Financial & Managerial
Accounting 2002e
Belverd E. Needles, Jr.
Marian Powers
Susan Crosson
----------Multimedia Slides by:
Harry Hooper
Santa Fe Community College
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1
Chapter 10
Long-Term Assets
LEARNING OBJECTIVES
1. Identify the types of long-term assets and
explain the management issues related to
accounting for them.
2. Distinguish between capital and revenue
expenditures, and account for the cost of
property, plant, and equipment.
3. Define depreciation, state the factors that
affect its computation, and show how to
record it.
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3
LEARNING OBJECTIVES
(continued)
4. Compute periodic depreciation under the
straight-line method, production method,
and declining-balance method.
5. Account for the disposal of depreciable
assets not involving exchanges.
6. Account for the disposal of depreciable
assets involving exchanges.
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4
LEARNING OBJECTIVES
(continued)
7. Identify the issues related to accounting for
natural resources and compute depletion.
8. Apply the matching rule to intangible
assets, including research and development
costs and goodwill.
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5
SUPPLEMENTAL OBJECTIVES
9. Apply depreciation methods to problems of
partial years, revised rates, groups of
similar items, special types of capital
expenditures, and cost recovery.
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6
Management Issues Related to
Accounting for Long-Term
Assets
OBJECTIVE 1
Identify the types of long-term assets
and explain the management issues
related to accounting for them.
Characteristics of
Long-Term Assets

Long-term assets are assets that:







Have a useful life of more than one year.
Are acquired for use in the operation of a business.
Are not intended for resale to customers.
Must be capable of repeated use for a period of at
least one year.
Support the operating cycle instead of being a part of
it.
Are reported at carrying (book) value.
Carrying value is the unexpired part of the cost of an
asset.
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8
 Assets
not used in the normal course of
business, such as speculative
investments, should be classified as
long-term investments, not property,
plant and equipment.
 Asset impairment occurs when the sum
of the expected cash flows from the asset
is less than the carrying value. The
carrying value is reduced to fair value,
and the reduction in carrying value is
recorded as a loss.
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9
Long-Term Assets as a Percentage of
Total Assets for Selected Industries
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10
Deciding to Acquire
Long-Term Assets
A capital budgeting decision.
 Decision is based on analyzing:
 The present value of the future positive and
negative cash flows.
 The costs of training and maintenance.
 The possibility that the expected savings may
not occur.
 Information on acquisitions of long-term assets
is found under investing activities in the
statement of cash flows.

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11
Classification of Long-Term Assets and Corresponding Expenses
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12
Carrying Value of Long-Term Assets on Balance Sheet
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13
Financing Long-Term
Assets

Financing alternatives:
 Use
cash flows from
operations.
 Take a long-term loan.
 Issue common stock.
 Issue long-term notes.
 Issue bonds.
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14
Applying the Matching Rule to
Long-Term Assets

Two important issues must be resolved.
1. How much of the total cost to allocate
to expense in the current accounting
period.
2. How much to retain on the balance
sheet as an asset to benefit future
periods.
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15
Questions about the Acquisition, Use,
and Disposal of Each Long-Term Asset
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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16
Issues of Accounting for Long-Term Assets
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17
It
is helpful to think of a long-term
asset as a long-term prepaid
expense.
Spread the cost of the services
provided by the asset over its
useful life.
As the services benefit the
company, the cost of the asset
becomes an expense.
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18
Discussion
Q. What are the characteristics of
long-term assets?
A. Long-term assets have a useful
life of more than one year, are
acquired for use in the operation
of a business, and are not
intended for resale to customers.
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19
Acquisition Cost of Property,
Plant, and Equipment
OBJECTIVE 2
Distinguish between capital and
revenue expenditures, and
account for the cost of property,
plant, and equipment.
Expenditures





An expenditure is a payment or an obligation to make future
payment for an asset or a service.
A capital expenditure is an expenditure for the purchase or
expansion of a long-term asset.
A revenue expenditure is an expenditure to the repair,
maintenance, and operation of a long-term asset.
Careful distinction between expenditures is important to the
proper application of the matching rule.
 Understatements and overstatements of income can
occur.
Determining when a payment is an expense and when it is
an asset is a matter of management judgment.
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21
Costs of Land
 Purchase
price.
 Commissions to real estate agents.
 Lawyers’ fees.
 Accrued taxes paid by the purchaser.
 Draining.
 Tearing down old building(s).
 Clearing and grading.
 Assessments for improvements.
 Landscaping.
Land is not subject to depreciation.
Not part of the list of “costs”
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22
Costs of Land Improvements
Include
driveways, parking lots, and
fences.
Have limited lives and are
depreciated.
Are recorded in the Land
Improvements account rather than
the Land account.
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23
Costs of Buildings
Purchase
price.
Repairs and other expenditures
required to put it in usable condition.
Buildings are subject to depreciation
because they have a limited useful life.
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24
Costs of Building Construction
(included in total building costs)
 Materials
 Labor
 Overhead
and other indirect costs
 Architects’ fees
 Insurance during construction
 Interest on construction loans
 Lawyers’ fees
 Building permits
 Outside contractors
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25
Costs of Equipment
Purchase
price.
Other expenditures including:
 Freight
 Insurance
in transit
 Excise taxes and tariffs
 Buying expenses
 Installation costs
 Cost of test runs
Equipment is subject to depreciation.
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26
Costs of Group Purchases
A lump sum purchase of land and other assets.
 Requires apportionment of the purchase price to
Land and other asset accounts.
 Land must have a separate ledger account because it
is nondepreciable.

Land
Building
Totals

Appraisal
$ 10,000
90,000
$100,000
Percentage
10
90
100
Apportionment
$ 8,500
76,500
$85,000
Thus, purchase price is $85,000.
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27
Discussion
Q. Dyeing a carpet may make it look almost
new. Why isn’t it a capital expenditure?
A. Although the carpet looks better, its
fibers are not stronger, and it probably
will not last significantly longer than it
would have before the color was changed.
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28
Accounting for Depreciation
OBJECTIVE 3
Define depreciation, state the
factors that affect its computation,
and show how to record it.
Definition of Depreciation
 Depreciation
accounting is described
by the AICPA as:
. . . a system of accounting which aims to
distribute the cost or other basic value of
tangible capital assets, less salvage (if any),
over the estimated useful life of the unit . . .
in a systematic and rational manner. It is a
process of allocation, not of valuation.
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30
Features of Depreciation
 All
tangible assets except land have a limited
useful life, because of physical deterioration
and obsolescence.
 Depreciation means the allocation of the cost
of a plant asset to the periods that benefit
from the service of that asset.
 Depreciation is not a process of valuation.
 Even if the market value of the asset
increases, depreciation must continue.
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31
Four Factors That Affect the
Computation of Depreciation
1. Cost.
 Net
purchase price.
 All reasonable and necessary expenditures to
get the asset in place and ready for use.
2. Residual value (salvage or disposal value).
 An
asset’s estimated net scrap, salvage, or
trade-in value as of the estimated date of
disposal.
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32
Four Factors That Affect the
Computation of Depreciation
(continued)
3. Depreciable cost.
 Cost less residual value.
 Depreciable cost is allocated over the useful
life of an asset.
4. Estimated useful life.
 Total number of service units expected from a
long-term asset.
 May be measured in years, miles, units, or
similar measures.
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33
Accounting for Depreciation
 Depreciation
is recorded at the end of the accounting
period by an adjusting entry in the following form:
Depreciation Expense, Asset Name
xxx
Accumulated Depreciation, Asset Name
xxx
To record depreciation for the period
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34
Discussion
Q. A company purchased a building five years
ago. The market value of the building is
now greater than it was when the building
was purchased. Explain why the company
should continue depreciating the building.
A. The company should continue depreciating
the building because depreciation is an
allocation of cost and not a valuation
process.
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35
Methods of Computing
Depreciation
OBJECTIVE 4
Compute periodic depreciation
under the straight-line method,
or production method and the
declining-balance method.
Straight-Line Method
 This
method spreads the depreciable costs evenly
over the asset’s estimated useful life.
 Annual depreciation is computed as follows:
Cost - Residual Value $10,000 - $1,000
Estimated Useful Life =
5 years
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= $1,800 per year
37
Depreciation Schedule,
Straight-Line Method
Date of Purchase
End of year 1
End of year 2
End of year 3
End of year 4
End of year 5
Stop at residual
value
Cost
$10,000
10,000
10,000
10,000
10,000
10,000
Yearly
Deprec.
0
$1,800
1,800
1,800
1,800
1,800
Same
each
year.
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Accum.
Deprec.
0
$1,800
3,600
5,400
7,200
9,000
Carrying
Value
$10,000
8,200
6,400
4,600
2,800
1,000
Increases Decreases
uniformly. uniformly.
38
Production Method
 This
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 depreciation
process.
 Annual depreciation is computed as follows:
Cost - Residual Value
$10,000 - $1,000 = $.10/mile
=
Estimated Units of Useful Life
90,000 miles
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39
Depreciation Schedule,
Production Method
DOP
EOY 1
EOY 2
EOY 3
EOY 4
EOY 5
Cost
$10,000
10,000
10,000
10,000
10,000
10,000
Miles
0
20,000
30,000
10,000
20,000
10,000
Yearly
Deprec.
0
$2,000
3,000
1,000
2,000
1,000
Accum.
Deprec.
0
$2,000
5,000
6,000
8,000
9,000
Relates
to miles.
Increases Decreases
related
related
to miles.
to miles.
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Carrying
Value
$10,000
8,000
5,000
4,000
2,000
1,000
40
Declining-Balance Method
An
accelerated method.
Results in relatively large amounts of
depreciation in the early years of an
asset’s life and smaller amounts in later
years.
Assumes that plant assets are most
efficient when new.
Is consistent with the matching rule.
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41
Accelerated Depreciation
 Recognizes
that changing technologies
result in earlier obsolescence.
 Maintains more constant total expenses
for equipment, assuming repair expense
is greater in later years.
 Most common rate of depreciation,
applied to the carrying value of a longterm asset, is twice the straight-line
percentage, known as double-decliningbalance method.
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42
Computation of
Double-Declining-Balance Method
 Annual
depreciation is computed as follows:
Number of years = Depreciation Rate (DR)
5 year asset = 20% per year x 2 = 40%
Depreciation Expense = DR x Carrying Value (CV)
CV = Cost - Accumulated Depreciation
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43
Depreciation Schedule,
Double-Declining-Balance Method
Cost
$10,000
10,000
10,000
10,000
10,000
10,000
DOP
EOY 1
EOY 2
EOY 3
EOY 4
EOY 5
YDR = 40%
5 yrs. = 20%
20% x 2
Yearly
Deprec.
0
$4,000
2,400
1,440
864
296
Accum.
Deprec.
0
$4,000
6,400
7,840
8,704
9,000
Carrying
Value
$10,000
6,000
3,600
2,160
1,296
1,000
(can’t go
below residual)
Increases Decreases
quickly.
quickly.
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44
Graphical Comparison of Three Methods
of Determining Depreciation
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45
Depreciation Methods Used by
600 Large Companies
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46
Discussion
Q. Contrast the assumptions underlying
the straight-line depreciation method
with the assumptions underlying the
production depreciation method.
A. The straight-line method assumes that
depreciation is associated with the
passage of time, whereas the
production method assumes that
depreciation is associated with use.
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47
Disposal of Depreciable Assets
OBJECTIVE 5
Account for the disposal
of depreciable assets not
involving exchanges.
Disposal of Depreciable Assets
3 ways of disposal:
1. Discarded
2. Sold for cash
3. Exchanged for another asset
Assume:
Machinery
6,500
Accumulated Depreciation, Machinery
4,200
Purchased: 1/1/x0
Carrying Value: (1/1/x7): $2,300 = $6,500 - $4,200
Estimated Useful Life: 10 Yrs; Residual Value: $500
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49
Depreciation for Partial
Year
 Disposal
takes place 9/30/x7
 It is necessary to record depreciation expense for the
partial year up to the date of disposal.
Sept. 30 Depreciation Expense, Machinery 450
Accumulated Depreciation,
Machinery
450
To record depreciation up
to date of disposal
[($6,500 - $500) ÷ 10] x 9/12 = $450
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50
Discarded Plant Assets
Sept. 30 Accumulated Depreciation,
Machinery
4,650
Loss on Disposal of Machinery 1,850
Machinery
6,500
Discarded machine no
longer used in the business
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51
Plant Assets Sold for Cash:
Receipts equal Carrying Value
Sept 30
Cash
1,850
Accumulated Depreciation,
Machinery
4,650
Machinery
6,500
Sale of machine for carrying
value; no gain or loss
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52
Plant Assets Sold for Cash:
Loss Recorded
Sept. 30 Cash
1,000
Accumulated Depreciation,
Machinery
4,650
Loss on Sale of Machinery
850
Machinery
6,500
Sale of machine at less than
carrying value; loss of
$850 = ($1,850 - $1,000)
recorded
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53
Plant Assets Sold for Cash:
Gain Recorded
Sept. 30 Cash
2,000
Accumulated Depreciation,
Machinery
4,650
Gain on Sale of Machinery
150
Machinery
6,500
Sale of machine at more than
carrying value; gain of
$150 = ($2,000 - $1,850)
recorded
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54
Discussion
Q. If a plant asset is discarded before the
end of its useful life, how is the
amount of loss measured?
A. If a plant asset is discarded before the
end of its useful life, the amount of
loss is equal to its carrying value (cost
less accumulated depreciation).
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55
Exchanges of Plant Assets
OBJECTIVE 6
Account for the disposal of
depreciable assets involving
exchanges.
Recognizing Gains and
Losses on Exchanges
Exchange
Losses
Gains
Recognized Recognized
For financial accounting purposes
Of dissimilar assets
Of similar assets
For income tax purposes
Of dissimilar assets
Of similar assets
Yes
Yes
Yes
No
Yes
No
Yes
No
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57
Loss Recognized on the Exchange
List price of new machine
Trade-in allowance for old machine
Cash payment requires
Sept 30 Machinery (new)
Accumulated Depreciation, Machinery
$12,000
(1,000)
$11,000
12,000
4,650
Loss on Exchange of Machinery
Machinery (old)
Cash
850
6500
11,000
Exchange of Machines
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58
Loss Not Recognized on the Exchange
(similar assets, tax purposes only)
Sept. 30
Carrying value of old machine
Cash paid
Cost basis of new machine
$1,850
11,000
$12,850
Machinery (new)
12,850
Accumulated Depreciation, Machinery
4,650
Machinery (old)
Cash
Exchange of machines
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6,500
11,000
59
Gain Recognized on the Exchange
List price of new machine
Trade-in allowance for old machine
Cash payment required
Sept 30
$12,000
(3,000)
$9,000
Machinery (new)
12,000
Accumulated Depreciation, machinery
4,650
Gain on exchange of machinery
1,150
Machinery (old)
6,500
Cash
9,000
Exchange of Machines
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60
Gain Not Recognized on the Exchange
Carrying value of old machine
Cash paid
Cost basis of new machine
Sept. 30
$1,850
9,000
$10,850
Machinery (new)
10,850
Accumulated Depreciation, Machinery 4,650
Machinery (old)
6,500
Cash
9,000
Exchange of machines
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61
Discussion
Q. Are gains on similar assets completely
unrecognized?
A. No. Since the basis of the new asset is
reduced by the unrecognized gain,
there will be less depreciation expense
over the life of the new asset.
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62
Accounting for
Natural Resources
OBJECTIVE 7
Identify the issues related to
accounting for natural resources
and compute depletion.
Accounting for Natural Assets
Natural
resources are shown on the
balance sheet as long-term assets.
These assets are converted into
inventory by cutting, pumping, or
mining.
They are recorded at acquisition cost.
As the asset is converted to inventory,
the asset account must be
proportionally reduced.
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64
Depletion


Depletion is used to describe not only the exhaustion of a
natural resource but also the proportional allocation of the
cost of a natural resource to the units extracted.
Costs are allocated much like the production method of
depreciation.
Dec. 31 Depletion Expense,
Coal Deposits
115,000
Accumulated Depletion,
Coal Deposits
115,000
To record depletion of coal mine:
$1 per ton for 115,000 tons mined and sold
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65
Depreciation of Closely Related
Long-Term Assets
Closely
related long-term assets are
those assets necessary to extract the
resource.
If the life of the asset is longer than the
life of the resource, it is depreciated on
the same basis as the depletion is
computed.
If the life of the asset is shorter than the
life of the resource, it is depreciated
over a shorter life.
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66
Development and Exploration
Costs in the Oil and Gas Industry



Successful efforts accounting.
 Cost recorded as an asset and depleted over the estimated
life of the resource.
 For an unsuccessful exploration, written off immediately as
a loss.
 More conservative method.
Full-costing method.
 All costs, including costs of dry wells, are recorded as assets
and depleted over the estimated life of the producing
resources.
 Improves earnings performance in the early years.
Either method is allowed under GAAP.
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67
Discussion
Q. Under what circumstances can a mining
company depreciate its long-term assets over
a period of time that is less than their useful
lives?
A. A mining company may depreciate its plant
assets over a period of time that is less than
their useful lives when the long-term assets
are so
closely associated with the natural resource
that they cannot be used after the resource is
depleted and the depletion period is shorter
than the useful lives of the assets.
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68
Accounting for
Intangible Assets
OBJECTIVE 8
Apply the matching rule to
intangible assets, including
research and development
costs and goodwill.
Intangible Assets
 Intangible
assets are long term but have no
physical substance.
 Value comes from the long-term rights or
advantages that it offers to its owners.
 Intangible assets include patents, copyrights,
leaseholds, leasehold improvements, trademarks
and brand names, franchises, licenses, and
goodwill.
 They are accounted for at acquisition cost.
 Goodwill and trademarks should not appear on the
balance sheet unless they have been purchased
from another party at a price established in the
marketplace.
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70
Accounting Issues for
Intangible Assets
 Accounting
issues are similar to other long-term
assets. APB Opinion 17 lists them as follows:
Determining an initial carrying amount.
 Accounting for periodic write-off or amortization.
 Accounting for that amount if the value declines
substantially and permanently.

 Because
of its intangibility, its value and useful
life may be quite hard to estimate.
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71
 Intangible
assets developed by a company for
its own benefit should be expensed.
 Intangible assets should be amortized over the
shorter of their useful life or their legal life
(not to exceed 40 years.)
 FASB is considering a proposal to eliminate
goodwill amortization.
 If an intangible asset become worthless before
it is fully amortized, the remaining carrying
value should be written off as a loss.
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72
Related Journal Entries
for Intangible Assets
Patent
Cash
Purchase of patent
18,000
Amortization Expense
Patent
Annual amortization
18,000
3,000
3,000
$18,000 ÷ 6 years = $3,000
Loss on Patent
15,000
Patent
Loss resulting from
patent’s becoming worthless
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15,000
73
Research and
Development Costs

The FASB has stated that:
1. Research and Development expenditures
should be treated as revenue expenditures
and charged to expense in the period when
incurred.
2. Costs of Research and Development are
continuous and necessary for the success of
a business and should be treated as current
expenses.
3. Research and Development costs do not
necessarily result in future benefits (assets).
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74
Computer Software Costs
 Costs
incurred in creating computer software for
sale or lease to others are considered R&D costs
until the product has been proved to be
technologically feasible.
 Costs incurred up to this point are expensed as
incurred.
 After the working program has been developed,
all software production costs are recorded as
assets and amortized over the estimated economic
life of the product using the straight-line method.
 Software developed for internal use by a company
may be amortized over its estimated economic life.
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Goodwill
 Goodwill
exists when a purchaser pays more for a
business than the fair market value of the net assets
if purchased separately.
 The payment above and beyond the fair market
value is recorded in the Goodwill account.
 APB #17 states that Goodwill should be amortized
over a reasonable number of future time periods,
but not longer than 40 years.
 Goodwill should not be recorded unless it is paid for
in connection with the purchase of a whole business.
 Goodwill = Purchase price - FMV of identifiable
assets.
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Discussion
Q. Why would a company spend thousands
of dollars on goodwill?
A. The company is paying for anticipated
superior earnings and probably feels it
will more than recoup the goodwill
purchased.
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77
Special Problems of
Depreciating Plant Assets
SUPPLEMENTAL OBJECTIVE 9
Apply depreciation methods to
problems of partial years, revised
rates, groups of similar items, special
types of capital expenditures, and
cost recovery.
Depreciation for Partial
Years
 Assume
an asset is purchased on September 5
and the yearly accounting period ends on
December 31.
Cost – Residual x
Life in Years
$3,600 - $600 x
6 years

Number of Months
12
4 = $167
12
Typically, round off to the nearest whole month.
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79
Revision of Depreciation
Rates
Revision
is made when it is determined
that an asset will last for a longer or
shorter period than originally thought.
The remaining depreciable cost of the
asset is spread over the remaining years
of useful life.
Depreciation expense is increased or
decreased to reflect the asset’s changed
life.
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Example Computation of Revised
Depreciation Rates
Initial Estimated Useful Life
Cost
(Depreciation Already Taken)
(Residual Value)
Remaining Depreciable Amount
Divide by remaining useful life
6 years
$7,000
(2,000)
(1,000)
$4,000
2 years
Dec. 31 Deprec. Exp., Delivery Truck
2,000
Accum. Deprec., Delivery Truck
2,000
To record depreciation expense for the year
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81
Group Depreciation
Group
depreciation is widely used
when like assets are grouped and
depreciated together.
This approach is convenient and
includes assets such as trucks and
office equipment.
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82
Special Types of
Capital Expenditures
An
addition is an enlargement to the
physical layout of a plant asset.
 The
cost is charged to the asset account.
A
betterment is an improvement that
does not add to the physical layout of a
plant asset.
 The
cost is charged to the asset account.
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83
Special Types of
Capital Expenditures (continued)
 Ordinary
repairs are expenditures necessary
to keep an asset in good operating condition.
 Such
repairs are a current expense.
 Extraordinary
repairs are repairs of a more
significant nature that increase the estimated
residual value or estimated useful life of an
asset.
 Recorded
by debiting the Accumulated
Depreciation account.
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84
Cost Recovery for Federal Income Tax
Purposes
 First
$17,500 ($25,000 by 2003) of equipment costs
each year may be expensed rather than capitalized.
 Modified Accelerated Cost Recovery System
(MACRS) discards the concepts of estimated
useful life and residual value.
 MACRS requires that a cost recovery allowance be
computed:
On the unadjusted cost of property being recovered.
 Over a period of years prescribed by the law for all
property of similar types.

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85
Cost Recovery for Federal
Income Tax Purposes
(continued…)
 Congress
hoped to encourage businesses to
invest in new plant and equipment by
allowing them to write off assets rapidly.
 Tax methods of depreciation are not usually
acceptable for financial reporting under
GAAP.
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86
Discussion
Q. What will be the effect on future
years’ income of charging an
addition to a building to repair
expense?
A. If an addition to a building is
charged to repair expense, future
years’ income will be overstated
and the current year’s income will
be understated.
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87
OK, LET’S REVIEW . . .
1. Identify the types of long-term assets
and explain the management issues
related to accounting for them.
2. Distinguish between capital and
revenue expenditures, and account
for the cost of property, plant, and
equipment.
3. Define depreciation, state the factors
that affect its computation, and show
how to record it.
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88
CONTINUING OUR REVIEW . . .
4. Compute periodic depreciation
under the straight-line method,
production method, and decliningbalance method.
5. Account for the disposal of
depreciable assets not involving
exchanges.
6. Account for the disposal of
depreciable assets involving
exchanges.
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89
AND FINALLY . . .
7. Identify the issues related to accounting for
natural resources and compute depletion.
8. Apply the matching rule to intangible assets,
including research and development costs
and goodwill.
SUPPLEMENTAL OBJECTIVE
9. Apply depreciation methods to problems of
partial years, revised rates, groups of similar
items, special types of capital expenditures,
and cost recovery.
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90