long lived assets and depreciation l.
Download
Skip this Video
Loading SlideShow in 5 Seconds..
Long-Lived Assets and Depreciation PowerPoint Presentation
Download Presentation
Long-Lived Assets and Depreciation

Loading in 2 Seconds...

play fullscreen
1 / 46

Long-Lived Assets and Depreciation - PowerPoint PPT Presentation


  • 1019 Views
  • Uploaded on

Long-Lived Assets and Depreciation. CHAPTER 8. Learning Objectives. After studying this chapter, you should be able to Distinguish a company’s expenses from expenditures that it should capitalize Measure the acquisition cost of tangible assets such as land, buildings, and equipment

loader
I am the owner, or an agent authorized to act on behalf of the owner, of the copyrighted work described.
capcha
Download Presentation

PowerPoint Slideshow about 'Long-Lived Assets and Depreciation' - elina


An Image/Link below is provided (as is) to download presentation

Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author.While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server.


- - - - - - - - - - - - - - - - - - - - - - - - - - E N D - - - - - - - - - - - - - - - - - - - - - - - - - -
Presentation Transcript
learning objectives
Learning Objectives

After studying this chapter, you should be able to

  • Distinguish a company’s expenses from expenditures that it should capitalize
  • Measure the acquisition cost of tangible assets such as land, buildings, and equipment
  • Compute depreciation for buildings and equipment using various depreciation methods
  • Recalculate depreciation in response to a change in estimated useful life or residual value
  • Differentiate financial statement depreciation from income tax depreciation
learning objectives3
Learning Objectives

After studying this chapter, you should be able to

  • Explain the effect of depreciation on cash flow
  • Account for expenditures after acquisition
  • Compute gains and losses on disposal of fixed assets and consider the implications of these gains and losses on the statement of cash flows
  • Account for the impairment of tangible assets
  • Account for various intangible assets
  • Explain the reporting for goodwill
  • Interpret depletion of natural resources
overview of long lived assets
Overview of Long-lived Assets
  • Long-lived assets are divided into tangible and intangible categories
  • Tangible assets are physical items that you can see and touch
    • Land
    • Natural resources
    • Buildings
    • Equipment
overview of long lived assets5
Overview of Long-lived Assets
  • Intangible assets are not physical in nature, consisting of contractual or legal rights or economic benefits
    • Patents
    • Trademarks
    • Copyrights
  • Land is reported at its historical cost in the financial records and is not depreciated
overview of long lived assets6
Overview of Long-lived Assets
  • Most other long-lived assets wear out or become obsolete
  • The costs of these assets are allocated over their useful life
    • Depreciation is the allocation of the cost of buildings, machinery, and equipment
    • Depletion is the allocation of the cost of natural resources
    • Amortization is the allocation of the cost of intangible assets
contrasting long lived asset expenditures with expenses
Contrasting Long-lived Asset Expenditures with Expenses
  • All purchases of goods or services are called expenditures
  • Companies capitalize expenditures for assets that benefit more than the current accounting year
  • The purchase price is added to an asset account rather than expensing it immediately
contrasting long lived asset expenditures with expenses8
Contrasting Long-lived Asset Expenditures with Expenses
  • The cost of repairs and parts are charged to expense rather than to an asset account
  • Decisions about whether to expense or capitalize expenditures require judgment
  • This is an area that management may inappropriately influence to increase reported net income
acquisition cost of tangible assets
Acquisition Cost of Tangible Assets
  • The acquisition cost of long-lived assets is the cash-equivalent purchase price
    • Includes incidental costs to complete the purchase, transport the asset, and prepare it for use
  • The acquisition cost of land includes
    • The purchase price
    • The cost of land surveys
    • Legal fees
    • Title fees and transfer taxes
    • Demolition costs of old structures
acquisition cost of tangible assets10
Acquisition Cost of Tangible Assets
  • Under historical-cost accounting, companies report land in the balance sheet at its original cost
  • The acquisition cost of buildings, plant, and equipment includes all costs of acquisition and preparation for use
    • Sales tax
    • Transportation
    • Installation
    • Repair cost prior to use
acquisition cost of tangible assets11
Acquisition Cost of Tangible Assets
  • An exchange of goods and services in which assets or liabilities exchanged are not cash is a nonmonetary exchange
  • A nonmonetary exchange is recorded at the fair market value of the consideration received or the fair market value of the consideration given up, whichever is more clearly determinable
  • Fair market value of an asset is the price for which a company could sell the asset to an independent third party
acquisition cost of tangible assets12
Acquisition Cost of Tangible Assets
  • Suppose that Woodside Corporation sold land to Tyron Company in exchange for shares of Tyron stock. Tyron is a publicly traded stock whose share price is observable each day. An appraiser valued the land at $100,000, while the stock had a market value at the time of the sale of $108,000. Tyron would record the following entry for this nonmonetary transaction:

Land 108,000

Common Stock 108,000

basket purchases
Basket Purchases
  • The acquisition of two or more types of assets for a lump-sum cost is sometimes called a basket purchase
  • The acquisition cost of a basket purchase is split among assets according to some estimate of relative sales value for the assets
basket purchases14
Basket Purchases
  • Suppose Gap, Inc., acquires land and a building for $1 million. How much of the $1 million should Gap allocate to land and how much to the building? If an independent appraiser indicates that the market values of the land and the building are $480,000 and $720,000, respectively, the cost would be allocated as follows:

(1) (2) (3) (4)

Appraised Total Cost Allocated

Value Weighting to Allocate Costs

Land $ 480,000 480/1,200 $1,000,000 $ 400,000

(or 40%)

Building 720,000 720/1,200 1,000,000 600,000

(or 60%)

Total $1,200,000 $1,000,000

depreciation of buildings and equipment
Depreciation of Buildings and Equipment
  • Depreciation is a system for cost allocation—not valuation
  • Accrual accounting initially capitalizes the cost and then allocates it in the form of depreciation over the periods the asset is used
  • This more effectively matches expenses with the revenues produced
depreciation of buildings and equipment16
Depreciation of Buildings and Equipment
  • Depreciable value is the difference between the total acquisition cost and the estimated residual value
  • It is the amount of the acquisition cost to be depreciated or allocated over the total useful life of the asset
  • The residual value is the amount a company expects to receive from sale or disposal of a long-lived asset at the end of its useful life
depreciation of buildings and equipment17
Depreciation of Buildings and Equipment
  • The useful life of an asset is the shorter of the physical life of the asset (before it wears out) or the economic life of the asset (before it becomes obsolete)
  • A list of depreciation amounts for each year of an asset’s useful life is a depreciation schedule
  • The following symbols and amounts are used to compare the various depreciation schedules for a $41,000 delivery truck purchased by Chang Company on January 1, 20X3:
depreciation of buildings and equipment18
Depreciation of Buildings and Equipment

Symbols Amounts for Illustration

C = total acquisition cost December 31, 20X2 $41,000

R = estimated residual value $ 1,000

n = estimated useful life (in years or miles) 4 years

200,000 miles

D = amount of depreciation Various

straight line depreciation
Straight-line Depreciation
  • Straight-line depreciation
    • Spreads the depreciable value evenly over the useful life of an asset
    • Is by far the most popular method for financial reporting purposes
  • The depreciation expense charged to Chang’s income statement is

Depreciation expense = (C – R) / n

= ($41,000 – 1,000) / 4 = $10,000 per year

depreciation based on units
Depreciation Based on Units
  • When physical wear and tear determines the useful life of the asset, depreciation may be based on units of service or units of production instead of units of time (years)
depreciation based on units21
Depreciation Based on Units
  • Chang’s truck has a useful life of 200,000 miles, so depreciation computed on a mileage basis is
  • If employees drive the truck 65,000 miles in the first year of use, depreciation expense for that year will be 65,000 x $.20 = $13,000

Depreciation expense per unit of service = (C - R) / n

= (41,000 – 1,000) / 200,000 miles

= .20 per mile

declining balance depreciation
Declining-balance Depreciation
  • The double-declining-balance (DDB) method is an accelerated method
  • DDB depreciation is computed as follows
    • Compute the straight-line rate by dividing 100% by the years of useful life
    • To compute the depreciation on an asset for any year, ignore the residual value and multiply the asset’s net book value at the beginning of the year by the DDB rate
declining balance depreciation23
Declining-balance Depreciation
  • The DDB method is applied to Chang Company’s truck as follows:

DDB rate = 2 x (100% / n)

DDB rate, 4-year life = 2 x (100% / 4) = 50%

DDB depreciation = DDB rate x Beginning book value

For year 1: D = .50 ($41,000)

= $20,500

For year 2: D = .50 ($41,000 - $20,500)

= $10,250

For year 3: D = .50 ($42,000 - $20,500 - $10,250)

= $5,125

For year 4: D = .50 ($41,000 - $20,500 - $10,250 - $5,125)

= $2,563

comparing and choosing depreciation methods
Comparing and Choosing Depreciation Methods
  • The next exhibit compares the results of straight-line and DDB depreciation for Chang Company’s truck
  • The DDB method provides $38,438 of total depreciation and does not allocate the full $40,000 depreciable value to expense
  • A pervasive rule: A depreciable asset is never depreciated below its estimated residual value
changes in estimated useful life or residual value
Changes in Estimated Useful Life or Residual Value
  • A company estimates the useful life and residual value of an asset at the time of its acquisition
  • If new information becomes known, the company must adopt the new estimate and revise the depreciation schedule
  • Depreciation expense is recomputed for the period in which the estimate is revised and all future periods
changes in estimated useful life or residual value27
Changes in Estimated Useful Life or Residual Value
  • Refer to the previous straight-line depreciation schedule for Chang company’s truck
  • Chang originally estimated a residual value of $1,000 and a useful life of 4 years for the truck
  • Suppose that at the beginning of year 4, Chang determines that it will continue to use the truck for 3 more years rather than 1 more year
changes in estimated useful life or residual value28
Changes in Estimated Useful Life or Residual Value
  • The net book value of the truck at the beginning of year 4 is $11,000
  • Chang must allocate the remaining $10,000 ($11,000 -$1,000) in allowable depreciation over a total of 3 years ($10,000 /3 = $3,333). The revised depreciation schedule is presented on the next slide:
contrasting income tax and shareholder reporting
Contrasting Income Tax and Shareholder Reporting
  • Reports to tax authorities must follow income tax rules and regulations
    • The Modified Accelerated Cost Recovery System (MACRS) is based on a declining-balance depreciation method
    • MACRS allows more depreciation in the early years of an asset’s life
  • Shareholder reports must follow GAAP
    • Straight-line depreciation is the most used method
    • It matches the asset cost to the periods of revenue generation
depreciation and cash flow
Depreciation and Cash Flow
  • Depreciation
    • Does not generate cash
    • Allocates the original cost of an asset to the periods of use
    • Is a deductible noncash expense for income tax purposes
  • Higher tax depreciation results in lower taxable income and lower taxes, keeping more cash in the business
expenditures after acquisition
Expenditures After Acquisition
  • Repairs and maintenance are treated as expenses of the current period
    • Repairs include the costs of breakdowns, accidents, or damage
    • Maintenance includes the routine costs of oiling, polishing, painting, and adjusting
  • Improvements are capitalized as assets
    • Improvements are expenditures that increase the future benefits provided by a fixed asset
gains and losses on sales of tangible assets
Gains and Losses on Sales of Tangible Assets
  • When a tangible asset is sold, a gain or loss occurs when there is a difference between the cash received and the net book value of the asset
    • Cash received > book value = gain
    • Cash received < book value = loss
  • The disposal requires the removal of the asset’s book value, which appears to two accounts:
    • Equipment
    • Accumulated Depreciation
gains and losses on sales of tangible assets34
Gains and Losses on Sales of Tangible Assets
  • Suppose equipment with an original cost of $41,000 and accumulated depreciation of $20,000 is sold for $27,000 cash
  • The journal entry for the disposal would be:

Cash 27,000

Accumulated depreciation 20,000

Equipment 41,000

Gain 6,000

income statement presentation
Income Statement Presentation
  • Companies usually include gains and losses as part of “other income” or “other expense”
    • Some companies list “other income” with sales revenue at the top of the income statement
    • Other companies report it after operating income—viewing it as not being a part of central operations
asset sales and the statement of cash flows
Asset Sales and the Statement of Cash Flows
  • Sales of fixed assets are investing activities on the statement of cash flows
  • Indirect method
    • Net income includes gains and losses, which do not affect cash flows
    • Gains are subtracted and losses are added to net income in the operating section
  • Direct method
    • Gains and losses are ignored
impairment of tangible assets
Impairment of Tangible Assets
  • An asset is considered to be impaired when it ceases to have economic value as large as the book value
  • Impairment of assets held for use:
    • Step 1: Recoverability test—if undiscounted expected cash flow < book value, impairment exists
    • Step 2: Impairment loss = book value – fair value
  • The entry to record the impairment loss is:

Loss on impairment xxx

Accumulated depreciation xxx

impairment of tangible assets38
Impairment of Tangible Assets
  • Impairment of assets to be disposed of:
    • Step 1: Recoverability test—if undiscounted expected cash flow < book value, impairment exists
    • Step 2: Impairment loss = book value – (fair value less the cost to sell)
  • Assets held for resale can be written up following an impairment loss only to the net book value at the time of the impairment
intangible assets
Intangible Assets
  • Intangible assets are those assets not physical in nature but instead are rights or claims to expected benefits that are often from contract rights
  • Accounting for intangible assets depends on two factors:
    • Whether the asset is acquired externally or developed internally
    • Whether the asset has a finite or infinite life
intangible assets40
Intangible Assets
  • Externally acquired vs. internally developed:
    • A company’s balance sheet lists an intangible asset only if the company purchased the rights to the asset from an external party
      • Example: Patent costs are capitalized as assets
      • Internally developed R&D costs (that may lead to patents) are expensed
    • R&D for computer software companies
      • Is expensed up to the time of technological feasibility
      • Thereafter, it is capitalized
intangible assets41
Intangible Assets
  • Finite lives vs. infinite lives:
    • The costs of intangible assets with finite lives are amortized over their useful lives
      • The useful life is the shorter of its economic useful life or its legal life, if any
    • Companies do not amortize intangible assets deemed to have infinite lives
      • They are subject to a periodic asset impairment test
examples of intangible assets
Examples of Intangible Assets
  • Patents are grants by the federal government to the inventor of a product or process, bestowing the exclusive right to produce and sell a given product , or use a process for up to 20 years
  • Copyrights are exclusive rights to reproduce and sell a book, musical composition, film, or similar creative item for the life of the creator plus 70 years
  • Trademarks are distinctive identifications of a manufactured product or a service, taking the form of a name, sign, slogan, logo, or emblem
examples of intangible assets43
Examples of Intangible Assets
  • Franchises and licenses are legal contracts that grant the buyer the right to sell a product or service in accordance with specified conditions
  • A leasehold is the right to use a fixed asset for a specified period of time beyond one year
  • Leasehold improvements occur when a lessee spends money to improve leased property
    • Improvements become a part of the leased property
    • Leasehold improvements are classified as fixed assets
impairment of intangible assets other than goodwill
Impairment of Intangible Assets Other than Goodwill
  • Finite life intangibles are amortized over their useful life
  • Indefinite life intangibles other than goodwill are subject to impairment testing
    • No recoverability test is required
    • Impairment loss = book value - fair value
goodwill
Goodwill
  • Goodwill
    • Arises when one company buys another company
    • Is the excess of the cost of the acquired company over the sum of the fair market value of its identifiable individual assets less the liabilities
  • If fair value < book value, an impairment loss is recognized
  • Goodwill is discussed in more detail in Chapter 11
depletion of natural resources
Depletion of Natural Resources
  • Natural resources are fixed assets such as minerals, oil, and timber (wasting assets)
  • Depletion is the allocation of the acquisition cost of natural resources
    • Depletion is measured on a units-of-production basis
    • Annual depletion may be a direct reduction of the asset, or accumulated in a separate contra account