Chapter 8
Reporting and Interpreting
Property, Plant, and
Equipment; Natural
Resources; and
Intangibles
8-2
Understanding The Business
Costly excess
capacity reduces
profits.
Insufficient
capacity results
in lost sales.
How much
is enough?
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies
8-3
Classifying Long-Lived Assets
Actively Used in Operations
Expected to Benefit Future Periods
Tangible
Intangible
Physical
Substance
No Physical
Substance
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies
8-4
Classifying Long-Lived Assets
Actively Used in Operations
Examples

Land
Expected to Benefit Future Periods
 Assets
subject to depreciation
Buildings and equipment
Furniture and fixtures
Tangible
Physical
Substance
McGraw-Hill/Irwin

Natural resource
assets
Intangible
subject to depletion

Physical
Mineral No
deposits
and timber
Substance
© 2004 The McGraw-Hill Companies
8-5
Classifying Long-Lived Assets
Actively Used in Operations
Examples

Value represented by rights
Expected
to Benefit Future Periods
that produce
benefits
Patents
Copyrights
Trademarks
Intangible
Tangible
Franchises
Goodwill
No Physical
Physical

Subject
to amortization
Substance
McGraw-Hill/Irwin
Substance
© 2004 The McGraw-Hill Companies
8-6
Fixed Asset Turnover
Fixed
=
Asset
Turnover
Net Sales Revenue
Average Net Fixed Assets
For the year 2000, Delta Airlines had $16,741 of
revenue. End-of-year fixed assets were $14,840
and beginning-of-year fixed assets were $12,450.
(All numbers in millions.)
This ratio measures a company’s
ability to generate sales given an
investment in fixed assets.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies
8-7
Fixed Asset Turnover
Fixed
=
Asset
Turnover
Net Sales Revenue
Average Net Fixed Assets
Fixed
=
Asset
Turnover
$16,741
($14,840 + $12,450) ÷ 2
= 1.23
2000 Fixed Asset Turnover Comparisons
Delta
Southwest
United
1.23
1.04
1.47
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies
8-8
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.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies
8-9
Acquisition Cost
Buildings

Purchase price

Architectural fees

Cost of permits

Excavation costs

Construction costs
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies
8-10
Acquisition Cost
Equipment

Purchase price

Installation costs

Modification to building
necessary to install
equipment

Transportation costs
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies
8-11
Acquisition Cost
Land






Purchase price
Real estate commissions
Title insurance premiums
Delinquent taxes
Surveying fees
Title search and transfer fees
Land is not depreciable.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies
8-12
Acquisition for Cash
On June 1, Delta Air Lines purchased
aircraft for $60,000,000 cash.
GENERAL JOURNAL
Date
June
Description
Debit
Page 8
Credit
1
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies
8-13
Acquisition for Cash
On June 1, Delta Air Lines purchased
aircraft for $60,000,000 cash.
GENERAL JOURNAL
Date
June
Description
1 Flight equipment
Cash
McGraw-Hill/Irwin
Debit
Page 8
Credit
60,000,000
60,000,000
© 2004 The McGraw-Hill Companies
8-14
Acquisition for Debt
On June 14, Delta Air Lines purchased
aircraft for $1,000,000 cash and a
$59,000,000 note payable.
GENERAL JOURNAL
Date
Description
Debit
Page 9
Credit
June 14
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies
8-15
Acquisition for Debt
On June 14, Delta Air Lines purchased
aircraft for $1,000,000 cash and a
$59,000,000 note payable.
GENERAL JOURNAL
Date
Description
June 14 Flight equipment
Cash
Note payable
McGraw-Hill/Irwin
Debit
Page 9
Credit
60,000,000
1,000,000
59,000,000
© 2004 The McGraw-Hill Companies
8-16
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.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies
8-17
Acquisition for
Noncash Consideration
On July 7, Delta gave Boeing 400,000
shares of $3 par value common stock with a
market value of $85 per share plus $26,000,000
in cash for aircraft.
GENERAL JOURNAL
Date
July
Description
Debit
Page 10
Credit
7
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies
8-18
Acquisition for
Noncash Consideration
On July 7, Delta gave Boeing 400,000
shares of $3 par value common stock with a
market value of $85 per share plus $26,000,000
in cash for aircraft.
GENERAL JOURNAL
Date
July
Description
7 Flight equipment
Cash
Common stock
Additional paid-in capital
McGraw-Hill/Irwin
Debit
Page 10
Credit
60,000,000
26,000,000
1,200,000
32,800,000
© 2004 The McGraw-Hill Companies
8-19
Acquisition by Construction
Asset cost includes:
All materials and
labor traceable to
the construction.
McGraw-Hill/Irwin
A reasonable
amount of
overhead.
Interest on debt
incurred during
the construction.
© 2004 The McGraw-Hill Companies
8-20
Repairs, Maintenance,
and Additions
Type of
Capital or
Expenditure Revenue
Identifying Characteristics
Ordinary
Revenue 1. Maintains normal operating condition
repairs and
2. Does not increase productivity
maintenance
3. Does not extend life beyond original
estimate
Extraordinary
repairs
Capital
1. Major overhauls or partial
replacements
2. Extends life beyond original estimate
Additions
Capital
1. Increases productivity
2. May extend useful life
3. Improvements or expansions
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies
8-21
Capital and Revenue
Expenditures
Financial Statement Effect
Treatment
Statement
Expense
Current Current
Income Taxes
Capital
Expenditure
Balance sheet
account debited
Deferred
Higher
Higher
Revenue Income statement Currently
Expenditure account debited recognized Lower
Lower
Many companies have policies expensing all
expenditures below a certain amount according to
the materiality constraint.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies
8-22
Depreciation
Depreciation is a cost allocation process
that systematically and rationally matches
acquisition costs of operational assets
with periods benefited by their use.
Balance Sheet
Acquisition
Cost
(Unused)
McGraw-Hill/Irwin
Income Statement
Cost
Allocation
Expense
(Used)
© 2004 The McGraw-Hill Companies
8-23
Depreciation
Depreciation
Expense
Depreciation for
the current year
Accumulated
Depreciation
Total of depreciation
to date on an asset
McGraw-Hill/Irwin
Income
Statement
Balance
Sheet
© 2004 The McGraw-Hill Companies
8-24
Depreciation on Delta’s
2000 Balance Sheet
Property and Equipment:
Flight equipment
Less: Accumulated depreciation
$ 17,565
5,173
$ 12,392
Ground property and equipment
Less: Accumulated depreciation
4,371
2,313
2,058
$
Advance payments for equipment
Total property and equipment
390
$ 14,840
Book Values
Book value =
/ Market value
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies
8-25
Depreciation Concepts
The calculation of depreciation requires three
amounts for each asset:
 Acquisition cost.
 Estimated useful life.
 Estimated residual value.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies
8-26
Alternative Depreciation Methods
 Straight-line
 Units-of-production
 Accelerated Method:
Declining balance
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies
8-27
Straight-Line Method
Depreciation
Expense per Year
=
Cost - Residual Value
Life in Years
At the beginning of the year, Delta purchased
equipment for $62,500 cash. The equipment has
an estimated useful life of 3 years and an
estimated residual value of $2,500.
SL
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies
8-28
Straight-Line Method
Depreciation
Expense per Year
=
Cost - Residual Value
Life in Years
Depreciation
Expense per Year
=
$62,500 - $2,500
3 years
Depreciation
Expense per Year
=
McGraw-Hill/Irwin
$20,000
SL
© 2004 The McGraw-Hill Companies
8-29
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
McGraw-Hill/Irwin
More than 95 percent of companies use the
straight-line method for some or all of their
assets disclosed in financial reports.
© 2004 The McGraw-Hill Companies
8-30
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
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies
8-31
Units-of-Production Method
At the beginning of the year, Delta purchased
ground equipment for $62,500 cash. The
equipment has a 100,000 mile useful life 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?
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies
8-32
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
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies
8-33
Units-of-Production Method
Year
Miles
1
2
3
30,000
50,000
20,000
100,000
McGraw-Hill/Irwin
Depreciation
Expense
Accumulated
Depreciation
Balance
$
$
18,000
18,000
Undepreciated
Balance
(book value)
$
62,500
44,500
© 2004 The McGraw-Hill Companies
8-34
Units-of-Production Method
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
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies
8-35
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
McGraw-Hill/Irwin
Low
Repair
Expense
Low
High
© 2004 The McGraw-Hill Companies
Double-Declining-Balance
Method
8-36
Declining balance rate of 2 is
double-declining-balance (DDB) rate.
Annual
Depreciation =
expense
Net
Book
Value
×
(
2
Useful Life in Years
)
Cost – Accumulated Depreciation
Annual computation ignores residual value.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies
Double-Declining-Balance
Method
8-37
At the beginning of the year, Delta
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.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies
Double-Declining-Balance
Method
Annual
Net
Depreciation = Book
expense
Value
×
(
2
Useful Life in Years
8-38
)
Year 1 Depreciation:
$62,500 ×
(
2
3 years
) = $41,667
Year 2 Depreciation:
($62,500 – $41,667) ×
McGraw-Hill/Irwin
(
2
3 years
) = $13,889
© 2004 The McGraw-Hill Companies
Double-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
8-39
Undepreciated
Balance
(book value)
$
62,500
20,833
6,944
2,315
Below residual value
($62,500 – $55,556) ×
McGraw-Hill/Irwin
(
2
3 years
) = $4,629
© 2004 The McGraw-Hill Companies
Double-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
8-40
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.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies
8-41
Depreciation and
Federal Income Tax
For tax purposes, most corporations use
the Modified Accelerated Cost Recovery
System (MACRS).
MACRS depreciation provides for rapid
write-off of an asset’s cost in order to
stimulate new investment.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies
8-42
Depreciation Methods
in Other Countries
Many countries, including Australia,
Brazil, England, and Mexico, use other
methods such as depreciation based
on the current fair value of assets.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies
8-43
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.
A loss should be recognized when an
asset suffers a permanent impairment.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies
8-44
Disposal of Property, Plant,
and Equipment
Voluntary disposals:

Sale

Trade-in

Retirement
Involuntary disposals:
Fire
 Accident

McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies
8-45
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).
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies
8-46
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.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies
8-47
Disposal of Property, Plant,
and Equipment
Delta Airlines sold flight equipment
for $5,000,000 cash at the end of its
17th year of use. The flight equipment
originally cost $20,000,000, and was
depreciated using the straight-line
method with zero salvage value
and a useful life of 20 years.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies
8-48
Disposal of Property, Plant,
and Equipment
The amount of depreciation
recorded at the end of the 17th year
to bring depreciation up to date is:
a.
b.
c.
d.
McGraw-Hill/Irwin
$0.
$1,000,000.
$2,000,000.
$4,000,000.
© 2004 The McGraw-Hill Companies
8-49
Disposal of Property, Plant,
and Equipment
The amount of depreciation
recorded at the end of the 17th year
to bring depreciation up to date is:
a.
b.
c.
d.
McGraw-Hill/Irwin
$0.
$1,000,000.
$2,000,000.
$4,000,000.
Annual Depreciation:
($20,000,000 - $0) ÷ 20 Years.
= $1,000,000
© 2004 The McGraw-Hill Companies
8-50
Disposal of Property, Plant,
and Equipment
After updating the depreciation,
the equipment’s book value at the
end of the 17th year is:
a.
b.
c.
d.
McGraw-Hill/Irwin
$3,000,000.
$16,000,000.
$17,000,000.
$4,000,000.
© 2004 The McGraw-Hill Companies
8-51
Disposal of Property, Plant,
and Equipment
Accumulated Depreciation =
(17yrs. ×the
$1,000,000)
= $17,000,000
After updating
depreciation,
the equipment’s
value atDepreciation
the
BV = Costbook
- Accumulated
end of
17th year
is:
BV the
= $20,000,000
- $17,000,000
= $3,000,000
a.
b.
c.
d.
McGraw-Hill/Irwin
$3,000,000.
$16,000,000.
$17,000,000.
$4,000,000.
© 2004 The McGraw-Hill Companies
8-52
Disposal of Property, Plant,
and Equipment
The equipment’s sale resulted in:
a.
b.
c.
d.
McGraw-Hill/Irwin
a gain of $2,000,000.
a gain of $3,000,000.
a gain of $4,000,000.
a loss of $2,000,000.
© 2004 The McGraw-Hill Companies
8-53
Disposal of Property, Plant,
and Equipment
The equipment’s sale resulted in:
a.
b.
c.
d.
a gain of $2,000,000.
a gain of $3,000,000.
a gain of $4,000,000.
a loss of $2,000,000.
Gain = Cash Received - Book Value
Gain = $5,000,000 - $3,000,000 = $2,000,000
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies
8-54
Disposal of Property, Plant,
and Equipment
Prepare the journal entry to record Delta’s sale
of the equipment at the end of the 17th year.
GENERAL JOURNAL
Date
McGraw-Hill/Irwin
Description
Debit
Page 8
Credit
© 2004 The McGraw-Hill Companies
8-55
Disposal of Property, Plant,
and Equipment
Prepare the journal entry to record Delta’s sale
of the equipment at the end of the 17th year.
GENERAL JOURNAL
Date
Description
Cash
Credit
5,000,000
Accumulated Depreciation
Gain on Sale
Flight Equipment
McGraw-Hill/Irwin
Debit
Page 8
17,000,000
2,000,000
20,000,000
© 2004 The McGraw-Hill Companies
8-56
Natural Resources
Total cost of
asset is the cost
of acquisition,
exploration,
and development.
Total cost is
allocated over
periods benefited
by means of
depletion.
Depletion is like depreciation.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies
8-57
Intangible Assets
Often provide
exclusive rights
or privileges.
Noncurrent assets
without physical
substance.
Intangible
Assets
Useful life is
often difficult
to determine.
McGraw-Hill/Irwin
Usually acquired
for operational
use.
© 2004 The McGraw-Hill Companies
8-58
Intangible Assets
Record at current
cash equivalent
cost, including
purchase price,
legal fees, and
filing fees.






McGraw-Hill/Irwin
Goodwill
Trademarks
Patents
Copyrights
Franchises
Leaseholds
© 2004 The McGraw-Hill Companies
8-59
Intangible Assets

Amortize over shorter of economic life or
legal life, subject to rules specified by
GAAP.

Use straight-line method.

Research and development costs are
normally expensed as incurred.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies
8-60
Intangible Assets
Goodwill
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.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies
8-61
Intangible Assets
Goodwill
Goodwill
Not amortized.
McGraw-Hill/Irwin
Subject to assessment
for impairment
value and may be
written down.
© 2004 The McGraw-Hill Companies
8-62
Intangible Assets
Goodwill
Eddy Company paid $1,000,000 to purchase
all of James Company’s assets and assumed
liabilities of $200,000. The acquired assets
were appraised at a fair value of $900,000.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies
8-63
Intangible Assets
Goodwill
What amount of goodwill should be
recorded on Eddy Company books?
a.
b.
c.
d.
McGraw-Hill/Irwin
$100,000
$200,000
$300,000
$400,000
© 2004 The McGraw-Hill Companies
8-64
Intangible Assets
Goodwill
What amount of goodwill should be
recorded on Eddy Company books?
F M V o f A sse ts
a.
b.
c.
d.
McGraw-Hill/Irwin
$100,000
$200,000
$300,000
$400,000
$
D e b t A ssu m e d
200,000
F M V o f N e t A sse ts
$
P u rch a se P rice
G o o d w ill
900,000
700,000
1,000,000
$
300,000
© 2004 The McGraw-Hill Companies
8-65
Intangible Assets
Trademarks
A symbol, design, or logo
associated with a business.
Internally
developed
trademarks
have no
recorded
asset cost.
McGraw-Hill/Irwin
Purchased
trademarks
are recorded
at cost.
© 2004 The McGraw-Hill Companies
8-66
Intangible Assets
Patents
Exclusive right granted
by federal government to sell or
manufacture an invention.
Cost is purchase
price plus legal
cost to defend.
McGraw-Hill/Irwin
Amortize cost
over the shorter of
useful life or 20 years.
© 2004 The McGraw-Hill Companies
8-67
Intangible Assets
Copyrights
Exclusive right granted by the federal
government to protect artistic or
intellectual properties.
Legal life is
life of creator
plus 70 years.
McGraw-Hill/Irwin
Amortize cost
over the period
benefited.
© 2004 The McGraw-Hill Companies
8-68
Intangible Assets
Franchises
Legally protected right to sell products or
provide services purchased by franchisee from
franchisor.
Purchase price is an intangible
asset that is amortized.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies
8-69
Intangible Assets
Leaseholds

A lease is a contract to
use property granted
by lessor to lessee and
rights granted under the
lease are called a leasehold.

A leasehold is recorded only
if advance payment is involved.
Otherwise periodic payments
are rent expense.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies
8-70
Intangible Assets
Leasehold Improvements
Long-lived alterations made by
lessee to leased property.
Leasehold improvements are recorded at
cost and amortized over their useful life.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies
8-71
This computer is
about to become
fully depreciated!
End of
Chapter 8
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies