Dutchess Community College
ACC 104 – Financial Accounting
Quiz Prep Chapter 9
Reporting & Analyzing Long-Lived Assets
Peter Rivera
April, 2007
Disclaimer
This Quiz Prep is provided as an outline of
the key concepts from the chapter.
It is not intended to be comprehensive or
exhaustive.
Quizzes may include material from the
classroom lectures, the text or the homework
assignments.
Long-Lived Assets
Two broad categories of long-lived assets:
• Property, Plant & Equipment
• Intangible Assets
Property, Plant & Equipment
Property: land
Improvements: driveways, fences, etc.
Plant: buildings
Equipment: machinery, furniture, PCs, etc.
Purchase vs. Lease
Advantages of Leasing:
• Reduced risk of obsolescence
• Little or no down payment
• Shared tax advantage
• Asset & Liabilities Not reported
if it is an Operating Lease
Capital Leases must be included
in the balance sheet
Capital vs. Revenue Expenditures
Purchase Costs of a long-lived asset are
Capitalized, i.e., they are recorded as an asset on
the balance sheet.
Ongoing Expenses, such as maintenance,
registrations, insurance, etc., are Revenue
Expenditures (textbook terminology) or
Expensed (common terminology).
Repairs can be capitalized only if they extend
the estimated useful life of the asset, otherwise
they are expensed.
Cost
The cost of an asset includes the purchase
price and anything to make it ready for its
intended use, e.g.,
• purchase price
• taxes
• installation
Depreciation
Depreciation is the allocation of the cost of
PP&E to expense over its useful life in a
rational and systematic manner.
It is NOT a valuation process!
Depreciation applies to:
• Improvements
• Plant (Buildings)
• Equipment
(Property) Land does NOT depreciate.
Depreciation
Cost
- Salvage Value
= Depreciable Amount
Useful Life can be defined as:
• Time; e.g., years
• Capacity; e.g., miles, units of production
Depreciation
3 of the most common depreciation methods are:
• Straight Line
• Declining Balance
• Units of Production
Straight line
• You purchase a truck for $ 32,000 on Nov. 1.
• It cost $1,000 for lettering.
• You paid $500 for 1 year registration.
• It is expected to last for 5 years and have a
$3,000 salvage value.
$ 32,000 Purchase Cost
+ 1,000 Lettering
= 33,000 Total Purchase Cost
Registration is an on-going expense and is
not capitalized.
Straight line
$ 33,000 Total Purchase Cost
- 3,000 Salvage Value
= 30,000 Depreciable Amount
÷
5 Years
= 6,000 Depreciation per Year
Straight line
If you are preparing the financial statements as of
December 31, then you have 2 months from
November 1:
$ 6,000 Depreciation per
÷
12
$ 500 Depreciation per Month
x
2 Months
= $ 1,000 Depreciation Expense
Dr
Depreciation Expense
Accumulated Depreciation
Cr
1,000
1,000
Straight line
If you are preparing the financial statements as of
December 31, then you have 2 months from
November 1:
$ 6,000 Depreciation per
÷
12
$ 500 Depreciation per Month
x
2 Months
= $ 1,000 Depreciation Expense
Dr
Depreciation Expense
Accumulated Depreciation
Cr
1,000
1,000
Straight line
Accumulated Depreciation is a
contra-asset account.
Balance Sheet Presentation:
PP&E Gross
$ 33,000
Less: Accumulated Depreciation 1,000
Net PP&E (Book Value)
$ 32,000
Straight line
Year
0
1
2
3
4
5
Annual
Depreciation
6,000
6,000
6,000
6,000
6,000
Annual Depreciation
is a constant amount
Accumulated
Depreciation
0
6,000
12,000
18,000
24,000
30,000
Book
Value
33,000
27,000
21,000
15,000
9,000
3,000
Book (Net) Value
declines in a straight
line
Straight line
Depreciation Expense will be constant:
$ 6,000
Year 5
Straight line
Book Value (Net Value) decreases in a straight line:
$ 33,000
$ 3,000
Day 1
+ 5 Years
Declining Balance
The Declining Balance Method calculates a
constant rate of depreciation on a declining net
balance, e.g., the double –declining balance
method assumes that the asset depreciates at 2 x
the annual straight line rate.
Estimate useful life = 5 years = 20% per year.
Double-declining balance = 2 x 20% = 40%
You are NOT required to know the
mechanics of the declining balance method.
Declining Balance
Year
0
1
2
3
4
5
Annual
Depreciation
13,200
7,920
4,752
2,851
1,277
40% of beginning
Book Value
Accumulated
Depreciation
0
13,200
21,120
25,872
28,723
30,000
Book
Value
33,000
19,800
11,880
7,128
4,277
3,000
Adjusted so that ending Book
Value = Salvage Value
You are NOT required to know the mechanics of the
declining balance method.
Declining Balance
Year
0
1
2
3
4
5
Annual
Depreciation
13,200
7,920
4,752
2,851
1,277
Annual Depreciation
is NOT a constant
amount
Accumulated
Depreciation
0
13,200
21,120
25,872
28,723
30,000
Book
Value
33,000
19,800
11,880
7,128
4,277
3,000
Book (Net) Value
declines at a
decelerating rate
Declining Balance
Depreciation Expense will be at a decreasing rate.
$ 13,200
$ 1,277
Year 5
Declining Balance
Book Value (Net Value) decreases at a decreasing
rate:
$ 33,000
$ 3,000
Day 1
+ 5 Years
Units of Activity
The truck is expected to last 100,000 miles.
$ 33,000 Total Purchase Cost
- 3,000 Salvage Value
= 30,000 Depreciable Amount
÷ 100,000 miles
= $.3 Depreciation per Mile
20,600 Miles for a period
x .3 Depreciation expense per mile
= $ 6,180 Depreciation Expense for that period
Units of Activity
Depreciation Expense will vary per period
depending on the actual usage for each period.
$ 10,000
Year 5
Units of Activity
Book Value (Net Value) will decrease at varying
rates:
$ 33,000
$ 3,000
Day 1
+ 5 Years
Depreciation
Note that the depreciation method used for financial
reporting purposes does NOT need to be the same
as that used for tax purposes.
Straight Line is the method most commonly
used for financial reporting purposes.
Accelerated Methods (such as Double-Declining
Balance) are the most common method used for
tax reporting purposes.
Disposals of Plant Assets
When an asset is disposed of,
• any asset received must be recorded, e.g., sold for
cash
• it must be removed from the accounting records,
• the PP&E
• Accumulated Depreciation
• the net gain or loss (the difference between any
asset received and the Book Value) must be
recorded
Disposals of Plant Assets
Example 1: a truck was sold for $5,000 cash
Through
date of
sale
Truck Cost
$ 30,000
Accumulated depreciation 27,000
Book Value
3,000
Dr
Cash
Accumulated Depreciation
Truck (PP&E)
Gain on Sale (non-operating revenue)
Cr
5,000
27,000
30,000
2,000
Disposals of Plant Assets
Example 2: a truck was sold for $1,000 cash
Through
date of
sale
Truck Cost
$ 30,000
Accumulated depreciation 27,000
Book Value
3,000
Dr
Cash
Accumulated Depreciation
Loss on Sale (non-operating loss)
Truck (PP&E)
Cr
1,000
27,000
2,000
30,000
Disposals of Plant Assets
Example 3: a truck was scrapped
Through
date of
sale
Truck Cost
$ 30,000
Accumulated depreciation 27,000
Book Value
3,000
Dr
Accumulated Depreciation
Loss on Disposal (non-operating loss)
Truck (PP&E)
Cr
27,000
3,000
30,000
Return On Assets Ratio
Return On Assets (ROA) =
Net Income
Average Total Assets
NOTE: Average
Higher is Better
Asset Turnover Ratio
Net Sales
Asset Turnover =
Average Total Assets
NOTE: Average
Higher is Better
Intangible Assets
Patents: exclusive right to an invention for 20 years
Copyrights: exclusive rights to an artistic work for
the life of the creator + 70 years.
Trademarks & Trade Names: have an indefinite
useful life.
Franchises & Licenses: Life may be limited or
unlimited.
Goodwill: Excess purchase price of an entire
business over the value of the tangible assets.
Intangible Assets
If the Intangible Asset has identifiable costs to
acquire, these costs can be capitalized.
Amortization is the allocation of these costs to
expense over the shorter of:
• their useful lives
• expiration of the protected period
(20 years for patents, etc.)
Intangible Assets
Generally,
Goodwill,
Trademarks and Trade Names
are NOT Amortized.
Note that PP&E is Depreciated
Intangibles are Amortized.