Chapter
Six
Accounting for
Long-Term
Operational
Assets
© 2015 McGraw-Hill Education.
LO 1
LO 1
Identify different
types of long-term
operational assets.
6-2
Tangible versus Intangible
Assets
Tangible assets have a physical presence;
they can be seen and touched. Intangible
assets are rights or privileges. They cannot
be seen or touched.
6-3
Tangible Long-Term Assets
1. Property, Plant, and Equipment – Sometimes called
plant assets or fixed assets. We depreciate these
assets over their useful life.
2. Natural Resources – Mineral deposits, oil and gas
reserves, timber stands, coal mines, and stone
quarries are some examples of natural resources. We
deplete these assets over their useful life.
3. Land – Has an infinite life and is not subject to
depreciation.
6-4
Intangible Assets
1. Intangible Assets with Identifiable Useful Lives –
These intangibles include patents and copyrights. We
amortize the cost of each over its useful life.
2. Intangible Assets with Indefinite Useful Lives These intangibles include renewable franchises,
trademarks, and goodwill. The cost of these assets is
not expensed unless it can be shown that there has
been an impairment in value.
6-5
LO 2
LO 1
Determine the cost
of long-term
operational assets.
6-6
Cost of Long-Term Assets
Buildings –
• Purchase price,
• Sales taxes,
• Title search and transfer document
costs,
• Realtor’s and attorney’s fees, and
• Remodeling costs.
Equipment –
• Purchase price (less
discounts),
• Sales taxes,
• Delivery costs,
• Installation costs, and
• Costs to adapt to intended
use.
6-7
Cost of Long-Term Assets
Land –
• Purchase price,
• Sales taxes,
• Title search and transfer document
costs,
• Realtor’s and attorney’s fees,
• Costs of removal of old buildings,
and
• Grading costs.
6-8
Basket Purchase Allocation
Beatty Company paid $240,000 for land and a building.
An independent appraiser provided these fair value
estimates: land $90,000, and building $270,000.
The $240,000 cost paid is separately assigned based on
% of total fair value.
Fair market value of building
Fair market value of land
Total fair market value
Amount
$ 270,000
90,000
$ 360,000
%
75%
25%
100%
6-9
Basket Purchase Allocation
The land and building that Beatty Company are assigned
their own allocation of the $240,000 paid based on the
individual % of total fair value. The “Allocation” is the
amount recorded in the accounting records.
Assign to building
Assign to land
$
Cost
240,000
240,000
%
75%
25%
100%
Allocation
$ 180,000
60,000
$ 240,000
6-10
LO 3
LO 1
Explain how different
depreciation
methods affect
financial statements.
6-11
Life Cycle of Operational Assets
Acquire
Funding
Buy
Asset
Retire
Asset
Use
Asset
6-12
Depreciation Method
1. Straight-line method - the same amount of
depreciation is taken each accounting period.
2. Double-declining-balance – produces more
depreciation expense in the early years of an
asset’s life, with a declining amount of
expense in later years.
3. Units-of-Production – produces varying
amounts of depreciation in different
accounting periods depending upon the
number of units produced.
6-13
Asset to be Depreciated
List price of van
$ 23,500
Cash discount 10%
(2,350)
Transportation cost
250
Cost of customization
2,600
Cost of van
$ 24,000
The van has a salvage value of $4,000, and an
estimated useful life of four years.
6-14
Straight-Line Depreciation
Life Cycle Phase 1
Acquire $25,000 cash from the sale of common
stock to purchase the van.
Assets
=
Cash
+
Van
-
Acc.
Dep.
25,000
+
n/a
-
n/a
Equity
=
Com.
Stk.
+ Ret. Earn.
=
25,000
+
n/a
Rev.
-
Exp.
=
Net
Income
n/a
-
n/a
=
n/a
Cash
Flow
25,000
FA
6-15
Straight-Line Depreciation
Life Cycle Phase 2
Purchase the van on January 1, 2014, for a net cost
of $24,000.
Assets
Cash
+
(24,000) +
=
Van
-
Acc.
Dep.
24,000
-
n/a
Equity
=
Com.
Stk.
=
n/a
+ Ret. Earn.
+
n/a
Rev.
-
Exp.
=
Net
Income
n/a
-
n/a
=
n/a
Cash
Flow
24,000 IA
6-16
Straight-Line Depreciation
Life Cycle Phase 3
Use the van to generate $8,000 revenue for the period.
Assets
Cash
8,000
=
+
Van
-
Acc.
Dep.
+
n/a
-
n/a
Equity
=
Com.
Stk.
=
n/a
+ Ret. Earn.
+
8,000
Rev.
-
8,000 -
Exp.
=
n/a
=
Net
Income
8,000
Cash
Flow
8,000 OA
Depreciation expense calculated under straight-line is
determined as followed:
(Asset Cost – Salvage Value) ÷ Useful Life
($24,000 – $4,000) ÷ 4 = $5,000 depreciation
Assets
=
Cash
+
Van
-
n/a
+
n/a
-
Acc.
Dep.
5,000
Equity
=
Com.
Stk.
=
n/a
+ Ret. Earn.
+
(5,000)
Rev.
-
n/a
-
Exp.
=
5,000 =
Net
Income
(5,000)
Cash
Flow
n/a
6-17
LO 4
LO 1
Determine how gains
and losses on
disposals of longterm operational
assets affect
financial statements.
6-18
Straight-Line Depreciation
Life Cycle Phase 4
On January 1, 2018, the van is sold for $4,500 cash.
Cost of Asset
Less Accumulated Depreciation
Book Value
Cash Proceeds
Gain on sale of van
Assets
Cash
+
Van
4,500 + (24,000) -
=
$ 24,000
20,000
4,000
4,500
$
500
($5,000 × 4 years)
Equity
Acc.
Dep.
= Com. Stk. + Ret. Earn.
(20,000) =
+
n/a
500
Rev. or
Gain
500 -
Exp. or
Loss
=
Net
Income
n/a
=
500
Cash Flow
4,500
IA
6-19
Exhibit 6.3: Financial Statements
under Straight-line Depreciation
6-20
Double-Declining-Balance Method
The double-declining-balance method is called an
accelerated depreciation method because more
depreciation expense is recorded in the early years than
in later years. Determining the amount of depreciation
expense in any year is the result of a three-step process.
1. Determine the straight-line rate of depreciation.
2. Multiply the straight-line rate times two.
3. Multiply the double-declining rate by the book
value of the asset at the beginning of the period.
(Book value = Cost minus Accumulated Depreciation.)
6-21
Double-Declining-Balance Method
(1 ÷ 4) = (25% straight-line rate × 2) = 50%
The 2016 Expense cannot be $3,000 and 2017
expense is $0. This is because only $20,000 in
total depreciation is allowed for this van.
Year
Year
2014
2005
2015
2006
2016
2007
2017
2008
Book Value
Valueatat
Beginning
Beginning of
ofYear
Year
($24,000 – $
0)
0)
($24,000 – $12,000)
($24,000 – $18,000)
($24,000
($24.000 -- $20,000)
$21,000)
Double
Double the
the
Straight-Line
Straight-Line
Rate
Rate
50%
50%
50%
50%
50%
50%
50%
50%
Annual
Annual
Depreciation
Depreciation
Expense
Expense
$$
12,000
12,000
6,000
6,000
2,000
3,000
0
1,500
$$
20,000
22,500
6-22
6-23
Units-of-Production Depreciation
Cost – Salvage value
Total estimated units of production
=
Depreciation
charge per unit
of production
Depreciation
Units of production Annual
charge per unit × in current
= Depreciation
of production
accounting period
Expense
6-24
Units-of-Production Depreciation
Here is the depreciation charge per
mile driven in our van:
$24,000 – $4,000
= $0.20 per mile
100,000 miles
Here is the calculation of depreciation
expense based on miles driven:
Year
2014
2015
2016
2017
Depreciation
Charge Per
Mile
$
0.20 ×
0.20 ×
0.20 ×
($20,000-$18,000)
Miles
Depreciation
Driven
Expense
40,000 = $
8,000
20,000 =
4,000
30,000 =
6,000
15,000
2,000
105,000
$
20,000
6-25
6-26
Comparison of Methods
6-27
LO 5
LO 1
Show how revising
estimates affects
financial statements.
6-28
Revision of Estimates
Estimates are frequently revised when new information
surfaces. Assume we purchased equipment on January
1, 2016, for $50,000 cash and estimated salvage value
was $3,000. The equipment has an estimated useful life
of eight years, and the company uses straight-line
depreciation.
($50,000 – $3,000) ÷ 8 = $5,875 depreciation per year
On January 1, 2020, after four years of depreciation,
it was determined that the machine has a remaining
useful life of ten more years for a total estimated
useful life of fourteen years.
6-29
Revision of Life Estimates
Year
2016
2017
2018
2019
2020
2021
2022
2023
Annual
Depreciation
$ 5,875
5,875
5,875
5,875
Accumulated
Depreciation
$5,875
11,750
17,625
23,500
Book Value
$44,125
38,250
32,375
26,500
We determine the
remaining annual
depreciation like
this:
$26,500 – $3,000 = $23,500 ÷ 10 years = $2,350 per year
for years 2020 through 2029
Year
2016
2017
2018
2019
2020
Annual
Depreciation
$ 5,875
5,875
5,875
5,875
2,350
Accumulated
Depreciation
$ 5,875
11,750
17,625
23,500
25,850
Book Value
$44,125
38,250
32,375
26,500
24,150
6-30
Revision of Salvage Estimates
Year
2016
2017
2018
2019
2020
2021
2022
2023
Annual
Depreciation
$ 5,875
5,875
5,875
5,875
Accumulated
Depreciation
$5,875
11,750
17,625
23,500
Book Value
$44,125
38,250
32,375
26,500
We determine the
remaining annual
depreciation like
this:
$26,500 – $6,000 = $20,500 ÷ 4 years = $5,125 per year
Year
2016
2017
2018
2019
2020
2021
7
2022
2023
Annual
Depreciation
$ 5,875
5,875
5,875
5,875
5,125
5,125
5,125
5,125
Accumulated
Depreciation
$5,875
11,750
17,625
23,500
28,625
33,750
38,875
44,000
Book
Value
$ 44,125
38,250
32,375
26,500
21,375
16,250
11,125
6,000
6-31
LO 6
LO 1
Explain how
continuing
expenditures for
operational assets
affect financial
statements.
6-32
Continuing Expenditures for
Plant Assets
Costs that Are Expensed
The cost of routine maintenance and minor repairs that
are incurred to keep an asset in good working order are
expensed as incurred.
Assume McGraw spent $500 cash for routine lubrication
and minor parts on machinery.
Assets
Cash
=
=
(500) =
Equity
Com. Stk. +
n/a
+
Ret.
Earn.
(500)
Rev.
-
n/a
-
Exp.
500
=
=
Net
Income
(500)
Cash
Flow
(500) OA
6-33
Continuing Expenditures for
Plant Assets
Costs that Are Capitalized
Expenditures that improve the quality of an asset are
capitalized as part of the cost of that asset.
Assume McGraw spent $4,000 cash for a major overhaul
of equipment to improve efficiency.
Assets
Cash
+
(4,000) +
=
Equity
-
Acc.
Dep.
=
Com.
Stk.
4,000 -
n/a
=
n/a
Mach.
+ Ret. Earn.
Rev.
-
Exp.
=
Net
Income
+
n/a
-
n/a
=
n/a
n/a
Cash
Flow
(4,000) IA
6-34
Continuing Expenditures for
Plant Assets
Costs that Extend the Life of an Asset
The amount of the expenditure should reduce the
balance in the accumulated depreciation account.
Assume McGraw spent $4,000 cash for improvements
that extended the life of machine two years.
Assets
Cash
+
(4,000) +
=
Mach.
-
Acc.
Dep.
n/a
-
(4,000) =
=
Equity
Com.
Stk.
n/a
+ Ret. Earn.
Rev.
-
Exp.
=
Net
Income
+
n/a
-
n/a
=
n/a
n/a
Cash
Flow
(4,000) IA
6-35
LO 7
LO 1
Explain how expense
recognition for
natural resources
(depletion affects
financial statements.
6-36
Natural Resources
Cost – Salvage value
Total estimated units recoverable
=
Depletion
charge per unit
of resource
Depletion
Number of units
Periodic
charge per unit × extracted and sold = Depletion
of resource
this period
Expense
6-37
Natural Resources
Apex Coal Mining paid $4,000,000 cash to purchase land that is
expected to yield 16,000,000 tons of coal. After all coal is extracted
the land is not expected to have any salvage value. In the first year,
the company extracted and sold 360,000 tons of coal.
$4,000,000 – $0
16,000,000 tons
= $0.25 per ton extracted and sold
The calculation for first year’s depletion is:
360,000 tons extracted and sold X $0.25
Assets
Cash
=
=
n/a
+
+
(90,000) =
n/a
+
4,000,000
$90,000
Equity
Com.
Stk.
+ Coal Mine
(4,000,000) +
n/a
=
=
+ Ret. Earn.
n/a
(90,000)
Rev.
-
Exp.
=
Net
Income
n/a
-
n/a
=
n/a
n/a
-
90,000 =
(90,000)
Cash Flow
(4,000,000)
IA
n/a
6-38
LO 8
LO 1
Explain how expense
recognition for
intangible asset
(amortization)
affects financial
statements.
6-39
Intangible Assets
Trademarks
A name or symbol that
identifies a company or a
product. The cost of a
trademark may include
design, purchase, or
defense of the trademark.
Patents
The exclusive legal right to
produce and sell a product
that has one or more
unique features. The legal
life of a patent is 20 years.
6-40
Intangible Assets
Copyrights
Protection of writings,
musical composition, work
of art, or other intellectual
property. The protection
extends for the life of the
creator plus 70 years.
Franchise
The exclusive right to sell
products or perform
services in certain
geographic areas.
6-41
Intangible Assets
Goodwill
The excess of cost over fair
value of net tangible assets
acquired in a business
acquisition.
Net Assets are equal to
Assets minus Liabilities
Seller Company has Net
Assets = $230,000
Seller Company
Balance Sheet
At December 31, 20XX
Assets
$
280,000
Liabilities
Stockholders' Equity
Total
$
$
50,000
230,000
280,000
6-42
Goodwill
Your company is willing to pay $350,000 ($300,000 cash and
assumption of $50,000 liabilities) to acquire Seller Company.
Seller Company
Balance Sheet
At December 31, 20XX
Assets
$
280,000
Liabilities
Stockholders' Equity
Total
Cash
+
(300,000) +
Assets
Rest.
Assets
=
+ Goodwill
280,000 +
Liab.
+
50,000
+
50,000
230,000
280,000
$
Equity
=
70,000 =
$
n/a
Rev.
-
Exp.
=
Net
Income
n/a
-
n/a
=
n/a
Cash Flow
(300,000) IA
6-43
Expensing Intangible Assets
An asset with an identifiable useful life is amortized using
the straight-line method over the shorter of the
intangible’s legal life or its useful life.
Assume we purchased a patent that has a 20-year legal
life but only an 11-year useful life for $44,000 cash.
Annual amortization expense = $44,000 / 11
=
Assets
Cash
+
(44,000) +
+
n/a
=
Patent
=
44,000 =
(4,000) =
$4,000
Liab.
Com.
Stk.
+
Equity
+
Ret. Earn.
Rev.
-
Exp.
=
Net
Income
n/a
n/a
+
+
n/a
n/a
-
n/a
=
n/a
(4,000)
n/a
-
4,000 =
(4,000)
Cash Flow
(44,000)
IA
n/a
6-44
Impairment of Intangible Asset
Intangible assets with indefinite useful lives must be tested for
impairment annually. If the fair value of the intangible asset is
less than its book value, an impairment loss is recognized.
Assume that the asset goodwill is determined to be
impaired and a decline in value of $30,000, The effects
on the financial statements would be:
Assets
Goodwill
=
Liab.
=
(30,000) =
+
+
n/a
+
Equity
Ret.
Earn.
(30,000)
Rev.
n/a
-
Exp.
30,000
=
=
Net
Income
(30,000)
Cash
Flow
n/a
6-45
Balance Sheet Presentation
6-46
LO 9
LO 1
Explain how expense
recognition choices
and industry
characteristics affect
financial
performance.
6-47
Effect of Judgment and Estimates
Assume that Alpha Company uses straight-line
depreciation and Zeta Company uses double-decliningbalance method. Let’s look at their partial financial
statements.
Income Statement
2015
2016
Alpha
Zeta
Alpha
Zeta
Sales
$ 50,000 $ 50,000 $ 50,000 $ 50,000
Cost of Good Sold (30,000) (30,000) (30,000) (30,000)
Gross Margin
20,000
20,000
20,000
20,000
Depreciation
(4,000)
(8,000) (4,000)
(4,800)
Net income
$ 16,000 $ 12,000 $ 16,000 $ 15,200
6-48
Effect of Judgment and Estimates
Assume that Alpha Company uses straight-line
depreciation and Zeta Company uses double-decliningbalance method. Let’s look at their partial financial
statements.
Assets
Accumulated Depreciation
Book Value
Plant Assets
2015
Alpha
Zeta
$ 20,000
$ 20,000
(4,000)
(8,000)
16,000
12,000
2016
Alpha
$ 20,000
(8,000)
12,000
Zeta
$ 20,000
(12,800)
7,200
6-49
Effect of Industry Characteristics
Does this mean that management of Manpower is
doing a better job than the management of Comcast or
Southwest Airlines? Not necessarily, because they
operate in different economic environments.
6-50
End of Chapter Six
6-51