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Chapter 9

Chapter 9. Investments: Property, Plant, and Equipment and Intangible Assets. Long-Term Assets. Property, plant, and equipment Tangible assets acquired for the use in business operations Land, buildings, and equipment Intangible Assets

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Chapter 9

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  1. Chapter 9 Investments: Property, Plant, and Equipment and Intangible Assets

  2. Long-Term Assets Property, plant, and equipment • Tangible assets acquired for the use in business operations • Land, buildings, and equipment Intangible Assets • Assets without physical substance that are used in business • Licenses, patents, franchises, and goodwill

  3. Capital Budgeting • Planning for investment in long-term assets • Long-term assets have value because they help companies generate future cash flows • Involves comparing the cost of the asset to the value of the expected cash flows, after adjusting for the time value of money Time value of money: The concept that a dollar today is worth more than a dollar received in the future

  4. Asset Acquisition • Include purchase price • Include costs incurred to acquire the asset and getting it ready for its intended use: • Sales tax, shipping, installation, and other costs. Fork Lift 12,500 Cash 3,500 Notes Payable 9,000 Purchased a fork lift for $12,000 and paid $500 for shipping; paid $3,500 cash and issued a note for $9,000 to the bank.

  5. Leases • A lease is a contract that specifies the terms under which the owner of an asset (the lessor) agrees to transfer the right to use the asset to another party (the lessee). • What terms should be included in a lease? • Term • Payment amount • Due dates

  6. Match Lease Terms • The party that is granted the right to use the property under the terms of a lease. Capital Lease • The owner of property that is leased (rented) to another party. Lessor Operating Lease • A simple rental agreement. • A leasing transaction that is recorded as a purchase by the lessee. Lessee

  7. Classifying Leases A lease is classified as a capital lease if it is non-cancelable and meets one of the following criteria: • Lease transfers ownership of the asset • Lease contains a bargain purchase option • Lease term is equal to 75 percent or more of the estimated life of the asset • Present value of the lease payments is equal to 90 percent or more of the fair market value of the asset

  8. Example: Operating Lease Dahl & Sons, Attorneys at Law, lease a building with monthly rental payments of $1,000. Make the appropriate entry if rent is paid in cash the first month. Rent (or Lease) Expense 1,000 Cash 1,000 To record monthly rent of storage building.

  9. Example: Capital Lease Dahl & Sons enter into a non-cancelable lease agreement that requires lease payments of $100,000 a year for 20 years. At the end of 20 years, Dahl & Sons will own the property. The present value of the lease payments at a 10 percent discount rate is $851,360. Make the appropriate entries for the first year. Leased Property 851,360 Lease Liability 851,360 To record commercial building acquired under a 20-year non-cancelable lease. Lease Liability 14,864 Interest Expense 85,136 Cash 100,000 To record annual payment under capital lease.

  10. Assets Acquired by Self-Construction Self-constructed assets • Recorded at cost • Include all expenditures incurred to build the asset and make it ready for its intended use Costs include • Materials used to build the asset • Construction labor • Capitalized interest • Some reasonable share of the general company overhead

  11. Basket Purchases • When two or more assets are acquired at a single price, the prices are allocated on the “relative fair market value” method. % of Total Asset FMV Value Cost Land $1,000,000 25% 0.25 x $3,600,000 = $ 900,000 Building 3,000,000 75% 0.75 x $3,600,000 = 2,700,000 Total $4,000,000 100% $3,600,000 Example: Dahl & Sons purchased land and a building at a total cost of $3,600,000. Prepare the entry to record the purchase. Land 900,000 Building 2,700,000 Cash 3,600,000 To record building and land acquired for $3,600,000.

  12. Depreciation • The process of cost allocation that assigns the original cost of plant and equipment to the periods benefited • Book value • The asset’s original cost less any accumulated depreciation • Salvage value • The amount expected to be received when the asset is sold at the end of its useful life

  13. Straight-Line Depreciation • Costs assigned equally to all periods benefited Annual Depreciation Expense Cost - Salvage value Estimated useful life (years) = $24,000 - $2,000 4 years = $5,500 Depreciation Expense 5,500 Accumulated Depreciation 5,500 To record annual depreciation for truck.

  14. Units-of-Production Depreciation • Assigning depreciation according to what has been used during the year. Cost - Salvage value Estimated life in units Per Unit Depreciation = Depreciation Expense Per unit depreciation Units produced = x ($24,000 - $2,000) 60,000 miles $4,400 = x 12,000 miles Depreciation Expense 4,400 Accumulated Depreciation 4,400 To record annual depreciation for truck.

  15. Partial-Year Depreciation Straight-line method • Calculate depreciation expense for the year • Distribute it evenly over the number of months the asset is held during the year Units-of-production method • The same as normal because it is based off of the actual usage

  16. Repairing and Improving Assets Ordinary expenditures • Typically benefit only the period in which they are made (i.e., repairs, maintenance, and minor improvements) • Expense when incurred Capital expenditures • Significant in amount and benefit more than the current period • Increase the productive life or capacity of the asset (i.e., engine overhaul, components added) • Capitalize and add to asset value • Depreciated over the remaining life of the asset

  17. Discarding and Selling Long-Term Assets • An asset’s cost and accumulated depreciation must be removed from the accounting records. • Assets can be: • Discarded (scrapped) • Sold • Exchanged

  18. Example: Discarding Property, Plant, and Equipment Dahl & Sons purchased an advance copier system for $15,000. It has a 5-year life, no salvage value, and is depreciated on a straight-line basis. If Frank pays $300 to have the copier removed, what is the appropriate entry? Accumulated Depreciation, Copier 15,000 Gain/Loss on Disposition of PP&E 300 Copier 15,000 Cash 300 Scrapped $15,000 copier and paid $300 disposal costs.

  19. Example: Discarding Property, Plant, and Equipment Dahl & Sons purchased an advanced copier system for $15,000. It has a 5-year life, no salvage value, and is depreciated on a straight-line basis. If the copier is sold for $600 after only four years of service, Dahl & Sons will experience a loss of $2,400. Make the appropriate entry. Cash 600 Accumulated Depreciation, Copier 12,000 Gain/Loss on Disposition of PP&E 2,400 Copier 15,000 Sold $15,000 copier at a loss of $2,400.

  20. Accounting for Intangibles Rights and privileges that are: • Long-lived • Not held for resale • Have no physical substance • Providing owner with competitive advantage over other firms Amortization • Periodic allocation to expense of an intangible asset’s cost • Conceptually, the same as depreciation • Intangible assets generally use straight-line amortization

  21. Types of Intangibles Patent • An exclusive right granted for 20 years by the U.S. Federal Government to manufacture and sell an invention Franchise • An entity that has been licensed to sell the product of a manufacturer or to offer a particular service in a given area License • The right to perform certain activities, generally granted by a government agency

  22. Recognizing Intangible Assets • Only recognized in the financial statements if they have been purchased • Amortize over the economic life of the intangible asset • Intangible assets with indefinite lives are not amortized • Intangible assets must be analyzed to determine if impairment has occurred

  23. Goodwill • An intangible asset that exists when a business is valued at more than the fair market value of its net assets, usually due to • Strategic location • Reputation • Good customer relations Intangible assets with indefinite lives are not amortized • Equal to the excess of the purchase price over the fair market value of the net assets purchased

  24. Example: Accounting for Goodwill Dahl & Sons purchased Clark & Associates for $1,200,000. At the time, the following market values existed for Clark’s assets and liabilities. Inventory $750,000) Long-term operating assets 220,000) Other assets 25,000) Liabilities (18,000) Total Net Assets $977,000) Inventory 750,000 Long-Term Operating Assets 220,000 Other Assets 25,000 Goodwill 223,000 Liabilities 18,000 Cash 1,200,000 Purchased Clark & Associates for $1,200,000.

  25. Measuring the Management of Long-Term Assets Fixed Asset Turnover • The amount of dollars in sales generated by each dollar of fixed assets • Standard values for this ratio differ from industry to industry Sales Average PP&E

  26. Accelerated Depreciation Methods Declining-balance method • An asset’s book value is multiplied by a constant depreciation rate • This is double the straight-line percentage in the case of double-declining balance (DDB) Sum-of-the-years’-digits method • A constant balance (cost minus salvage value) is multiplied by a declining depreciation rate calculated based off of the sum of the years

  27. Depreciation Methods

  28. Double-Declining Balance Dahl & Sons purchased a truck for $12,000. The truck has a salvage value of $2,000 and a useful life of 4 years. Compute depreciation using the DDB depreciation method for the first 2 years. Book Value Asset’s Life in Years x 2 = Depreciation Expense ($12,000 - $0) 4 Year 1 = x 2 = $6,000 ($12,000 - $6,000) 4 Year 2 = x 2 = $3,000

  29. Sum-of-the-Year’s-Digits Method Dahl & Sons purchased a truck for $12,000. The truck has a salvage value of $2,000 and a useful life of 4 years. Compute depreciation using the SYD depreciation method for the first 2 years. Cost-Salvage Value Current Year / (4+3+2+1) (Sum of the years of the asset’s life) ($12,000 - $2,000) 4 / (4 + 3 + 2 + 1) ($12,000 - $2,000) 3 / (4 + 3 + 2 + 1) Year 1 Year 2 = = = = $4,000 $3,000

  30. Change in Depreciation Estimates and Methods • Depreciation is only an estimate • Changes in estimates of useful life and salvage value may occur • Changes in method can also occur • When there is a change in estimate, past periods’ depreciation amounts remain the same

  31. Change in Estimates Dahl & Sons purchased a truck for $24,000 with a $2,000 salvage value and a 4-year useful life. After 3 years, better information reveals the truck has a 6-year useful life and a $3,000 salvage value. Calculate a new depreciation expense for the next three years.

  32. Chapter 9 Review Problem See on page 418-420

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