1 Before Class starts.(make sure your name is on all submissions) Fourth Homework due 10/27(MW) or 10/28(TR) before class. No exceptions. Help session 10/26 1:00-3:30pm in GBS130 Fifth Homework due 11/3(MW) or 11/4(TR) before class. No exceptions. Help Session 11/2 1:00-3:30pm in GBS130. Second Exam 11/6 6:00-9:00 pm All alternative arrangements completed by 10/23. What questions do you have for me? TA Office Hours 6-7 T&R in GBS401 & Accounting Lab Hours on File cabinet downstairs contains your mail folder. Your homework and exams returned there.
7 E9-18 T account analysis The following financial information was taken from the records of Fredrickson and Peiffer. a. Reconstruct the entry that recorded the sale of equipment during b. How much equipment was purchased during 2014? BALANCE SHEET: Equipment $26,900 $23,400 Less: Accumulated depreciation 10,500 9,800 Net book or carrying value $16,400 $13,600 INCOME STATEMENT: Depreciation expense $3,800 $3,500 Loss on sale of equipment STATEMENT OF CASH FLOWS: Cash received from sale of equipment $4,300 0
8 BE9-3 Acquisition of Fixed Assets The footnote was taken from the 2012 annual report of Johnson & Johnson (dollars in millions). a. Approximately how much was invested in land during 2012? b. Why did accumulated depreciation increase during 2012? c. J&J uses the straight-line method of depreciation. If the company used an accelerated method, what effect would that decision have on the balance sheet? d. What dollar amount appeared on J&J s 2012 balance sheet for PPE? Land and land improvements $793 $754 Building and building equipment $10,046 $9,389 Machinery and equipment 21,075 19,182 Construction in progress 2,740 2,504 $34,654 $31,829 Less accumulated depreciation 18,557 17,090 $16,097 $14,739
10 E9-16 Reverse T-account Based on the following: a. How much cash was collected on sale of equipment? b. Reconstruct the sale entry BALANCE SHEET Equipment $37,500 $32,700 Less AD 17,600 14,300 Book Value 19,900 18,400 INCOME STATEMENT Depreciation expense $7,200 $6,800 Gain on sale 2,100 0
11 Acquisition - What Costs to Capitalize? General Rule: Capitalize (add to an asset account) the costs to acquire the asset and to prepare it for its intended use. Dr. Asset (purchase price, sales tax, delivery, installation, etc) Cr. Cash, Notes Payable, etc
12 Land Has indefinite life and therefore is not depreciated Historical Cost includes: Purchase price, Closing costs, Cost to get ready for intended use (i.e., clearing, grading, soil testing, filling), permanent improvements. (Note: Sale of salvaged materials reduces cost) Land Improvements Depreciable since directly associated with building rather than inextricably associated with land. i.e. if building replaced then these improvements would be replaced or their costs would be incurred again. Have definite life and therefore are depreciated Fences, walls, parking lots, driveways Buildings Have definite life and therefore are depreciated Proportionate share of purchase price, or construction cost, Closing Cost, Architect & Attorney fees Machinery, Equipment, Furniture & Fixtures Purchase price (net of cash discounts), Freight & handling, Insurance while in transit, Installation Example: Server farm--invoice cost, transportation, assembly, installation, testing labor, any modifications to building to get into working order.
13 Self Constructed Assets What to Capitalize? Direct Materials & Labor Variable Overhead Applied Fixed Overhead Interest During Construction, if constructed for company s own use by someone else and progress payments &/or deposit are required
15 E9-1 Capitalized Cost and Depreciation Base Lowery Inc. purchased new plant equipment on The company paid $920,000 for the equipment, $62,000 for transportation, and $10,000 for insurance on the equipment while in transit. The company also estimates that over the equipment s useful life it will require additional power, which will cause utility costs to increase $90,000. The equipment has an estimated salvage value of $50,000. a. What amount should the company capitalize for this equipment on ? b. What is the depreciation base of this equipment? c. What amount will be depreciated over the life of this equipment?
16 Lump Sum or Group Purchase of PPE Generally allocate price to the assets acquired based on their relative fair market values. Up to management to subjectively determine the relative FMVs.
17 Group Purchase
18 Post-acquisition Expenditures: Betterments or Maintenance? Betterments: Increase asset s useful life Improve quality of asset s output Increase quantity of asset s output Reduce asset s operating costs Maintenance maintain existing productivity or useful life Accounting treatment Betterments are capitalized [Capital expenditures] Maintenance expenditures are expensed[revenue expenditures]
20 What do you know about depreciation?
21 Depreciation (Cost Allocation) Depreciation is a method of cost allocation. it is used to allocate the capitalized cost of PP&E over the years benefited (matching) Note: depreciation will decrease the carrying value of the asset, but it is not a valuation technique (i.e., book value is not market value)
22 Depreciation (Cost Allocation) Useful Life Salvage Value Depreciation methods (1) Activity (units-of-production) (2) Straight-line (3) Double-declining balance (4) 150 percent declining balance (5) Sum-of-the-years digits (6) MACRS (income tax depreciation) Under IFRS, depreciation accounting is very similar to US GAAP.
23 Class Example Given the following information regarding an automobile purchased by the company on January 2, 2008: Cost to acquire = $10,000 Estimated life = 4 years Estimated miles = 100,000 miles Salvage value = $2,000 Calculate depreciation expense for the first two years under each of the following methods.
24 (1) Units-of-Production (Activity) Assume that the car was driven 20,000 miles in the year 2008, and 30,000 miles in Annual depreciation = Cost - Salvage Value x Current Activity Total expected activity For 2008= 10,000-2,000 x 20,000 = $1, ,000 miles For 2009 = 10,000-2,000 x 30,000 = $2, ,000 miles
25 (2) Straight-Line Annual depreciation = Cost - Salvage Estimated Life = $10,000 - $2,000 = $2,000 per year 4 years
26 (3) Double-Declining Balance DDB is an accelerated depreciation technique. It generates more expense in the early years and less in the later years. Annual depreciation = % (Cost - A/D) or %(Book Value) where A/D is the accumulated depreciation for all prior years, and the percentage is double the straight line rate, or 2 x 1/Estimate life. In the example, the % = 2 x 1/4 = 2/4 = 50%. Depreciation expense (D.E.)for: 2008 = 50% x (10,000-0) = $5, = 50% x(10,000-5,000) = $2,500
27 Depreciation Example
28 Straight line
29 Your turn
30 Production/Units of Production/Activity Method
31 Your turn
32 Double declining balance or 200% declining balance
33 Your turn
34 E9-11 Depreciation Methods Apex Trucking purchased a truck for $100,000 on The useful life was estimated to be 5 years or 200,000 miles. Salvage value was estimated at $20,000. Over the actual life of the truck it logged the following miles: Year 1: 48,000; Year 2: 35,000; Year 3: 40,000; Year 4: 25,000; Year 5: 35,000; and Year 6: 10,000. At the end of the sixth year the truck was sold for $12,000. Prepare the journal entries to record depreciation over the life of the truck and its sale, assuming these methods: a. Activity method
35 E9-11 Depreciation Methods Apex Trucking purchased a truck for $100,000 on The useful life was estimated to be 5 years or 200,000 miles. Salvage value was estimated at $20,000. Over the actual life of the truck it logged the following miles: Year 1: 48,000; Year 2: 35,000; Year 3: 40,000; Year 4: 25,000; Year 5: 35,000; and Year 6: 10,000. At the end of the sixth year the truck was sold for $12,000. Prepare the journal entries to record depreciation over the life of the truck and its sale, assuming these methods: b. Straight-line method
36 E9-11 Depreciation Methods Apex Trucking purchased a truck for $100,000 on The useful life was estimated to be 5 years or 200,000 miles. Salvage value was estimated at $20,000. Over the actual life of the truck it logged the following miles: Year 1: 48,000; Year 2: 35,000; Year 3: 40,000; Year 4: 25,000; Year 5: 35,000; and Year 6: 10,000. At the end of the sixth year the truck was sold for $12,000. Prepare the journal entries to record depreciation over the life of the truck and its sale, assuming these methods: c. Double declining balance
37 E9-9 Depreciation Company buys a lathe on for $300,000, estimates a 4 year life and can sell it at the end of the fourth year for $60,000. a. Compute the annual depreciation expense using straight line and Double declining balance methods. b. What are your considerations when choosing a depreciation method for financial purposes?
38 MACRS MACRS (modified accelerated cost recovery system) is a technique developed by the IRS for tax reporting. It utilizes combinations of DDB, 150%DB, and SL to calculate a table of percentages that can be applied to any depreciable asset. Additionally, the IRS assumes no salvage value, and a half year in the first and last year of depreciation (some limitations on fourth quarter purchases).
39 Change in Estimate The change in estimate affects only the current and future years; we do not go back and change the previous years that have already been posted. To calculate the new depreciation expense, first find out how much depreciation has been posted (the Accumulated Depreciation to date). Then use the following formula (to modify the straight-line depreciation rate): Remaining Book Value - New Est. Salvage Remaining Estimated Life
40 Class Problem: Problem 9-7 Facts: In 2009 equipment costing $180,000, a salvage value of $30,000, and a useful life of 10 years was acquired. In the beginning of 2014, the company added three years to the original useful-life estimate. Two steps in solving: (1)Determine Book Value at 1/1/14: First: annual depr. expense = (180,000-30,000)/10 years = 15,000/yr. Then Accumulated Depr. to 1/1/14: 15,000 x 5 yrs = $75,000 So BV = 180,000-75,000 = 105,000
41 Class Problem: Problem 9-7 (2) Estimate depreciation expense for 2014, assuming revised useful life: BV - SV = 105,000-30,000 = $9,375 per yr. Remaining life Journal entry: Depreciation Expense 9,375 Accum. Depreciation 9,375
42 E9-7 Facts: In 2011 equipment costing $60,000, a salvage value of $12,000, and a useful life of 5 years was acquired. In the beginning of 2014, the company added three years to the original useful-life estimate. a. Compute the book value of the machine as of using the straight line method. b. Prepare the journal entry to record 2014 depreciation expense.
43 PPE Disposals Depreciate PPE up to date of disposal. Remove PPE and its associated Accumulated depreciation. Record receipt or payment of cash. Recognize any gain or lass on disposal (the difference between to disposed asset s book value and the net value of the assets received). Types: Retirements (i.e., garbage, donation), Sales, Trade-in on Dissimilar assets
44 Disposal: Retirement, Sale or Trade-In Retirement : Dr. Loss (if not fully depreciated) Dr. Acc Dep Cr. Asset Sale: Dr. Cash Dr. Acc Dep Cr. Asset Dr. Loss if BV > Cash or Cr. Gain if BV < Cash Trade-ins (for dissimilar assets): asset received should be valued at the fair market value of assets given up, or the fair market value of the asset received, whichever is more evident and objectively determined
45 Sample Disposal Example Using earlier example (cost = $10,000, salvage = $2,000). After 4 years straight-line, $8,000 would be in A/D. 1. Assume the asset is retired (no cash received) Loss on retirement 2,000 Accumulated Depr. 8,000 Automobiles 10, Assume the asset is sold for $3,000: Cash 3,000 Accumulated Depr. 8,000 Automobiles 10,000 Gain on sale 1,000
46 Class Exercise: Exercise 9-15 Facts: Cost $25,000; Salvage $5,000, useful life 5 years. DDB used. First calculate depreciation: DDB % = 1/5 x 2 = 2/5 = 40% Depr. Book Date % Cost - A/D Expense Value 1/1/12 25,000 12/31/12 40% (25,000-0) = 10,000 15,000 12/31/13 40% (25,000-10,000) = 6,000 9,000 12/31/14 40% (25,000-16,000) = 3,600 5,400 12/31/15 PLUG 400* 5,000=SV 12/31/ ,000 *formula will exceed salvage value limit in 2015; just depreciate $400, to salvage of $5,000.
47 Exercise 9-15, continued (a) JE to scrap after 3 years, assumes that no cash is received: (b) JE to scrap after 5 years, assumes that no cash is received:
48 Exercise 9-15, continued (c) JE to sell for $8,000 after 3 years: (d) JE if, after 5 years, the equipment and $28,000 traded for a dissimilar asset with a fair market value of $30,000:
49 B. Intangible Assets Intangible assets are characterized by (1) lack of physical evidence, and (2) high uncertainty about future benefits. Cost is amortized over useful life (or legal life, if less), but not to exceed 40 years. Adjusting Journal Entry if definite life: Dr. Amortization expense XX Cr. Intangible asset XX Exception is Goodwill which has an indefinite life, no longer amortized but subject to impairment test. If balance sheet value of asset is determined to exceed its estimated fair market value, it is found to be impaired and written down to its fair value. Under IFRS, revaluing intangibles is an option, but not a requirement. Under US GAAP, revaluation is not an option.
50 (1) Patents (20 year legal life) A company may capitalize the following the cost of acquiring an externally developed patent. filing fees for internally or externally developed patents. the legal fees for acquiring and successfully defending a patent (internal or external). A company cannot capitalize the following: legal fees for unsuccessfully defending a patent expense instead Most research and development costs for an internally developed patent--expense
51 Research and Development Costs (for internally developed patents) Prior to 1974, most companies capitalized research and development costs, then amortized the cost to future periods. The FASB stated in SFAS 2 that, because future benefits were uncertain, companies should expense all R&D costs, unless they were related to tangible assets (like buildings and equipment) that had multi-year lives. Companies complied with the standard, but for several years many companies actually reduced their R&D activities, because of concern for excess expense on the income statement.
52 Other Intangible Assets (2) Copyrights granted for the life of the creator plus 70 years. capitalization rules similar to patents: costs of internally developed copyright material cannot be capitalized. (3) Trademarks and Trade Names granted for 10 year periods, but indefinite renewals. some of design costs may be capitalized. (4) Organization Costs costs related to the creation of a company including underwriting fees, legal and accounting, licenses, titles, etc. treatment similar to R&D costs; even though there may be some future benefit, costs are expensed in the period incurred. (5) Software Development Costs (SFAS 86) Capitalize the costs of developing software for sale or lease. Expense software development costs if for internal use.
53 Other Intangible Assets - continued (6) Goodwill (also discussed in Chapter 8) Recognized when one company purchases another company. Causes include reputation, good customer relations, superior product development, etc. To calculate: Purchase price paid for the company versus the fair market value of the net assets acquired = Goodwill (the excess amount paid) No longer amortized, instead subjected to an impairment test, i.e.,
55 P9-13 Goodwill recognition On D Inc. purchased S Inc for $1.8 million. The total FMV of the individual assets of S Inc is $1.35 million and the liabilities are valued on the balance sheet at FMV. The balance sheet of S Inc at time of purchase: Assets Liab & SHE Current assets $650,000 Liabilities $250,000 Long-lived assets 330,000 SHE 730,000 Total Assets $980,000 Total L&SHE $980,000 a. How can the FMV of assets exceed the value on the BS? b. Why would D Inc pay more for S Inc than the FMV of assets less liabilities? c. Provide journal entry to record the purchase. d. In recent past goodwill was amortized over a period of time not to exceed 40 years. Why not?
56 IFRS vs. US GAAP: Revaluations to Fair Market Value One very important way in which IFRS differs from US GAAP involves the use of fair market value as a basis for valuation on the balance sheet. Under US GAAP, long-lived assets must be accounted for at original cost less accumulated depreciation. Under IFRS, companies can either follow the US GAAP method or they can periodically revalue their long-lived assets to fair market value. In essence, US GAAP tends to follow a conservative lower-ofcost-or-market valuation principle, whereas IFRS allows managers the option to more closely follow a pure market valuation principle.
57 ID9-13 Google 10-K Disclosures Answer the following questions: a. What % of total assets do property, plant, and equipment and long-lived assets in total make up? b. What is the largest category of property, plant, and equipment?
58 ID9-13 Google 10-K Disclosures c. How large is the depreciation and/or amortization expense relative to sales, and why is it listed on the statement of cash flows?
59 ID9-13 Google 10-K Disclosures Answer the following questions: d. How much did NIKE invest in PPE, and how much cash did it receive from disposals of PPE? e. What is the largest intangible asset?
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