CHAPTER 8
REPORTING AND INTERPRETING
PROPERTY, PLANT, AND EQUIPMENT;
INTANGIBLES; AND NATURAL RESOURCES
PowerPoint Authors:
Susan Coomer Galbreath, Ph.D., CPA
Charles W Caldwell, D.B.A., CMA
Jon A. Booker, Ph.D., CPA, CIA
Cynthia J. Rooney, Ph.D., CPA
McGraw-Hill/Irwin
Copyright © 2014 by The McGraw-Hill Companies, Inc. All rights reserved.
UNDERSTANDING THE BUSINESS
Insufficient
capacity results
in lost sales.
How much
is enough?
Costly excess
capacity reduces
profits.
8-2
CLASSIFYING LONG-LIVED ASSETS
Actively Used in Operations
Expected to Benefit Future Periods
Tangible
Intangible
Physical
Substance
No Physical
Substance
8-3
CLASSIFYING LONG-LIVED ASSETS

Land

Assets subject to depreciation
 Buildings and equipment
 Furniture and fixtures

Natural resource assets
subject to depletion

Mineral deposits and timber
 Definite life
Patents
 Copyrights
 Franchises
 Indefinite life
 Trademarks
 Goodwill

Tangible
Intangible
Physical
Substance
No Physical
Substance
8-4
FIXED ASSET TURNOVER
Net Sales (or Operating Revenues)
Fixed Asset
=
Turnover
Average Net Fixed Assets
This ratio measures the sales dollars generated
by each dollar of fixed assets used.
During 2011, Southwest Airlines had $15,658 of operating revenues.
End-of-year fixed assets were $12,127 and beginning-of-year fixed
assets were $10,578. (All numbers in millions.)
Fixed Asset
=
Turnover
$15,658
($10,578 + $12,127) ÷ 2
= 1.38
2011 Fixed Asset Turnover Comparisons
Southwest
Delta
United
1.38
1.73
2.96
8-5
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.
Buildings
• Purchase price
• Renovation and repair costs
• Legal and realty fees
• Title fees
8-6
MEASURING AND RECORDING
ACQUISITION COST
Equipment
• Purchase price
• Installation costs
• Modification to building
necessary to install
equipment
• Transportation costs
Land
• Purchase price
• Real estate commissions
• Title insurance premiums
• Delinquent taxes
• Surveying fees
• Title search and transfer fees
Land is not depreciated
8-7
MEASURING AND RECORDING
ACQUISITION COST
Acquisition
for Cash
On January 1, Southwest Airlines
purchased aircraft for $75,000,000 cash.
Acquisition
for Debt
On January 14, Southwest Airlines
purchased aircraft for $1,000,000 cash
and a $74,000,000 note payable.
8-8
ACQUISITION FOR NONCASH
CONSIDERATION
Record at the current market value of the consideration
given, or the current market value of the asset acquired,
whichever is more clearly evident.
On July 7, Southwest gave Boeing 1,000,000 shares of
$1.00 par value common stock with a market value of
$50 per share plus $25,000,000 in cash for aircraft.
8-9
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.
8-10
REPAIRS, MAINTENANCE, AND
IMPROVEMENTS
Type of
Expenditure
Identifying Characteristics
Ordinary
1. Maintains normal operating condition
repairs and 2. Does not increase productivity
maintenance 3. Does not extend life beyond original
estimate
4. Recurring in nature and involve small
amounts of money at each occurence
Additions and 1. Major overhauls or partial
Improvements
replacements
2. Usually occur infrequently
3. Increases efficiency
4. May extend useful life
5. Involve large amounts of money
Accounting
Treatment
Expense
in period
incurred
Add to
asset
account
(Capitalize)
8-11
REPAIRS, MAINTENANCE, AND
IMPROVEMENTS
Financial Statement Effect
Treatment
Statement
Expense
Current Current
Income Taxes
Capitalize
Balance sheet
account debited
Deferred
Higher
Higher
Lower
Lower
Expense
Income statement Currently
account debited recognized
To aid with the capitalize/expense decision,
many companies record all expenditures below
a certain dollar amount as expenses.
8-12
DEPRECIATION CONCEPTS
Depreciation is the process of allocating the cost of
buildings and equipment over their productive lives
using a systematic and rational method.
Balance Sheet
Acquisition
Cost
(Unused)
Income Statement
Cost
Allocation
Expense
(Used)
Depreciation
Expense
Depreciation for
the current year
Income
Statement
Accumulated
Depreciation
Total depreciation
to date on an asset
Balance
Sheet
8-13
DEPRECIATION CONCEPTS
An adjusting journal entry is needed at the end of each period
to reflect the use of buildings and equipment for the period:
8-14
DEPRECIATION CONCEPTS
The calculation of depreciation requires
three amounts for each asset:
 Acquisition cost.
 Estimated useful life.
 Estimated residual value.
8-15
STRAIGHT-LINE METHOD
Depreciation
Expense per Year
=
Cost - Residual Value
Useful Life in Years
At the beginning of the year, Southwest 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.
Depreciation
Expense per Year
=
Depreciation
Expense per Year
=
$62,500 - $2,500
3 years
$20,000
8-16
STRAIGHT-LINE METHOD
Depreciation Accumulated
Expense
Depreciation
Year
(debit)
(credit)
1
2
3
$ 20,000
20,000
20,000
$ 60,000
$
$
20,000
20,000
20,000
60,000
Accumulated
Depreciation
Balance
$
20,000
40,000
60,000
Undepreciated
Balance
(book value)
$
62,500
42,500
22,500
2,500
Residual Value
SL
More companies use the straight-line
method of depreciation in their financial
reports than all other methods combined.
8-17
UNITS-OF-PRODUCTION METHOD
Step 1:
Depreciation =
Rate
Cost - Residual Value
Life in Units of Production
Step 2:
Number of
Depreciation
Depreciation
× Units Produced
=
Expense
Rate
for the Year
At the beginning of the year, Southwest purchased ground equipment
for $62,500 cash. The equipment has an estimated useful life of
100,000 miles 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?
8-18
UNITS-OF-PRODUCTION METHOD
Step 1:
Depreciation = $62,500 - $2,500 = $.60 per mile
100,000 miles
Rate
Step 2:
Depreciation
= $.60 per mile × 30,000 miles = $18,000
Expense
Year
Miles
1
2
3
30,000
50,000
20,000
100,000
Depreciation
Expense
Accumulated
Depreciation
Balance
$
$
$
18,000
30,000
12,000
60,000
18,000
48,000
60,000
Undepreciated
Balance
(book value)
$
62,500
44,500
14,500
2,500
Residual Value
8-19
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.
Depreciation
Expense
Early Years
High
Later Years
Low
Repair
Expense
Low
High
8-20
DECLINING-BALANCE METHOD
Declining balance rate
of 2 is double-decliningbalance (DDB) rate.
Cost – Accumulated Depreciation
Annual
Depreciation =
expense
Net
Book
Value
×
(
2
Useful Life in Years
)
Annual computation ignores residual value.
At the beginning of the year, Southwest 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.
8-21
DECLINING-BALANCE METHOD
Annual
Depreciation
expense
Net
Book
Value
=
×
(
2
Useful Life in Years
)
Year 1 Depreciation:
$62,500 ×
(
2
3 years
) = $41,667
Year 2 Depreciation:
($62,500 – $41,667) ×
(
2
3 years
) = $13,889
8-22
DECLINING-BALANCE METHOD
Year
1
2
3
Depreciation
Expense
(debit)
Accumulated
Depreciation
Balance
$
$
$
41,667
13,889
4,629
60,185
41,667
55,556
60,185
Undepreciated
Balance
(book value)
$
62,500
20,833
6,944
2,315
Below residual value
($62,500 – $55,556) ×
(
2
3 years
) = $4,629
8-23
DECLINING-BALANCE METHOD
Year
1
2
3
Depreciation
Expense
(debit)
Accumulated
Depreciation
Balance
$
$
$
41,667
13,889
4,444
60,000
41,667
55,556
60,000
Undepreciated
Balance
(book value)
$
62,500
20,833
6,944
2,500
Depreciation expense is limited to the amount that
reduces book value to the estimated residual value.
8-24
INTERNATIONAL PERSPECTIVE
COMPONENT ALLOCATION
Under IFRS, the cost of an individual asset’s
components is allocated among each significant
component and then depreciated separately
over that component’s useful life.
8-25
TAX REPORTING
Most public companies maintain two sets of accounting records
reflecting the same transactions, but accounted for using two
different sets of measurement rules. One set is prepared under
GAAP for reporting to stockholders. The other set is prepared to
determine the company’s tax obligation under the Internal Revenue
Code (IRC). The two sets of rules differ because the objectives of
GAAP and the IRC differ.
8-26
MEASURING 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.
Recognize a
loss when
an asset
suffers a
permanent
impairment.
8-27
DISPOSAL OF PROPERTY, PLANT
AND EQUIPMENT
Disposal of Property, Plant and Equipment
Voluntary disposals:
• Sale
• Trade-in
• Retirement
Involuntary disposals:
• Fire
• Accident
8-28
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).
8-29
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.
Southwest Airlines sold flight equipment
for $11,000,000 cash at the end of its
17th year of use. The flight equipment originally
cost $30,000,000, and was depreciated using the
straight-line method with zero residual value
and a useful life of 25 years.
Let’s answer the following questions.
8-30
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:
a.
b.
c.
d.
$0.
$1,200,000.
$1,500,000.
$2,000,000.
Annual Depreciation:
($30,000,000 – $0) ÷ 25 Years.
= $1,200,000
8-31
DISPOSAL OF PROPERTY, PLANT
AND EQUIPMENT
After updating the depreciation,
the equipment’s book value at the end of
the 17th year is:
Accumulated Depreciation =
a.
b.
c.
d.
$9,600,000.
$20,400,000.
$12,800,000.
$6,600,000.
(17yrs. × $1,200,000) = $20,400,000
BV = Cost – Accumulated Depreciation
BV = $30,000,000 – $20,400,000
= $9,600,000
8-32
DISPOSAL OF PROPERTY, PLANT
AND EQUIPMENT
The equipment’s sale resulted in:
a.
b.
c.
d.
a gain of $1,400,000.
a gain of $6,200,000.
a gain of $3,800,000.
a loss of $1,700,000.
Gain = Cash Received – Book Value
Gain = $11,000,000 – $9,600,000 = $1,400,000
8-33
DISPOSAL OF PROPERTY, PLANT
AND EQUIPMENT
Prepare the journal entry to record Southwest’s
sale of the equipment at the end of the 17th year.
8-34
ACQUISITION AND AMORTIZATION OF
INTANGIBLE ASSETS
Noncurrent assets
without physical
substance.
Useful life is
often difficult
to determine.
Intangible
Assets
Often provide
exclusive rights
or privileges.
Usually acquired
for operational
use.
Only purchased intangibles are recorded, and they are
normally recorded at current cash equivalent cost, including
purchase price, legal fees, and filing fees.
8-35
ACQUISITION AND AMORTIZATION OF
INTANGIBLE ASSETS
Definite Life
• Amortize over shorter of
economic life or legal life.
• Use straight-line method.
Indefinite Life
• Not amortized.
• Tested at least annually
for possible impairment,
and book value is reduced
to fair value if impaired.
Amortization is a cost allocation process
similar to depreciation and depletion.
8-36
ACQUISITION AND AMORTIZATION OF
INTANGIBLE ASSETS
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.
Goodwill is not amortized. Its value must be reviewed
at least annually for possible impairment, and the
book value is reduced to fair value if impaired.
8-37
ACQUISITION AND AMORTIZATION OF
INTANGIBLE ASSETS
Arpec Company paid $2,000,000 to purchase
all of Utek Company’s assets and assumed liabilities of $400,000.
The acquired assets were appraised at a fair value of $1,800,000.
What amount of goodwill should be
recorded on Arpec Company books?
a.
b.
c.
d.
$200,000
$400,000
$600,000
$800,000
FMV of Assets
Debt Assumed
FMV of Net Assets
Purchase Price
Goodwill
$ 1,800,000
400,000
1,400,000
2,000,000
$
600,000
8-38
ACQUISITION AND AMORTIZATION OF
INTANGIBLE ASSETS
Trademarks
Copyrights
• A symbol, design, or logo
associated with a business.
• The exclusive right to publish,
use, and sell a literary,
musical, or artistic work.
• An exclusive legal right to use
a name, image, or slogan.
• Trademarks are almost
always internally developed,
have indefinite life, and are
not amortized.
• Legal life is life of creator plus
70 years.
• Amortize cost over the period
benefited.
8-39
ACQUISITION AND AMORTIZATION OF
INTANGIBLE ASSETS
Patents
• Exclusive right granted by the 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.
Technology
• A category of intangible assets that includes a company’s
website and any computer programs written by its employees.
8-40
ACQUISITION AND AMORTIZATION OF
INTANGIBLE ASSETS
Franchises
• Legally protected right
purchased by a
franchisee to sell
products or provide
services for a specified
period and purpose.
• Purchase price is an
intangible asset that is
amortized.
Licenses and Operating
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.
8-41
RESEARCH AND DEVELOPMENT
EXPENSE
Research and development expenses are
not intangible assets under U.S. GAAP.
The cost to development an intangible
asset internally is normally recorded as
research and development expense.
8-42
INTERNATIONAL PERSPECTIVE
DIFFERENCES IN ACCOUNTING FOR TANGIBLE AND
INTANGIBLE ASSETS
8-43
ACQUISITION AND DEPLETION OF
NATURAL RESOURCES
Extracted from
the natural
environment.
A noncurrent
asset presented
at cost less
accumulated
depletion.
Total cost of
asset is the cost
of acquisition,
exploration,
and development.
Total cost is
allocated over
periods benefited
by means of
depletion.
Examples: oil, coal, gold
Depletion is like units-of-production depreciation.
8-44
ACQUISITION AND DEPLETION OF
NATURAL RESOURCES
The unit depletion rate is calculated as follows:
Acquisition and
Development Cost
–
Residual
Value
Estimated Recoverable Units
Depletion cost for a period is:
UNIT DEPLETION
RATE
×
NUMBER OF UNITS
EXTRACTED IN PERIOD
Cost of
goods sold
Depletion
cost
Inventory
for sale
Unsold
Inventory
8-45
FOCUS ON CASH FLOWS
8-46
CHAPTER SUPPLEMENT:
CHANGES IN DEPRECIATION ESTIMATES
Depreciation Expense is based on . . .
ESTIMATED
useful life
ESTIMATED
residual value
If the estimates change, the book value less any residual
value at the date of change is depreciated over the
remaining useful life.
Southwest purchased an aircraft for $60,000,000. The aircraft is
depreciated using the straight-line method with a useful life of 20
years and an estimated residual value of $3,000,000. In year 5,
Southwest changed the estimated useful life to 25 years and
lowered the residual value to $2,400,000. Calculate depreciation
expense for the fifth year using the straight-line method.
8-47
CHAPTER SUPPLEMENT:
CHANGES IN DEPRECIATION ESTIMATES
Acquisition cost
Accumulated depreciation (years 1-5)
($2,850,000 per year × 4 years)
Remaining book value
Less: New residual value
New depreciable amount
Divide by remaining life
Revised annual depreciation
$ 60,000,000
11,400,000
48,600,000
2,400,000
46,200,000
÷ 21
$ 2,200,000
8-48
END OF CHAPTER 8
8-49