Week11, Chap 8 Accounting 1A, Financial Accounting Reporting and Interpreting Property, Plant, and Equipment;Natural Resources; and Intangibles Instructor: Michael Booth
Understanding The Business Insufficient capacity results in lost sales. Costly excess capacity reduces profits. How much is enough?
Nature of long-lived productive assets Define, classify, and explain Interpret the fixed asset turnover ratio.
Classifying Long-Lived Assets Actively Used in Operations Expected to Benefit Future Periods Tangible Physical Substance Intangible No Physical Substance
Classifying Long-Lived Assets Expected to Benefit Future Periods Tangible Physical Substance Actively Used in Operations Land Examples Assets subject to depreciation Buildings and equipment Furniture and fixtures Intangible Natural resource assets subject to depletion No Physical Substance Mineral deposits and timber
Classifying Long-Lived Assets Expected to Benefit Future Periods Physical Substance Actively Used in Operations Examples Value represented by rights that produce benefits Patents Copyrights Trademarks Franchises Tangible Goodwill Subject to amortization Intangible No Physical Substance
Fixed Asset Turnover Fixed Asset Turnover = Net Sales Revenue Average Net Fixed Assets For the year 2008, Delta Airlines had $13,303 of revenue. End-of-year fixed assets were $16,752 and beginning-of-year fixed assets were $16,524. (All numbers in millions.) This ratio measures a company s ability to generate sales given an investment in fixed assets.
Fixed Asset Turnover Fixed Asset Turnover = Net Sales Revenue Average Net Fixed Assets Fixed Asset Turnover $13,303 = = 0.80 ($16,524 + $16,752) 2 2008 Fixed Asset Turnover Comparisons Delta Southwest United 0.8 0.84 0.85
Cost Principle Apply to measure the acquisition and maintenance: Property Plant equipment.
Measuring and Recording Acquisition Cost Acquisition cost includes the purchase price and all expenditures needed to prepare the asset for its intended use. Acquisition cost does not include financing charges and cash discounts.
Acquisition Cost Buildings Purchase price Renovation and repair costs Legal and realty fees Title fees
Acquisition Cost Equipment Purchase price Installation costs Modification to building necessary to install equipment Transportation costs
Acquisition Cost Land Purchase price Real estate commissions Title insurance premiums Delinquent taxes Surveying fees Title search and transfer fees Land is not depreciable.
Acquisition for Cash On January 1, Delta Air Lines purchased aircraft for $70,000,000 cash. GENERAL JOURNAL Page 8 Date Description Debit Credit Jan. 1
Acquisition for Cash On January 1, Delta Air Lines purchased aircraft for $70,000,000 cash. GENERAL JOURNAL Page 8 Date Description Debit Credit Jan. 1 Flight equipment 70,000,000 Cash 70,000,000
Acquisition for Debt On January 14, Delta Air Lines purchased aircraft for $1,000,000 cash and a $69,000,000 note payable. GENERAL JOURNAL Page 9 Date Description Debit Credit Jan. 14
Acquisition for Debt On January 14, Delta Air Lines purchased aircraft for $1,000,000 cash and a $69,000,000 note payable. GENERAL JOURNAL Page 9 Date Description Debit Credit Jan. 14 Flight equipment 70,000,000 Cash 1,000,000 Note payable 69,000,000
Acquisition for Noncash Consideration On July 7, Delta gave Boeing 6,000,000 shares of $1.50 par value common stock with a market value of $7 per share plus $28,000,000 in cash for aircraft. Total cost for aircraft $70,000,000 GENERAL JOURNAL Page 10 Date Description Debit Credit July 7
Acquisition for Noncash Consideration On July 7, Delta gave Boeing 6,000,000 shares of $1.50 par value common stock with a market value of $7 per share plus $28,000,000 in cash for aircraft. GENERAL JOURNAL Page 10 Date Description Debit Credit July 7 Flight equipment 70,000,000 Cash 28,000,000 Common stock 9,000,000 Additional paid-in capital 33,000,000
Acquisition by Construction Asset cost includes: All materials and labor traceable to the construction. A reasonable amount of overhead. Interest on debt incurred during the construction.
Repairs, Maintenance, and Additions Type of Capital or Expenditure Revenue Identifying Characteristics Ordinary Revenue 1. Maintains normal operating condition repairs and (Expense) 2. Does not increase productivity maintenance 3. Does not extend life beyond original estimate Extraordinary Capital 1. Major overhauls or partial repairs replacements 2. Extends life beyond original estimate Additions Capital 1. Increases productivity 2. May extend useful life 3. Improvements or expansions
Capital and Revenue Expenditures Financial Statement Effect Current Current Treatment Statement Expense Income Taxes Capital Balance sheet Expenditure account debited Deferred Higher Higher Revenue Income statement Currently Expenditure account debited recognized Low er Lower Many companies have policies expensing all expenditures below a certain amount according to the materiality constraint.
Depreciation, Amortization, Depletion Apply various cost allocation methods as assets are held and used over time. Depreciation
Depreciation Depreciation is a cost allocation process that systematically and rationally matches acquisition costs of operational assets with periods benefited by their use. Balance Sheet Acquisition Cost (Unused) Cost Allocation Income Statement Expense (Used)
Depreciation Depreciation Expense Depreciation for the current year Income Statement Accumulated Depreciation Total of depreciation to date on an asset Balance Sheet
Depreciation on Delta s Balance Sheet Property and Equipment: Flight equipment $ 21,008 Less: Accumulated depreciation 6,497 $ 14,511 Equipment under capial lease 463 Less: Accumulated amortization 353 110 Ground property and equipment 4,477 Less: Accumulated depreciation 2,408 2,069 Advance payments for equipment 62 Total property and equipment $ 16,752 Book Values Book value = / Market value
Depreciation Concepts The calculation of depreciation requires three amounts for each asset: Acquisition cost. Estimated useful life. Estimated residual value.
Alternative Depreciation Methods Straight-line Units-of-production Accelerated Method: Declining balance
Straight-Line Method Depreciation Expense per Year = Cost - Residual Value Life in Years At the beginning of the year, Delta purchased ground equipment for $62,500 cash. The equipment has an estimated useful life of 3 years and an estimated residual value of $2,500. SL
Straight-Line Method Depreciation Expense per Year = Cost - Residual Value Life in Years Depreciation Expense per Year = $62,500 - $2,500 3 years Depreciation Expense per Year = $20,000 SL
Straight-Line Method Depreciation Accumulated Accumulated Undepreciated Expense Depreciation Depreciation Balance Year (debit) (credit) Balance (book value) $ 62,500 1 $ 20,000 $ 20,000 $ 20,000 42,500 2 20,000 20,000 40,000 22,500 3 20,000 20,000 60,000 2,500 $ 60,000 $ 60,000 Residual Value SL More companies use the straight-line method of depreciation in their financial reports than all other methods combined.
Units-of-Production Method Step 1: Depreciation Rate = Cost - Residual Value Life in Units of Production Step 2: Depreciation Expense = Depreciation Rate Number of Units Produced for the Year
Units-of-Production Method At the beginning of the year, Delta purchased ground equipment for $62,500 cash. The equipment has a 100,000 mile useful life and an estimated residual value of $2,500. If the equipment is used 30,000 miles in the first year, what is the amount of depreciation expense?
Units-of-Production Method Step 1: Depreciation Rate = $62,500 - $2,500 100,000 miles = $.60 per mile Step 2: Depreciation Expense = $.60 per mile 30,000 miles = $18,000
Units-of-Production Method Accumulated Undepreciated Depreciation Depreciation Balance Year Miles Expense Balance (book value) $ 62,500 1 30,000 $ 18,000 $ 18,000 44,500 2 50,000 3 20,000 100,000
Units-of-Production Method Accumulated Undepreciated Depreciation Depreciation Balance Year Miles Expense Balance (book value) $ 62,500 1 30,000 $ 18,000 $ 18,000 44,500 2 50,000 30,000 48,000 14,500 3 20,000 12,000 60,000 2,500 100,000 $ 60,000 Residual Value
Accelerated Depreciation Accelerated depreciation matches higher depreciation expense with higher revenues in the early years of an asset s useful life when the asset is more efficient. Early Years Later Years Depreciation Expense High Low Repair Expense Low High
Declining-Balance Method The book value of an asset at the beginning of the year is multiplied by a percentage to determine depreciation for the year. This is an accelerated method of depreciation. This method ignores salvage value. The double-declining-balance method is a common application of this formula.
Double-Declining-Balance Method Declining balance rate of 2 is double-declining-balance (DDB) rate. Annual Depreciation expense Net = Book 2 Useful Life in Years Value ( ) Cost Accumulated Depreciation Annual computation ignores residual value.
Double-Declining-Balance Method At the beginning of the year, Delta purchased equipment for $62,500 cash. The equipment has an estimated useful life of 3 years and an estimated residual value of $2,500. Calculate the depreciation expense for the first two years.
Double-Declining-Balance Method Annual Depreciation expense Net = Book 2 Useful Life in Years Value ( ) Year 1 Depreciation: $62,500 ( 3 years ) 2 = $41,667 Year 2 Depreciation: ($62,500 $41,667) ( 3 years ) 2 = $13,889
Double-Declining-Balance Method Depreciation Accumulated Undepreciated Expense Depreciation Balance Year (debit) Balance (book value) $ 62,500 1 $ 41,667 $ 41,667 20,833 2 13,889 55,556 6,944 3 4,629 60,185 2,315 $ 60,185 Below residual value ($62,500 $55,556) ( 2 3 years ) = $4,629
Double-Declining-Balance Method Depreciation Accumulated Undepreciated Expense Depreciation Balance Year (debit) Balance (book value) $ 62,500 1 $ 41,667 $ 41,667 20,833 2 13,889 55,556 6,944 3 4,444 60,000 2,500 $ 60,000 Depreciation expense is limited to the amount that reduces book value to the estimated residual value.
Depreciation and Federal Income Tax For tax purposes, most corporations use the Modified Accelerated Cost Recovery System (MACRS). MACRS depreciation provides for rapid writeoff of an asset s cost in order to stimulate new investment.
The effect of asset impairment on financial statements.
Asset Impairment Impairment is the loss of a significant portion of the utility of an asset through... Casualty. Obsolescence. Lack of demand for the asset s services. A loss should be recognized when an asset suffers a permanent impairment.
Analyze the disposal of property, plant, and equipment.
Disposal of Property, Plant, and Equipment Voluntary disposals: Sale Trade-in Retirement Involuntary disposals: Fire Accident
Disposal of Property, Plant, and Equipment Update depreciation to the date of disposal. Journalize disposal by: Recording cash received (debit) or paid (credit). Recording a gain (credit) or loss (debit). Writing off accumulated depreciation (debit). Writing off the asset cost (credit).
Disposal of Property, Plant, and Equipment If Cash > BV, record a gain (credit). If Cash < BV, record a loss (debit). If Cash = BV, no gain or loss.
Disposal of Property, Plant, and Equipment Delta Airlines sold flight equipment for $5,000,000 cash at the end of its 17th year of use. The flight equipment originally cost $20,000,000, and was depreciated using the straight-line method with zero residual value and a useful life of 20 years.
Disposal of Property, Plant, and Equipment The amount of depreciation expense recorded at the end of the 17th year to bring depreciation up to date is: $1,000,000. Annual Depreciation: ($20,000,000 - $0) 20 Years. = $1,000,000
Disposal of Property, Plant, and Equipment After updating the depreciation, BV = $20,000,000 - $17,000,000 the equipment s = $3,000,000 book value at the end of the 17th year is: $3,000,000 Accumulated Depreciation = (17yrs. $1,000,000) = $17,000,000 BV = Cost - Accumulated Depreciation
Disposal of Property, Plant, and Equipment The equipment s sale resulted in:. a gain of $2,000,000. Gain = Cash Received (Sales Price) - Book Value Gain = $5,000,000 - $3,000,000 = $2,000,000
Disposal of Property, Plant, and Equipment Prepare the journal entry to record Delta s sale of the equipment at the end of the 17th year. GENERAL JOURNAL Page 8 Date Description Debit Credit
Disposal of Property, Plant, and Equipment Prepare the journal entry to record Delta s sale of the equipment at the end of the 17th year. GENERAL JOURNAL Page 8 Date Description Debit Credit Cash 5,000,000 Accumulated Depreciation 17,000,000 Gain on Sale 2,000,000 Flight Equipment 20,000,000
Apply measurement and reporting concepts for natural resources and intangible assets.
Natural Resources Extracted from the natural environment. A noncurrent asset presented at cost less accumulated depletion. Examples: oil, coal, gold
Natural Resources Total cost of asset is the cost of acquisition, exploration, and development. Total cost is allocated over periods benefited by means of depletion. Depletion is like depreciation.
Depletion of Natural Resources Depletion is calculated using the units-of-production method. Unit depletion rate is calculated as follows: Acquisition and Development Cost Residual Value Estimated Recoverable Units
Depletion of Natural Resources Total depletion cost for a period is: UNIT DEPLETION RATE NUMBER OF UNITS EXTRACTED IN PERIOD Total depletion cost Inventory for sale Cost of goods sold Unsold Inventory
Natural Resources Specialized plant assets may be required to extract the natural resource. These assets are recorded in a separate account and depreciated.
Intangible Assets Noncurrent assets without physical substance. Often provide exclusive rights or privileges. Intangible Assets Useful life is often difficult to determine. Usually acquired for operational use.
Intangible Assets Record at current cash equivalent cost, including purchase price, legal fees, and filing fees. Goodwill Trademarks Patents Copyrights Franchises Licensing Rights Technology
Intangible Assets Definite Life Indefinite Life Amortize over shorter of economic life or legal life, subject to rules specified by GAAP. Use straight-line method. Not amortized. Tested at least annually for possible impairment, and book value is reduced to fair value if if impaired. Amortization is a cost allocation process similar to depreciation and depletion.
Intangible Assets Goodwill Goodwill Occurs when one company buys another company. Only purchased goodwill is an intangible asset. The amount by which the purchase price exceeds the fair market value of net assets acquired.
Intangible Assets Goodwill Goodwill Indefinite Life Not amortized. Value must be reviewed at least annually for possible impairment, and book value is reduced to fair value if impaired.
Intangible Assets Goodwill FaceBook paid $2,000,000 to purchase all of U-Serve company s assets and assumed liabilities of $400,000. The acquired assets were appraised at a fair value of $1,800,000.
Intangible Assets Goodwill What amount of goodwill should be recorded on FaceBook books? $600,000 FMV of Assets $ 1,800,000 Debt Assumed 400,000 FMV of Net Assets 1,400,000 Purchase Price 2,000,000 Goodwill $ 600,000
Intangible Assets Trademarks A symbol, design, or logo associated with a business. Internally developed trademarks have no recorded asset cost. Purchased trademarks are recorded at cost.
Intangible Assets Patents Exclusive right granted by federal government to sell or manufacture an invention. Cost is purchase price plus legal cost to defend. Amortize cost over the shorter of useful life or 20 years. Research and development costs that might result in a patent are normally expensed as incurred.
Intangible Assets Copyrights Exclusive right granted by the federal government to protect artistic or intellectual properties. Legal life is life of creator plus 70 years. Amortize cost over the period benefited.
Intangible Assets Franchises Legally protected right to sell products or provide services purchased by franchisee from franchisor. Purchase price is an intangible asset that is amortized.
Intangible Assets Licensing Rights Limited permissions to use a product or service according to specific terms and conditions. You may be using computer software that is made available to you through a campus licensing agreement.
Intangible Assets - Technology A category of intangible assets that includes a company s website and any computer programs written by its employees.