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Chapter 9. REPORTING AND ANALYZING LONG-LIVED ASSETS. Operating Assets. Long-term, or non-current, assets acquired for use in a business rather than for resale. Examples include. Property, Plant, and Equipment Intangible Assets Natural Resources. Nature of Operating Assets.

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Chapter 9

REPORTING AND ANALYZING LONG-LIVED ASSETS


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Operating Assets

Long-term, or non-current, assets acquired for use in a business rather than for resale. Examples include

Property, Plant, and Equipment

Intangible Assets

Natural Resources


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Nature of Operating Assets

Property, Plant, and Equipment--Tangible, long-lived assets acquired for business operations. Depreciation is the process of allocating the costs of these assets over their estimated useful lives.


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Nature of Operating Assets

  • Property, Plant, and Equipment

  • Intangible Assets--Intangible long-lived assets without physical substance that are used in business. Amortization is the process of allocating the costs of these assets over their estimated useful lives.


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Nature of Operating Assets

  • Property, Plant, and Equipment

  • Intangible Assets

  • Natural Resources--Assets that are physically consumed or waste away in the course of business. Depletion is the process of allocating costs of natural resources as they are mined or extracted.


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Accounting for Property, Plant, and Equipment

Recording asset acquisition.

Allocating the cost of an asset over its useful life, or depreciation.

Accounting for maintenance, repairs, and improvements made to the asset.

Accounting for sale or disposal of the asset.


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Assets Acquired by Purchase

John Doe purchased a delivery truck to use in his business. The cost of the truck was $50,000. What entry will John make if he paid cash for the truck?


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Assets Acquired by Purchase

John Doe purchased a delivery truck to use in his business. The cost of the truck was $50,000. What entry will John make if he paid cash for the truck?

Delivery Truck................................ 50,000

Cash........................................ 50,000

Purchased a delivery truck for $50,000.


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Assets Acquired by Purchase

John Doe purchased a delivery truck to use in his business. The cost of the truck was $50,000. What entry will John make if he purchased the truck with $10,000 cash and then borrowed the remaining $40,000?


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Assets Acquired by Purchase

John Doe purchased a delivery truck to use in his business. The cost of the truck was $50,000. What entry will John make if he purchased the truck with $10,000 cash and then borrowed the remaining $40,000?

Delivery Truck................................ 50,000

Cash........................................ 10,000

Notes Payable.......................... 40,000

Purchased a delivery truck for $50,000.


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Assets Acquired by Purchase

John Doe purchased a delivery truck to use in his business. The cost of the truck was $50,000. What entry will John make if he traded a piece of land worth $50,000 for the truck?


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Assets Acquired by Purchase

John Doe purchased a delivery truck to use in his business. The cost of the truck was $50,000. What entry will John make if he traded a piece of land worth $50,000 for the truck?

Delivery Truck................................ 50,000

Land......................................... 50,000

Purchased a delivery truck for $50,000.


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Plant Assets

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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Buildings

  • If a building is purchased, but needs to be readied for its intended use, cost includes

    • expenditures for remodeling rooms or offices

    • replacing or repairing

      • roof

      • floors

      • electrical wiring

      • plumbing


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Buildings

  • 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)

    • real estate broker's commissions


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Plant AssetsLand

Cost of land includes

  • Cash price, closing costs, brokers’ commissions, accrued property taxes, etc.

  • Can also include costs to raze a building, drain and fill the land

  • Proceeds from sale of salvaged materials are deducted from the cost


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Cost ofLand Improvements

  • All expenditures necessary to make the improvements ready for their intended use

    • Drive ways

    • Parking lots

    • Fences

    • Underground sprinklers


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Assets Acquired by Purchase

Basket Purchase--The purchase of two or more assets acquired together at a single price.

Relative Fair Market Value Method--A way of allocating a basket purchase price to the individual assets acquired based on their respective market values.


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Basket Purchase

When two or more assets are acquired at a single price. The prices are allocated on a “relative fair market value method.”

In the example below, on Oct 31 we purchased land and building for a total of $360,000.


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Basket Purchase

When two or more assets are acquired at a single price. The prices are allocated on a “relative fair market value method.”

In the example below, we purchased land and building for a total of $360,000.

Asset FMV Total Value Cost `

Land $100,000 25% .25 x 360,000 = $ 90,000

Building $300,000 75% .75 x 360,000 = $ 270,000

$400,000 100% $ 360,000


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Basket Purchase

When two or more assets are acquired at a single price. The prices are allocated on a “relative fair market value method.”

In the example below, we purchased land and building for a total of $360,000.

Asset FMV Total Value Cost `

Land $100,000 25% .25 x 360,000 = $ 90,000

Building $300,000 75% .75 x 360,000 = $ 270,000

$400,000 100% $ 360,000

Journal Entry: Land............. 90,000

Building........ 270,000

Cash..... 360,000


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Basket Purchase

Unless, of course, the intent of purchasing the building was to demolish it and build a new one.

In which case, the whole cost, plus the demolition cost, is the cost of the land.


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CASH

Allocating The Costs of Plant and Equipment to Expense

Depreciation--A systematic write-off each period of the original cost assigned to the asset.

Useful Life--The length of time a company expects to use an asset.

Salvage or Residual Value--What the asset will be worth at the end of its useful life (net of disposal costs).


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Other Terms

Accumulated Depreciation--The total depreciation recorded on an asset since its acquisition. It is a contra-asset account that is offset against the cost of the asset on the balance sheet.

Book Value--Equal to the original cost of the asset less accumulated depreciation.


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Calculating Depreciation Expense

In order to calculate depreciation expense, the following information is needed:

The original cost.

The estimated useful life.

The salvage or residual value.


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Depreciation Expense

$24,000

Allocate the expenses (cost) of the asset –

– to the periods it contributes to revenue


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Straight-Line Method

The depreciation method in which the cost of an asset is allocated equally over each period of the asset’s estimated useful life.

The asset is assumed to benefit all periods equally.


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Time-Factor Depreciation Formulas

Straight-Line--Recognizes equal periodic depreciation charges of the asset’s useful life. The formula for Straight-Line is:


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Time-Factor Depreciation Formulas

Straight-Line--Recognizes equal periodic depreciation charges of the asset’s useful life. The formula for Straight-Line is:

Depreciation = Cost - Salvage Value

Expense Useful Life (years)


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Example: Depreciation

  • The following information will be used to provide an example of calculating depreciation:

    • Acquisition Cost $24,000

    • Estimated Residual Value $ 2,000

    • Estimated Useful Life 4 years

    • This is the second year the asset has

      been in use.


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Example: Depreciation

Depreciation = Cost - Salvage Value

Expense Useful Life (years)


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Example: Depreciation

Depreciation = Cost - Salvage Value

Expense Useful Life (years)

Depreciation = $24,000 - $2,000

Expense 4

Depreciation = $5,500 per year

Expense


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Example: Depreciation

The journal entry to record depreciation for 2005 would be:

Depreciation Expense..................... 5,500

Accumulated Depreciation........ 5,500

To record depreciation expense for the asset.



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Depreciation Methods

  • Straight Line

  • Units-of-production

  • Sum-of-the-years’ digits

  • Declining Balance





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Comparison of Methods

Depreciation Expense


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Partial-Year Depreciation

If the asset was not purchased at the beginning or end of the year, then depreciation should only be recorded for the months the asset was in use.

To simplify the process, some companies take a full year depreciation in the year of purchase, but take no depreciation expense in the year the asset is sold.


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Example: Depreciation

  • The following information will be used to provide an example of calculating depreciation:

    • Acquisition Cost $24,000

    • Estimated Residual Value $ 2,000

    • Estimated Useful Life 4 years

    • This is the first year the asset has

      been in use


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Example: Depreciation

Depreciation = Cost - Salvage Value

Expense Useful Life (years)


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Example: Depreciation

Depreciation = Cost - Salvage Value

Expense Useful Life (years)

= $24,000 - $2,000 = $5,500

4

Depreciation = $5,500 x .5 = $2,750

Expense 1st yr


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Example: Depreciation

The journal entry to record depreciation for 2005 would be:

Depreciation Expense..................... 2,750

Accumulated Depreciation........ 2,750

To record depreciation expense for the asset.


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Depreciation for Income Taxes

Depreciation for tax purposes must be computed in accordance with federal income tax law.

Modified Accelerated Cost Recovery System (MACRS).

Due to MACRS depreciation calculations, the depreciation expense for federal income tax will differ from the depreciation computed for financial reporting purposes.


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Expenditures for Plant and Equipment

  • Ordinary Expenditures--Expenditures for repairs, maintenance, and minor improvements which benefit the period in which they are made.

  • Capital Expenditure--Expenditures that lengthen an asset’s useful life, increases its capacity, or changes its use.


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Capital Expenditures

In order to classify as a capital expenditure, three criteria should be met:

  • The amount must be significant.

  • It should benefit the company for several periods.

  • It should increase the productive life or capacity of the asset.


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Example: Ordinary Expenditure

Tool Time paid $3,000 during the year to maintain the company truck. What entry needs to be made?


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Example: Ordinary Expenditure

Tool Time paid $3,000 during the year to maintain the company truck. What entry needs to be made?

Maintenance Expense........... 3,000

Cash................................ 3,000

Spent $3,000 to maintain truck.


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Example: Capital Expenditure

Tool Time paid $10,000 to rebuild the engine in the company truck. It is expected that the new engine will add 2 years to the useful life of the truck.


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Example: Capital Expenditure

Tool Time paid $10,000 to rebuild the engine in the company truck. It is expected that the new engine will add 2 years to the useful life of the truck.

Company Truck.................. 10,000

Cash............................. 10,000

Spent $10,000 to rebuild truck engine.


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Disposal of Property,Plant, and Equipment

Discarding

Selling

Exchanging for another asset


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Example: Disposal

John Doe decided to scrap a truck at the end of its useful life of 10 years. The original cost of the truck was $20,000. What entry will John make to scrap the truck?

Ignore John’s legal fees


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Example: Disposal

John Doe decided to scrap a truck at the end of its useful life of 10 years. The original cost of the truck was $20,000. What entry will John make to scrap the truck?

Accumulated Depreciation....... 20,000

Truck…............................... 20,000

Scrapped $20,000 truck.


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Example: Disposal

John Doe decided to scrap a truck after using it for only 9 years of its useful life of 10 years. The original cost of the truck was $20,000. What entry will John make to scrap the truck?


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Example: Disposal

John Doe decided to scrap a truck after using it for only 9 years of its useful life of 10 years. The original cost of the truck was $20,000. What entry will John make to scrap the truck?

Accumulated Depreciation............ 18,000

Loss on Disposal........................... 2,000

Truck...................................... 20,000

Scrapped $20,000 truck.


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Example: Sale

John Doe decided to sell the truck after using it for its useful life of 10 years. The original cost of the truck was $20,000. What entry will John make if he sells the truck for $3,000?


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Example: Sale

John Doe decided to sell the truck after using it for its useful life of 10 years. The original cost of the truck was $20,000. What entry will John make if he sells the truck for $3,000?

Cash….......................................... 3,000

Accumulated Depreciation............ 20,000

Truck….................................... 20,000

Gain on Sale…........................ 3,000

Sold a $20,000 truck for $3,000.


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Example: Sale

John Doe decided to sell the truck after using it for 8 years of its useful life of 10 years. The original cost of the truck was $20,000. What’s the entry if he sells the truck for $3,000?


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Example: Sale

John Doe decided to sell the truck after using it for 8 years of its useful life of 10 years. The original cost of the truck was $20,000. What’s the entry if he sells the truck for $3,000?

Cash............................................. 3,000

Accumulated Depreciation............ 16,000

Loss on Sale................................. 1,000

Truck....................................... 20,000

Sold a $20,000 truck for $3,000.


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Lease

Depending on the lease provisions, a lease may resemble a purchase or a rental agreement.

A contract that specifies the terms under which the owner of an asset transfers the right to use the asset to another party.


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Assets Acquired by Leasing

Lessee--The party granted the right to use the property under the terms of a lease.

Lessor--The owner of the property that is rented (leased) to another party.

Operating Lease--A simple rental agreement.

Capital Lease--A leasing transaction that is recorded as a purchase by the lessee.


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Lease Provisions

Cancellation Clause

Specifies under what

circumstances the lease

may be canceled.


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Lease Provisions

Cancellation Clause

Specifies under what

circumstances the lease

may be canceled.

Delineates time period the

lease is to be in force.

Term


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Lease Provisions

Cancellation Clause

Specifies under what

circumstances the lease

may be canceled.

Delineates time period the

lease is to be in force.

Term

Bargain Purchase Option

Grants lessee the right to

purchase the asset at the end of the lease term for less than the residual value.


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Lease Provisions

Minimum Lease Payment

Minimum Lease

Payment

Rental payment required

over lease term plus any

payment for residual value.


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Lease Provisions

Minimum Lease Payment

Minimum Lease

Payment

Rental payment required

over lease term plus any

payment for residual value.

Residual Value

Market value of leased

asset at end of lease term.


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Classifying Leases

Lease classification can have a major impact on the financial statements.

  • A lease is classified an operating lease if the criteria for a capital lease are not met.

  • A lease is classified as a capital lease if it is non-cancelable and meets any one of the following four criteria.


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Capital Lease Criteria

  • The lease transfers ownership of the leased asset to the lessee by the end of the lease term.

  • The lease contains an option allowing the lessee to purchase the asset at the end of the lease term at a bargain price.

  • The lease term is equal to 75 percent or more of the estimated economic life of the asset.

  • The present value of the lease payments at the beginning of the lease is 90 percent or more of the fair market value of the leased asset.


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Classifying a Lease

Yes

Transfer of Ownership?

No

Yes

Bargain Purchase

Option?

No

Yes

Term  75% of

Useful Life?

No

Yes

PV Payment 90%

of FMV?

Capital

Lease

Operating

Lease

No


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Example: Operating Lease

Bob Jones signed a two-year lease which requires a monthly payment of $1,000. When the lease expires, Bob will either move out or negotiate a new lease. The journal entry is the following:


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Example: Operating Lease

Bob Jones signed a two-year lease which requires a monthly payment of $1,000. When the lease expires, Bob will either move out or negotiate a new lease. The journal entry is the following:

Rent (or Lease) Expense......... 1,000

Cash.................................. 1,000

To record monthly rent on office building.


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Example: Capital Lease

Dreams Inc. leased a hotel for lease payments of $100,000 for 20 years. Since at the end of 20 years Dreams will own the property, the lease is treated as a purchase. The journal entries are as follows:


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Example: Capital Lease

Dreams Inc. leased a hotel for lease payments of $100,000 for 20 years. Since at the end of 20 years Dreams will own the property, the lease is treated as a purchase. The journal entries are as follows:

Leased Property.................. 851,360

Lease Liability................ 851,360

To record hotel acquired under a 20-year lease.


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Example: Capital Lease

Dreams Inc. leased a hotel for lease payments of $100,000 for 20 years. Since at the end of 20 years Dreams will own the property, the lease is treated as a purchase. The journal entries are as follows:

Leased Property.................. 851,360

Lease Liability................ 851,360

To record hotel acquired under a 20-year lease.

Lease Liability...................... 14,864

Interest Expense.................. 85,136

Cash.............................. 100,000

To record annual capital lease payments.


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Intangible Assets

Rights and privileges that are long-lived, are not held for resale, have no physical substance, and usually provide their owner with a competitive advantage.


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Accounting for Intangible Assets

Patent--An exclusive right granted for 17 years by the government to manufacture and sell an invention.

Franchise--An exclusive right to sell a product or offer a service in a certain geographical area.

Goodwill--An intangible asset that shows a business is worth more than the net value of its assets.


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Amortization

The periodic allocation to expense of an intangible asset’s cost. The straight-line method is used most frequently.


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Example: Patent

Uncle Buck purchased a patent for $100,000. The useful life was 5 years. What entry is needed to record the purchase?


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Example: Patent

Uncle Buck purchased a patent for $100,000. The useful life was 5 years. What entry is needed to record the purchase?

Patent.......................................... 100,000

Cash...................................... 100,000

Purchased a patent for $100,000.


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Example: Patent

Uncle Buck purchased a patent for $100,000. The useful life was 5 years. What entry is needed to record the patent’s amortization after the first year?


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Example: Patent

Uncle Buck purchased a patent for $100,000. The useful life was 5 years. What entry is needed to record the patent’s amortization after the first year?

Amortization Expense, Patent......... 20,000

Patent...................................... 20,000

To amortize patent for 1/5 of the cost.


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Goodwill

An intangible asset that exists when a business is valued at more than the fair market value of its net assets.

Goodwill should be recorded only if its value can be objectively determined.

Goodwill is never written up above its original cost.


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Example: Goodwill

Bob, Inc. purchased a company for $200,000. The fair market value was determined to be $150,000. What amount of goodwill is recorded?


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Example: Goodwill

Bob, Inc. purchased a company for $200,000. The fair market value was determined to be $150,000. What amount of goodwill is recorded?

Purchase Price............................... 200,000

Fair Market Value........................... 150,000

Goodwill 50,000


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Example: Goodwill

Bob, Inc. purchased a company for $200,000. The fair market value was determined to be $150,000. If goodwill is amortized over 40 years, what is the journal entry for goodwill expenses after the first year?


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Example: Goodwill

Bob, Inc. purchased a company for $200,000. The fair market value was determined to be $150,000. If goodwill is amortized over 40 years, what is the journal entry for goodwill expenses after the first year?

Amortization Expense, Goodwill........ 1,250

Goodwill...................................... 1,250

To amortize Goodwill for 1/40 of the cost.


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Accounting forNatural Resources

Depletion--The process of cost allocation that assigns the original costs of a natural resource to the periods benefited.

Involves the calculation of a depletion rate for each unit of the natural resource.


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Example: Depletion

Coal Time paid $1,000,000 for a coal mine. The mine contained an estimated 250,000 tons of coal. What entry is made for the purchase of the coal mine?


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Example: Depletion

Coal Time paid $1,000,000 for a coal mine. The mine contained an estimated 250,000 tons of coal. What entry is made for the purchase of the coal mine?

Coal Mine................... 1,000,000

Cash..................... 1,000,000

Purchased coal mine for $1,000,000.


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Example: Depletion

Coal Time paid $1,000,000 for a coal mine. The mine contained an estimated 250,000 tons of coal. During 2005, 30,000 tons of coal were mined. What is the depletion expense for 2005?


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Example: Depletion

Coal Time paid $1,000,000 for a coal mine. The mine contained an estimated 250,000 tons of coal. During 2005, 30,000 tons of coal were mined. What is the depletion expense for 2005?

Depletion Expense........... 120,000

Coal Mine................... 120,000

Mined 30,000 tons at $4.00 per ton.


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