Chapter 8
Operating Assets:
Property, Plant, and Equipment,
Natural Resources,
and Intangibles
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1
Mattel, Inc.
Partial Balance Sheet
Property, Plant and Equipment:
Land
Buildings
At
Machinery and equipment
Capitalized leases
Cost
Leasehold improvements
Less: accumulated depreciation
Tools, dies and molds, net
Book Value
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$ 35,113
192,323
354,469
23,271
82,643
924,832
203,408
549,108
187,349
$ 736,457
2
Acquisition Cost of P,P&E

All costs necessary to acquire asset and
prepare for intended use
Invoice
Price
+
Taxes
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Freight Charges
Installation
Costs
3
Group Asset Purchases
Allocate cost of lump-sum purchase based
on fair market values
Cost
$500,000
Fair Market
Value
Building =
$400,000
Land =
$120,000
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% of
Market
Value
77%
23%
Allocated
Cost
$385,000
$115,000
4
Capitalization of Interest

Interest can be included
as part of the cost of an
asset if:
»
»
company constructs asset
over time, and
borrows money to finance
construction
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Depreciation of P,P & E
Match
Cost of
Assets
with periods
benefited
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
29
30
31
via
Straight-Line
Units of
Production
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Accelerated
Methods
6
Straight-Line Method

Allocates cost of asset evenly over its
useful life
$9,000
3 year life
$3,000
Year 1
$3,000
Year 2
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$3,000
Year 3
7
Units-of-Production Method

Allocate asset cost based on number of
units produced over its useful life
depreciation =
per unit
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Double declining-balance Method
Double the straight-line rate on a
declining balance (book value)
 Accelerated method - higher amount of
depreciation in early years

Straight-line
Rate
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Depreciation Example
On January 1, Owens Manufacturing
Company purchases a machine for
$10,000. The life of the machine is
estimated at three years, after which it is
expected to be sold for $1,000.
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Depreciation Example
Calculate Owens's depreciation of the
machine for years 1 - 3 using the straightline, units-of-production and double
declining balance depreciation methods.
$10,000 cost - $1,000 residual value =
$9,000 to be depreciated
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Straight-Line Depreciation
Depreciation
= Cost - Residual Value
Life
= $10,000 - $1,000
3 years
= $3,000
$9,000
3 year life
$3,000
Year 1
$3,000
Year 2
$3,000
Year 3
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Units-of-Production Depreciation

Owen’s estimated machine production:
Yr. 1
10,000units
Yr. 2
20,000 units
Yr. 3
15,000 units
Total 45,000 units
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Units-of-Production Depreciation
Depreciation
per unit
= Cost - Residual Value
Total Units in Life
= $10,000 - $1,000
45,000
= $ .20
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Units-of-Production Depreciation

Owen’s annual depreciation:
Yr. 1 10,000 units x $.20/unit = $2,000
Yr. 2 20,000 units x $.20/unit = 4,000
Yr. 3 15,000 units x $.20/unit =
3,000
$9,000
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Double declining-balance
Depreciation
DDB rate = (100% / useful life) x 2
= (100% / 3 years) x 2
= 66.7%
Initially
ignore
residual value
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Double declining-balance
Depreciation
Year 1 Depreciation
Year
1
Rate
66.7%
= Beginning book value x rate
= $10,000 x 66.7%
= $6,667
Beginning
Ending
Book Value Depreciation Book Value
$10,000
$6,667
$3,333
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Double declining-balance
Depreciation
Year 2 Depreciation
Year
1
2
Rate
66.7%
66.7%
= Beginning book value x rate
= $3,333 x 66.7%
= $2,233
Beginning
Ending
Book Value Depreciation Book Value
$10,000
$6,667
$3,333
$ 3,333
2,233
1,100
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Double declining-balance
Depreciation
Year
1
2
3
Rate
66.7%
66.7%
66.7%
Beginning
Ending
Book Value Depreciation Book Value
$10,000
$6,667
$3,333
$ 3,333
2,233
1,100
$ 1,100
100
1,000
$9,000
Final year’s depreciation =
amount needed to equate
book value with salvage
value
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= Residual
Value
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Straight-line vs. DDB Depreciation
$ 7,000
$ 6,000
$ 5,000
$ 4,000
S tra ig h t-lin e
$ 3,000
DD B
$ 2,000
$ 1,000
$0
Year 1
Year 2
Yea r 3
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Reasons for Choosing
Straight-Line Depreciation
Simplicity
 Reporting to
stockholders
 Comparability
 Bonus plans

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Reasons for Choosing
Accelerated Methods
Technological rate of change and
competitiveness
 Minimize taxable income

Income Taxes
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Changes in Depreciation Estimates
Recompute depreciation schedule using
new estimates
 Record prospectively (i.e. change should
affect current and future years only)

Useful life is
7 years vs. 5?
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Change in Estimate
Example:
$9,000 truck originally expected to be
depreciated over 3 years. After 2 years,
useful life is increased to 4 years.
$3,000
$3,000
Yr. 1
Yr. 2
Depreciation
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planned
$3,000
Yr. 3
revise
estimate
24
Change in Estimate
Example:

$3,000 remaining book value allocated
prospectively over remaining life
$3,000
Yr. 1
Depreciation
$3,000
Yr. 2
$1,500
$1,500
Yr. 3
Yr. 4
revise
estimate
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Capital vs. Revenue Expenditures
 Capital
»
Treat as asset addition to
be depreciated over a
period of time
 Revenue
»
Expenditure
Expenditure
Expense immediately
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Balance
Sheet
Income
Statement
26
Capital vs. Revenue Expenditures
General Guidelines:
» Increase asset life
» Increase asset productivity
» Normal maintenance
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 Capitalize
 Capitalize
 Expense
27
Capital Expenditures
Example:
$9,000 truck originally expected to be depreciated
over 3 years. After 2 years, replace engine at
cost of $2,000. Truck life is increased by 2
years.
planned
$3,000
$3,000
$3,000
Yr. 1
Yr. 2
Yr. 3
replace
engine
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Capital Expenditures
Example:

$3,000 remaining book value + $2,000
capital expenditure depreciated
prospectively over remaining life
$3,000
Yr. 1
$3,000
Yr. 2
$2,500
$2,500
Yr. 3
Yr. 4
replace
engine
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Disposal of Operating Assets
Record depreciation up to date of disposal
 Compute gain or loss on disposal

Proceeds > Book Value = Gain
Proceeds < Book Value = Loss
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Disposal of Operating Assets
Example:

Sell truck (cost $10,000; accumulated
depreciation $6,000) for $3,500
Sales price
Less book value:
Asset cost
Less: accumulated
depreciation
= Loss on sale
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$ 3,500
$10,000
6,000
4,000
($ 500)
31
Boise Cascade Corporation
Partial Balance Sheet
Property
(in thousands)
Property and Equipment:
Land and land improvements
Buildings and improvements
Machinery and equipment
Less: accumulated depreciation
Timber, timberlands, and
timber deposits
Natural Resources
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$
63,307
575,509
4,082,724
(2,150,385)
2,571,155
270,570
$2,841,725
32
Natural Resources
Resource consumed as it is used
 Expense called depletion vs. depreciation
 Depletion method similar to units of
production

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Time Warner, Inc.
Partial Balance Sheet
Operating Assets:
(in millions)
Property, plant and equipment, net $ 1,991
Music catalogues, contracts
and copyrights
876
Cable television and sports franchises 2,868
Goodwill
11,919
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Intangible Assets

Long-term assets with no physical
properties
Patents
Copyrights
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Trademarks
Goodwill
35
Intangible Assets

Includes cost to acquire and prepare for
intended use
Purchase Price
+
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Acquisition
Costs
(i.e. legal fees,
registration
fees, etc.)
36
Research & Development

Must be expensed in
period incurred

Difficult to identify future
benefits
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Amortization of Intangibles
Normally recorded using straight-line
method
 Reported net of accumulated
amortization
 Amortized over legal or useful life,
whichever is shorter

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Amortization of Intangibles
Example:
Discovery Corporation purchases a
patent for $2,000 and incurs $1,000 in
legal and registration fees. The patent’s
remaining legal life is 12 years, but its
anticipated useful life is 5 years.
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Amortization of Intangibles
Discovery’s Annual Amortization:
Purchase price
$2,000
Acquisition costs
1,000
Total
3,000
divide by:
lesser of legal or useful life 5 years
Annual amortization
$ 600
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Amortization of Intangibles
Discovery’s Balance Sheet Presentation:
Upon
End of
Purchase Yr. 1
Yr. 5
Long-term Assets:
Intangible assets,
net of accum.
amortization
$3,000
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$2,400
$ 0
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Analyzing Long-term Assets
Average Life = Property, Plant & Equipment
Depreciation Expense
What is the
average
depreciable
period of the
company’s assets?
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Analyzing Long-term Assets
Average Age = Accumulated Depreciation
Depreciation Expense
Are assets old or
new?
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Analyzing Long-term Assets
Asset Turnover = Net Sales
Average Total Assets
How productive
are the company’s
assets?
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Exhibit 8-8
Long-term Assets and the
Statement of Cash Flows
Operating Activities
Net income
Depreciation and Amortization
Gain on sale of asset
Loss on sale of asset
Investing Activities
Purchase of asset
Sale of asset
Financing Activities
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xxxx
+
+
+
45
End of Chapter 8
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