

Goodwill

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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.

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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.

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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

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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

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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 managementdesirable location

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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

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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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COP Y RI GHT

Copyright © 1999, John Wiley & Sons, Inc. All rights reserved. Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful. Request for further information should be addressed to the

Permissions Department, John Wiley & Sons, Inc. The purchaser may make back-up copies for his/her own use only and not for

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