CHAPTER
9
Long-Term Assets
Financial and
Managerial
Accounting
10e
Needles
Powers
Crosson
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Concepts Underlying Long-Term Assets
 Long-term assets have the following
characteristics:
– They have a useful life of more than one year.
– They are used in the operation of a business.
– They are not intended for resale to customers.
 Under accrual accounting, the cost of these assets,
with the exception of land and some intangible
assets, is allocated to the periods they benefit.
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Valuation and Disclosure of Long-Term Assets
 Long-term assets are generally reported and
valued at carrying value.
– Carrying value (or book value) is the unexpired part of
an asset’s cost.
– Asset impairment occurs when the carrying value of a
long-term asset exceeds its fair value—i.e., when an
asset loses some or all of its potential to generate
revenue before the end of its useful life.
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Recognition of the Acquisition Cost of
Long-Term Assets (slide 1 of 2)
 An expenditure is a payment or an obligation to make a
future payment for an asset or a service. Expenditures are
classified as capital expenditures or revenue expenditures.
– A capital expenditure is for the purchase or expansion
of a long-term asset.
 Capital expenditures are recorded in asset accounts.
– A revenue expenditure is for the ordinary repairs and
maintenance needed to keep a long-term asset in good
operating condition.
 Revenue expenditures are recorded in expense accounts.
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Recognition of the Acquisition Cost of
Long-Term Assets (slide 2 of 2)
 Capital expenditures include:
– outlays for plant assets, natural resources, and
intangible assets
– additions—enlargements to the physical layout of a
plant asset
– betterments—improvements to a plant asset but not an
addition to the plant’s physical layout
– extraordinary repairs—repairs that significantly
enhance a plant asset’s estimated useful life or residual
value; recorded by reducing the Accumulated
Depreciation account
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Acquisition Cost of Property,
Plant, and Equipment
 The acquisition cost of property, plant, and
equipment includes all expenditures reasonable
and necessary to get an asset in place and ready
for use.
Cost of Asset = Purchase Price + Additional Expenditures
(freight, installation, etc.)
– Interest charges incurred in purchasing an asset are not
a cost of the asset, but an operating expense.
– Small expenditures for long-term assets may be
treated as expenses if they are not material.
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Determining the Acquisition Cost of Property, Plant,
and Equipment: Land and Land Improvements
 Land: Expenditures that should be debited to the Land
account include: purchase price of the land; commissions to
real estate agents; lawyer’s fees; accrued taxes paid by
the purchaser; costs of preparing the land to build on, such
as costs of tearing down old buildings and grading the
land; assessments for local improvements; and
landscaping.
 Land Improvements: Improvements to real estate, such as
driveways, parking lots, and fences, that have a limited
life are subject to depreciation. They are recorded in an
account called Land Improvements.
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Determining the Acquisition Cost of Property,
Plant, and Equipment: Buildings
 When a company buys a building, the cost includes
the purchase price and all expenditures required to
put the building in usable condition.
 When a company constructs its own building, the
cost includes: costs of materials, labor, and
overhead; architects’ fees and lawyers’ fees;
insurance during construction; interest on
construction loans during construction; and building
permits.
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Determining the Acquisition Cost of Property,
Plant, and Equipment: Leasehold Improvements
 Improvements to leased property, such as the
installation of carpet or walls, on the books of the
lessee that become the property of the lessor (the
owner of the property) at the end of the lease are
called leasehold improvements.
– These are usually classified in the property, plant, and
equipment section of the balance sheet.
– The cost of these improvements is depreciated over the
remaining term of the lease or the useful life of the
improvement, whichever is shorter.
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Determining the Acquisition Cost of Property, Plant,
and Equipment: Equipment and Group Purchases
 Equipment: The cost of equipment includes all
expenditures connected with purchasing the equipment
and preparing it for use. These expenditures include:
invoice price less cash discounts; freight, including
insurance; excise taxes and tariffs; buying expenses;
installation costs; and test runs to ready the equipment
for operation.
 Group Purchases: Companies sometimes purchase land
and other assets for a lump sum. The lump sum must be
apportioned between the land and other assets.
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Depreciation
 Depreciation refers to the allocation of the cost of
a plant asset over its estimated useful life, not to
the asset’s physical deterioration or to its
decrease in market value.
– The major factors that limit a depreciable asset’s useful
life are:
 Physical deterioration—the result of use or exposure to the
elements, such as sun or wind
 Obsolescence—the process of becoming out of date
– Depreciation is recorded even if an asset increases in
value.
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Factors in Computing Depreciation
 Factors in computing depreciation include:
– Cost—the net purchase price of an asset plus all
expenditures to get it in place and ready for use
– Residual value (or salvage, disposal, or trade-in
value)—the portion of an asset’s cost that a company
expects to recover when it disposes of the asset
– Depreciable cost—an asset’s cost less its residual value
– Estimated useful life—the total number of service units
expected from a long-term asset
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Computing Depreciation:
Straight-Line and Production Methods
 When the straight-line method is used, the asset’s
depreciable cost is spread evenly over the estimated
useful life of the asset. Under this method, depreciation is
calculated as follows:
 The production method is based on the assumption that
depreciation is solely the result of use and that the
passage of time plays no role in the process. Under this
method, depreciation is calculated as follows:
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Computing Depreciation:
Declining-Balance Method
 An accelerated method of depreciation results in larger
amounts of depreciation in the early years of an asset’s
life than in later years.
– Thus, depreciation charges will be highest in years when the asset
is newest and when revenue generation from the asset is highest.
 The declining-balance method is the most common
accelerated method of depreciation. With this method,
depreciation is computed by applying a fixed rate to the
declining value of a long-term asset.
– The most common rate is a percentage equal to twice the straightline depreciation percentage. When this rate is used, the method is
usually called the double-declining-balance method.
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Special Issues in Determining Depreciation
 Group Depreciation: Large companies group similar assets, such as
machines, to calculate depreciation.
 It is often necessary to calculate depreciation for partial years
because assets are often purchased mid-year.
 The tax law allows rapid write-offs of plant assets, which differs from
the depreciation methods most companies use for financial reporting.
As a result of the Economic Stimulus Act of 2008, the tax law allows
a small company to expense the first $250,000 of equipment
expenditures.
 Sometimes the estimate of useful life is revised, so that the
depreciation changes over the asset’s remaining useful life.
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Disposal of Depreciable Assets
 When plant assets are no longer useful because they have
physically deteriorated or become obsolete, a company
can sell them, discard them, or trade them in on the
purchase of a new asset.
– A company must record depreciation expense for the
partial year up to the date of disposal.
– The carrying value of a fully depreciated asset is zero
if it has no residual value. When the asset is discarded,
no gain or loss results.
– For an asset with a carrying value, a loss equal to the
carrying value should be recorded when it is discarded.
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Exchanges of Plant Assets
 Exchanges may involve similar assets, such as an
old machine traded in on a newer model, or
dissimilar assets, such as a cement mixer traded in
on a truck.
– In both cases, the purchase price is reduced by the
amount of the trade-in allowance.
 If the trade-in allowance is greater than the asset’s carrying
value, the company realizes a gain.
 If the allowance is less, it suffers a loss.
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Natural Resources
 Natural resources are long-term assets that are
converted to inventory by cutting, pumping, mining, or
other extraction methods.
– They are recorded at acquisition cost. As these
resources are converted to inventory, their asset
accounts must be proportionately reduced.
– The useful life of the plant assets used to extract the
natural resources may be longer than the time it will
take to extract the resources.
 If a company plans to abandon these assets after all the
resources have been extracted, they should be depreciated on
the same basis as depletion of the natural resources.
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Depletion
 Depletion refers not only to the exhaustion of a
natural resource but also to the proportional
allocation of the cost of a natural resource to the
units extracted.
– When a natural resource is purchased or developed,
the total units that will be available, such as tons of
coal, must be estimated.
– The depletion cost per unit is computed as follows.
Depletion Cost per Unit =
Cost − Residual Value
Estimated Number of Units
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Development and Exploration Costs
in the Oil and Gas Industry
Exploring and developing oil and gas resources can be
accounted for under one of two methods:
 Successful efforts
accounting—Under this
method, the cost of
successful exploration is a
cost of the resource.
– It is recorded as an asset
and depleted over the
resource’s estimated life.
The cost of unsuccessful
exploration is written off
immediately as a loss.
 Full-costing method—
Under this method, all
costs of exploration are
recorded as assets and
depleted over the
estimated life of the
resources.
– This includes the costs of
unsuccessful exploration,
such as the cost of dry wells.
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Intangible Assets
(slide 1 of 2)
 An intangible asset’s value comes from the longterm rights it affords its owner.
– Common types of intangible assets are:
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Copyright
Patent
Leasehold
Software
Noncompete covenant
Franchise, License
Customer list
Goodwill
Trademark, Brand name
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Intangible Assets
(slide 2 of 2)
 Intangible assets are accounted for at the amount that a
company paid for them and should be included on a
company’s balance sheet only if purchased from another
party at a price established in the marketplace.
– The useful life of an intangible asset is the period over which the
asset is expected to contribute to the company’s future cash flows.
It may be:
 Definite—subject to a legal limit or can be reasonably estimated
 Indefinite—not limited by legal, regulatory, contractual, competitive,
economic, or other factors (and not amortized)
– All intangible assets are subject to an annual impairment test to
determine if the assets justify their value on the balance sheet.
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Research and Development Costs
 Research and development (R&D) activities include
development of new products, testing of existing and
proposed products, and pure research.
– The FASB requires that all R&D costs be charged to expense in the
period in which they are incurred.
– Costs that companies incur in developing software for sale or lease
or for their own use are considered R&D costs until the product has
proved feasible.
– Once proved feasible, all software production costs are recorded
as assets and amortized over the software’s estimated useful life,
using the straight-line method.
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Goodwill
 From an accounting standpoint, goodwill exists when a
purchaser pays more for a business than the fair market
value of the business’s net assets.
– Goodwill may reflect customer satisfaction, good management,
efficiency, having a monopoly, good locations, and good
employee relations.
– The FASB requires that purchased goodwill be reported as a
separate line item on the balance sheet and that it be reviewed
annually for impairment.
– A company should record goodwill only when it acquires a
controlling interest in another business.
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Management Decisions Relating to
Long-Term Assets
 A company may need to finance major acquisitions of
long-term assets with the issue of stock, long-term
notes, or bonds.
 A measure of a company’s success in funding these
acquisitions is free cash flow.
- Free cash flow is the amount of cash that remains after
deducting the funds a company must commit to continue
operating at its planned level.
 These commitments include: current or continuing operations,
interest, income taxes, dividends, and net capital expenditures
(purchases of plant assets minus sales of plant assets).
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Free Cash Flow
 Free cash flow is computed as follows:
Free Cash Flow = Net Cash Flows from Operating Activities
− Dividends − Purchases of Plant Assets +
Sales of Plant Assets
– A positive free cash flow means that a company has met
all its cash commitments and has cash available to reduce
debt or to expand operations.
– A negative free cash flow means that it will have to sell
investments, borrow money, or issue stock to continue at its
planned level.
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Ethics in Acquiring and Financing
Long-Term Assets (slide 1 of 2)
 When a company acquires a long-term asset, it defers
some of the asset’s cost to later periods.
– Thus, the current period’s profitability looks better than
it would if the asset’s total cost had been expensed.
 To avoid fraudulent reporting of long-term assets, a
company’s management must apply accrual accounting in
resolving two important issues:
– The amount of the total cost of a long-term asset to
allocate to expense in the current period.
– The amount to retain on the balance sheet as an asset.
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Ethics in Acquiring and Financing
Long-Term Assets (slide 2 of 2)
– To resolve these issues, management must
answer four important questions:
1. How is the cost of the long-term asset determined?
2. How should the expired portion of the cost of the
long-term asset be allocated against revenues
over time?
3. How should subsequent expenditures, such as
repairs and additions, be treated?
4. How should disposal of the long-term asset be
recorded?
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