9- 1
Chapter Eight
Accounting for LongTerm Operational
Assets
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2015
9- 2
Chapter 8
Long-Term
Operational Assets
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2015
9- 3
Classification of Operational Assets
Operational assets are used by a
business to generate revenue.
l Tangible operational assets have
physical substance.
l
– Property, Plant, and Equipment –
Sometimes called plant assets or fixed
assets. We depreciate these assets over
their useful life.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2015
9- 4
Classification of Operational Assets
l
Tangible operational assets have
physical substance.
– Land – Has an infinite life and is not
subject to depreciation.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2015
9- 5
Classification of Operational Assets
l
Tangible operational assets have
physical substance.
– 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.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2015
8-6
Cost of Long-Term Assets
Buildings
•Purchase price
•Sales taxes
•Title search and transfer document costs
•Realtor’s and attorney’s fees
•Remodeling costs
Land
Equipment
•Purchase price (less
discounts)
•Sales taxes
•Delivery costs
•Installation costs
•Costs to adapt to intended use
McGraw-Hill/Irwin
•Purchase price
•Sales taxes
•Title search and transfer
document costs
•Realtor’s and attorney’s fees
•Costs of removal of old
buildings
•Grading costs
© The McGraw-Hill Companies, Inc., 2015
9- 7
Classification of Operational Assets
l
Intangible operational assets lack
physical substance and confer specific
use rights on the owner.
Patents
p Copyrights
p Franchises
p Licenses
p Trademarks
p
McGraw-Hill/Irwin
Burger Queen
Franchise
© The McGraw-Hill Companies, Inc., 2015
9- 8
Basket Purchases of Assets
When land and building are purchased
together, the land cost and the building
cost are placed in separate accounts.
The total cost of the purchase is
separated on the basis of relative
market values.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2015
9- 9
Basket Purchases of Assets
Example: On March 1, Arco Co. purchased
land and building for $100,000 cash. The
appraised value of the building was $90,000
and the land was appraised at $30,000.
How much of the $100,000
purchase price will be
allocated to each account?
Land = ? Building = ?
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2015
9- 10
Basket Purchases of Assets
Fair Market Values:
Appraised
Values
Building
Land
$ 90,000
$ 30,000
Total market value
$120,000
Allocation of cost:
Total Cost
Building
Land
McGraw-Hill/Irwin
* $100,000 =
* $100,000 =
© The McGraw-Hill Companies, Inc., 2015
9- 11
Basket Purchases of Assets
Fair Market Values:
Appraised
Values
Building
Land
Total market value
Percent
$ 90,000 75%
$ 30,000 25%
$120,000
Allocation of cost:
Total Cost
Building
Land
McGraw-Hill/Irwin
* $100,000 =
* $100,000 =
© The McGraw-Hill Companies, Inc., 2015
9- 12
Basket Purchases of Assets
Fair Market Values:
Appraised
Values
Building
Land
Total market value
Allocation of cost:
Building
Land
McGraw-Hill/Irwin
Percent
$ 90,000 75%
$ 30,000 25%
$120,000 100%
Total Cost
* $100,000 =
* $100,000 =
© The McGraw-Hill Companies, Inc., 2015
9- 13
Basket Purchases of Assets
Fair Market Values:
Appraised
Values
Percent
Building
Land
$ 90,000
$ 30,000
75%
25%
Total market value
$120,000 100%
Allocation of cost:
Total Cost
Building
Land
McGraw-Hill/Irwin
75% * $100,000 =
25% * $100,000 =
© The McGraw-Hill Companies, Inc., 2015
9- 14
Basket Purchases of Assets
Fair Market Values:
Appraised
Values
Building
Land
$ 90,000
$ 30,000
Total market value
$120,000
Allocation of cost:
Total Cost
Building
Land
McGraw-Hill/Irwin
Allocated
Cost
75% * $100,000 = $75,000
25% * $100,000 = $25,000
© The McGraw-Hill Companies, Inc., 2015
9- 15
Basket Purchases of Assets
General Journal entry:
Building
Land
Cash
$ 75,000
$ 25,000
$100,000
Allocation of cost:
Total Cost
Building
Land
McGraw-Hill/Irwin
Allocated
Cost
75% * $100,000 = $75,000
25% * $100,000 = $25,000
© The McGraw-Hill Companies, Inc., 2015
9- 16
Depreciation
You’ve purchased an asset that will be used to benefit
more than one year of operations. When you buy the
asset you do NOT “expense” it. You postpone (defer)
the recognition of the expense until you have used the
asset over a period of time.
Recognizing an expenditure by spreading it
over several years, allocating a part of the
expense to each of several periods during
which the asset is used, is called
depreciation.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2015
Depreciation
l
l
The portion of the cost of an
asset allocated to any one
accounting period is called-DEPRECIATION EXPENSE
Depreciation of an asset is
an allocation process-spreading the cost of an
asset that benefits more than
one accounting period over
the estimated useful life of
the asset.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2015
Example of Depreciation:
l
McGraw-Hill/Irwin
ABC Sports Bar Co.
bought equipment for
$55,000. The asset is
expected to last five
years and have a
$10,000 salvage value
at the end of its useful
life. How will the
purchase and use of
the asset affect the
financial statements?
© The McGraw-Hill Companies, Inc., 2015
l
We want to allocate the cost of the asset to the
income statement as an expense during the time
period we use the asset. Why?
To comply with the MATCHING principle.
Expenses incurred must be “matched” to the same
time period the revenues (from using this equipment)
are recorded.
If we depreciate the asset using the STRAIGHT LINE
method, we will divide the cost of the asset (minus any
estimated salvage value) by the useful life:
(55,000-10,000)/5 yrs. = $9,000 depreciation expense
each year.
l
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2015
Effect on the financial statements:
Purchase of asset:
_Balance Sheet
u
Increases assets (eg. Equip); may decrease “cash” asset
(thus, no effect on net assets) or may increase a liability
_Income Statement
_Statement of Changes in Stockholders’
Equity
_Statement of Cash Flows
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2015
Effect on the financial statements:
Purchase of asset:
_Balance Sheet
u Increases assets; may decrease an asset (cash) or
increase a liability (payable) if we haven’t paid yet.
_Income Statement
u No effect
_Statement of Changes in Stockholders’
Equity
_Statement of Cash Flows
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2015
Effect on the financial statements:
Purchase of asset:
_Balance Sheet
u Increases assets; may decrease an asset (cash) or
increase a liability (payable) if we haven’t paid yet.
_Income Statement
u No effect
_Statement of Changes in Stockholders’
Equity
u No effect
_Statement of Cash Flows
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2015
Effect on the financial statements:
Purchase of asset:
_Balance Sheet
u Increases assets; may decrease an asset (cash) or
increase a liability (payable) if we haven’t paid yet.
_Income Statement
u No effect
_Statement of Changes in Stockholders’
Equity
u No effect
_Statement of Cash Flows
u Depends on whether or not the asset was purchased for
cash. If cash is paid it is an Investing Activity cash flow.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2015
Use of the asset:
l
Balance Sheet
u
l
Reduces the net value of the asset by increasing a
contra-asset account called accumulated depreciation
Income Statement
Accumulated Depreciation is a
Permanent
(Asset)
Account.
It
l Statement of Changes in Stockholders’ Equity
accumulates the depreciation
expense
year of the asset’s
l Statement
of each
Cash Flows
useful life.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2015
Use of the asset:
l
Balance Sheet
u
l
Reduces the net value of the asset by increasing a
contra-asset called accumulated depreciation
Income Statement
u
Increase in depreciation expense reduces Net Income
l
Statement of Changes in Stockholders’ Equity
l
Statement of Cash Flows
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2015
Use of the asset:
l
Balance Sheet
u
l
Income Statement
u
l
Increase in depreciation expense reduces Net Income
Statement of Changes in Stockholders’ Equity
u
l
Reduces the net value of the asset by increasing a
contra-asset called accumulated depreciation
Since the Net Income decreased, the remaining
Retained Earnings will decrease causing total
Stockholders’ Equity to decrease.
Statement of Cash Flows
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2015
Use of the asset:
l
Balance Sheet
u
l
Income Statement
u
l
Increase in depreciation expense reduces Net Income
Statement of Changes in Stockholders’ Equity
u
l
Reduces the net value of the asset by increasing a
contra-asset called accumulated depreciation
Since the Net Income decreased, the remaining
Retained Earnings will decrease causing total
Stockholders’ Equity to decrease.
Statement of Cash Flows
u
No cash involved. Depreciation is an adjusting entry.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2015
8-28
Depreciation Methods
1. Straight-line method - the same amount
is depreciated each accounting period.
2. Units-of-Production – produces varying
amounts of depreciation in different
accounting periods depending upon the
number of units produced.
3. 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.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2015
Example of Balance Sheet
ABC Sports Bar, Inc.
Balance Sheet
As of December 31, 2014
Assets
Cash
Computer Equipment
Less: Accumulated Depreciation
Total Assets
McGraw-Hill/Irwin
11,000
$
46,000
57,000
$
12,000
$
45,000
57,000
55,000
(9,000)
Liabilities
Unearned Revenue
Stockholders' Equity
Commn Stock
$
Retained Earnings
Total Stockholders' Equity
Total Liabilities and Stockholders' Equity
$
Net
Asset
Balance
1,000
44,000
© The McGraw-Hill Companies, Inc., 2015
9- 30
Straight-Line Method
Depreciation
Expense per Year
McGraw-Hill/Irwin
=
Cost - Salvage Value
Life in Years
© The McGraw-Hill Companies, Inc., 2015
9- 31
Straight-Line Method: Example
On January 1, 2013, equipment was purchased
for $55,000 cash. The equipment has an
estimated useful life of 5 years and an estimated
Salvage value of $10,000.
What is the annual straight-line depreciation
expense?
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2015
Straight-Line Method: Example
On January 1, 2013, equipment was purchased for
$55,000 cash. The equipment has an estimated
useful life of 5 years and an estimated Salvage value
of $10,000.
Assets
Cash
+ Eqpt
AccDep
(55,000)
55,000 = NA
Account Title
Equipment
Cash
McGraw-Hill/Irwin
=
Equity
= Com. Stk.
=
NA
Ret. Earn.
NA
Rev. – Exp. = Net Inc.
NA
– NA
Debit
55,000
= NA
Cash Flow
(55,000) IA
Credit
55,000
8-32
© The McGraw-Hill Companies, Inc., 2015
9- 33
Straight-Line Method: Example
Depreciation
Expense per Year
Depreciation
Expense per Year
Depreciation
Expense per Year
McGraw-Hill/Irwin
=
=
Cost - Salvage Value
Life in Years
55,000 - 10,000
5
=
9,000
© The McGraw-Hill Companies, Inc., 2015
9- 34
Straight-Line Method: Example
The company use the equipment to generate
$30,000 revenue for the period
Assets
30,000
NA
= Liab.
NA
= NA
(9,000)
NA
+ Equity
+
30,000
(9,000)
Cash
Service revenue
Depreciation expense
Accumulated depreciation
McGraw-Hill/Irwin
–
30,000 –
NA
–
Rev.
Exp.
=
NA
=
9,000
Net Inc.
30,000
(9,000)
Cash Flow
30,000 OA
NA
30,000
30,000
9,000
9,000
© The McGraw-Hill Companies, Inc., 2015
9- 35
Units-of-Production Method
Step 1:
Depreciation
Rate
=
Cost - Salvage Value
Estimated units of useful life
Depreciation Rate =
Depreciation charge
per each unit
produced
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2015
9- 36
Units-of-Production Method
Step 1:
Depreciation
Rate
=
Cost - Salvage Value
Estimated units of useful life
=
Number of
Depreciation
× Units Produced
Rate
for the Year
Step 2:
Depreciation
Expense
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2015
9- 37
Example of Units of Production Method
Given the same information [asset cost $55,000,
has a salvage value of $10,000, has a useful life
of five years] plus the fact that the asset is
estimated to have a total productive capacity of
100,000 units during the useful life:
If 22,000 units were produced this year, what
is the amount of depreciation expense?
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2015
9- 38
Example of Production Method
Step 1:
Depreciation = Cost - salvage value = $45,000 = $.45
Rate
Productive output
100,000 Per unit
Step 2:
Dep. rate x units produced
Depreciation
= $ .45/unit x 22,000
=
Expense
McGraw-Hill/Irwin
$9,900
© The McGraw-Hill Companies, Inc., 2015
9- 39
Example of Production Method
If 15,000 units are produced during the
second year of the asset’s life, what is the
amount of depreciation expense?
$0.45 x 15,000 = $6,750
l What is the Accumulated Depreciation at the
end of the second year?
$9,900 + $6,750 = $16,650
l What is the 12/31/05 Equip. Book Value?
l
$55,000 cost - $16,650 Accum. Dep. = $38,350
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2015
9- 40
Accelerated Depreciation
l
Accelerated depreciation methods result in
more depreciation expense in the early
years of an asset’s useful life and less
depreciation expense in later years of the
an asset’s useful life.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2015
9- 41
Double-Declining Balance Method
l
Declining-balance depreciation is based on
the straight-line rate multiplied by an
acceleration factor.
– For example, when the acceleration
factor is 200 percent, the method is
referred to as double-declining
balance depreciation.
l
Declining-balance depreciation
computations ignore salvage value.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2015
9- 42
Double-Declining Balance Method
Annual Depreciation is calculated with
the following formula:
Book Value × (2 × Straight-Line Rate)
Straight-Line:
$55,000 – 10,000
1
5
x
2 = 2 or
5
McGraw-Hill/Irwin
x
1
5 yrs
40%
© The McGraw-Hill Companies, Inc., 2015
9- 43
Double-Declining-Balance
Example
Using the same information from our
earlier example [asset cost $55,000,
Salvage value is $10,000, and useful life
is 5 years]:
Calculate the depreciation expense
for the asset’s life.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2015
9- 44
Double-Declining-Balance Example
Beginning
Deprec.
Year Book Value DDB Rate Expense Accum Dep
1
55,000
40% 22,000
22,000
2
33,000
40% 13,200
35,200
3
19,800
McGraw-Hill/Irwin
End Bk
Value
33,000
19,800
© The McGraw-Hill Companies, Inc., 2015
9- 45
Double-Declining-Balance Example
Beginning
Year Book Value DDB Rate
1 55,000
40%
2 33,000
40%
3 19,800
40%
McGraw-Hill/Irwin
Deprec.
Expense Accum Dep
22,000 22,000
13,200 35,200
7,920
End Bk
Value
33,000
19,800
© The McGraw-Hill Companies, Inc., 2015
9- 46
Double-Declining-Balance Example
Beginning
Deprec.
End Bk
Year Book Value DDB Rate Expense Accum Dep Value
1
55,000
40%
22,000
22,000
33,000
2
33,000
40%
13,200
35,200
19,800
3
19,800
40%
7,920
43,120
11,880
4
11,880
40%
4,752
47,872
7,128
Solution:
4
11,880
1,880
45,000
10,000
5
10,000
0
0 10,000
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2015
9- 47
Comparison of Depreciation Methods
Straight-line Production* Double-Declining Bal.
Dep. Accum. Dep. Accum.
Dep. Accum.
Year Exp. Dep. Exp. Dep.
Exp.
Dep.
1
9000
9000
2
9000 18000
9900
9900
22,000
22,000
6750 16650
13,200
35,200
3
9000 27000 11250 27900
7,920
43,120
4
9000 36000 11250 39150
1,8801
45,000
5
9000 45000
01
45,000
5850 45000
*Units produced were Yr 1= 22,000; Yr 2=15,000; Yrs 3&4=25,000 each;
Yr. 5=13,000. [1 In yr. 4, didn’t use DDB formula. Wrote-off last 1,880.]
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2015
9- 48
Comparison of Depreciation Methods
l
The total amount of depreciation recorded
over the useful life of an asset is the same
regardless of the method used.
l
Depreciation expense recorded in any one
period will vary according to method used.
l
The straight-line method is used for
financial accounting purposes (“the books”)
by about 95 percent of companies because
it is easy to use and to explain to financial
statement users.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2015
9- 49
Disposal
of
Operational Assets
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2015
9- 50
Horizontal Model Transaction Analysis
Balance Sheet
Assets
= Liab.+ Equity
Cash + Equip.- Acc.D.= A/P + C.C.+ R.E.
1 70,000
2 (55,000) 55,000
3 30,000
4
+ 9000
B 45,000 55,000 9000
McGraw-Hill/Irwin
70,000
Income Statement Cashflow
Rev./ Exp.
Statem’t
Gains - Loss= N.I. OA,IA,FA
70,000 FA
(55,000) IA
30000 30,000
30,000 30,000 OA
(9000)
9,000 (9000)
70,000 21000
Closed out
45,000 B
© The McGraw-Hill Companies, Inc., 2015
9- 51
Horizontal Model Transaction Analysis
Balance Sheet
Assets
= Liab.+ Equity
Cash + Equip.- Acc.D.= A/P + C.C.+ R.E.
1 70,000
2 (55,000) 55,000
3 30,000
4
+ 9000
B 45,000 55,000 9000
McGraw-Hill/Irwin
70,000
Income Statement Cashflow
Rev./ Exp.
Statem’t
Gains - Loss= N.I. OA,IA,FA
70,000 FA
(55,000) IA
30000 30,000
30,000 30,000 OA
(9000)
9,000 (9000)
70,000 21000
Closed out
45,000 B
© The McGraw-Hill Companies, Inc., 2015
9- 52
Horizontal Model Transaction Analysis
Balance Sheet
Assets
= Liab.+ Equity
Cash + Equip.- Acc.D.= A/P + C.C.+ R.E.
1 70,000
2 (55,000) 55,000
3 30,000
4
+ 9000
B 45,000 55,000 9000
5
9000
B 45,000 55,000 18,000
McGraw-Hill/Irwin
70,000
Income Statement Cashflow
Rev./ Exp.
Statem’t
Gains - Loss= N.I. OA,IA,FA
70,000 FA
(55,000) IA
30000 30,000
30,000 30,000 OA
(9000)
9,000 (9000)
70,000 21000
Closed out
45,000 B
(9000)
9,000 (9000)
70,000 12,000
Closed out
45,000 B
© The McGraw-Hill Companies, Inc., 2015
9- 53
Horizontal Model Transaction Analysis
Balance Sheet
Assets
= Liab.+ Equity
Cash + Equip.- Acc.D.= A/P + C.C.+ R.E.
1 70,000
2 (55,000) 55,000
3 30,000
4
+ 9000
B 45,000 55,000 9000
5
9000
B 45,000 55,000 18,000
McGraw-Hill/Irwin
70,000
Income Statement Cashflow
Rev./ Exp.
Statem’t
Gains - Loss= N.I. OA,IA,FA
70,000 FA
(55,000) IA
30000 30,000
30,000 30,000 OA
(9000)
9,000 (9000)
70,000 21000
Closed out
45,000 B
(9000)
9,000 (9000)
70,00012,000
Closed out
45,000 B
© The McGraw-Hill Companies, Inc., 2015
9- 54
Horizontal Model Transaction Analysis
Balance Sheet
Income Statement Cashflow
Assets
= Liab.+ Equity
Rev./ Exp.
Statem’t
Cash + Equip.- Acc.D. = A/P + C.C.+ R.E. Gains - Loss= N.I. OA,IA,FA
1 70,000
2 (55,000) 55,000
3 30,000
4
+ 9000
B 45,000 55,000 9000
5
9000
B 45,000 55,000 18,000
6
6,000
McGraw-Hill/Irwin
70,000
70,000 FA
(55,000) IA
30000 30,000
30,000 30,000 OA
(9000)
9,000 (9000)
70,000 21000
Closed out
45,000 B
(9000)
9,000 (9000)
70,00012,000
Closed out
45,000 B
(6000)
6,000 (6000)
© The McGraw-Hill Companies, Inc., 2015
9- 55
Disposal of Operational Assets
1. Update the depreciation on the asset to
the date of disposal.
2. Record the disposal by . . .
– Removing the asset cost (credit).
– Removing the Accumulated Depreciation
(debit).
– Recording cash received (debit) or cash paid
(credit).
– Recording a loss (debit) or gain (credit).
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2015
9- 56
Gain or Loss on Disposal?
How do we know if there is a Loss or Gain on the disposal?
l
Compare cash received for the asset with
the asset’s book value (BV).
– If cash greater than BV, record a gain (credit).
– If cash less than BV, record a loss (debit).
– If cash equals BV, no gain or loss.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2015
9- 57
Disposal of Operational Assets
How do we know if there is a Loss or Gain on the disposal?
Compare cash received for the asset with
the asset’s book value (BV).
.
Cash received
Equipment, cost
$55,000
Less: Accum. Dep. 24,000
Equip, Book Value
Gain (Loss)
McGraw-Hill/Irwin
$26,000
31,000
$ (5,000)
© The McGraw-Hill Companies, Inc., 2015
9- 58
Horizontal Model Transaction Analysis
Balance Sheet
Assets
= Liab.+ Equity
Cash + Equip.- Acc.D.= A/P + C.C.+ R.E.
1 70,000
70,000
70,000 FA
2 (55,000) 55,000
3 30,000
4
+ 9000
B 45,000 55,000 9000
5
9000
B 45,000 55,000 18,000
6
6,000
7 26,000 (55,000) (24,000)
McGraw-Hill/Irwin
Income Statement Cashflow
Rev./ Exp.
Statem’t
Gains - Loss= N.I. OA,IA,FA
(55,000) IA
30000 30,000
30,000 30,000 OA
(9000)
9,000 (9000)
70,000 21000
Closed out
45,000 B
(9000)
9,000 (9000)
70,00012,000
Closed out
45,000 B
(6000)
6,000 (6000)
(5000)
5,000 (5000) 26,000 IA
© The McGraw-Hill Companies, Inc., 2015
9- 59
Journalize the Disposal
Cash
$26,000
Accumulated Depreciation (to remove) 24,000
Loss on Disposal of Equipment
Equipment (original cost)
5,000
55,000
What if there had been a GAIN on disposal?
The GAIN would be a CREDIT in the
journal entry above (and there would be
more cash).
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2015
9- 60
Horizontal Model Transaction Analysis
Balance Sheet
Income Statement Cashflow
Assets
= Liab.+ Equity
Rev./ Exp.
Statem’t
Cash + Equip.- Acc.D. = A/P + C.C.+ R.E. Gains - Loss= N.I. OA,IA,FA
1 70,000
2 (55,000) 55,000
3 30,000
4
+ 9000
B 45,000 55,000 9000
5
9000
B 45,000 55,000 18,000
6
6,000
7 26,000 (55,000) (24,000)
B 71,000
0
0
McGraw-Hill/Irwin
70,000
70,000 FA
(55,000) IA
30000 30,000
30,000 30,000 OA
(9000)
9,000 (9000)
70,000 21000
Closed out
45,000 B
(9000)
9,000 (9000)
70,00012,000
Closed out
45,000 B
(6000)
6,000 (6000)
(5000)
5,000 (5000) 26,000 IA
70,000 1,000
Closed out
71,000 B
© The McGraw-Hill Companies, Inc., 2015
9- 61
What’s the result? - For Year 3
How much depreciation expense is on the 2015 Income Statement?
$6,000
How much Gain or Loss is on the 2015 Income Statement?
$5,000 Loss on Disposal
How much Accumulated Deprec. is on the 12/31/15 Bal. Sheet?
$0
(We don’t have the equipment anymore.)
What is the equipment’s Book Value
(or Carrying Value) at the end of 2015?
$0
McGraw-Hill/Irwin
(We don’t have the equipment anymore.)
© The McGraw-Hill Companies, Inc., 2015
9- 62
Depreciation and Federal Income Tax
l
Most corporations use the Modified
Accelerated Cost Recovery System
(MACRS) for tax purposes. (Could use
straight-line depreciation.)
l
MACRS provides for rapid write-off of
an asset’s cost in order to stimulate
investment in modern facilities.
l
MACRS uses half-year convention
and assumes no Salvage value.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2015
9- 63
Depreciation and Federal Income Tax
MACRS example
Same purchase recorded previously:
On Jan. 1, 2013 equipment costing $55,000
was purchased. Estimated life = 5 yrs.
Estimated Salvage value = $10,000.
Calculate the depreciation tax
deduction assuming the equipment
is classified as “5 year property.”
Note: See tax tables in your text for 5-Yr. and 7-Yr. properties.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2015
9- 64
Depreciation and Federal Income Tax
MACRS example
IRS
yr.
1
2
3
4
5
6
Equipm’t Depreciation
Cost
Deduction
x $55,000 = $11,000
x 55,000 =
17,600
x 55,000 =
10,560
x 55,000 =
6,336
x 55,000 =
6,336
x 55,000 =
3,168
100%
$55,000 = 100%
Table
%
20.00
32.00
19.20
11.52
11.52
5.76
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2015
9- 65
Revising Estimates of Salvage
Value or of Useful Life
l
l
l
When an estimate is revised, no
changes are made to amounts
reported in the past.
The new estimates are
incorporated into the present
and future calculations only.
Depreciation amounts are
revised using the book value,
estimated useful life and salvage
value at beginning of the year of
the revision.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2015
9- 66
Revising Estimates of Salvage
Value or of Useful Life - Example
On Jan. 1, 2013 the Goodview Co.
purchased Equipment costing $55,000. It
was estimated to last 5 years and have a
$10,000 Salvage value. Straight-line
depreciation ($9,000) has been used.
On Jan. 1, 2015 management determined
that the equipment would last 4 years from
this date, but would only be worth $5,000 at
the end of that time.
How much depreciation expense should be
recorded each year starting on Dec. 31, 2015?
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2015
9- 67
Revising Estimates of Salvage
Value or of Useful Life - Example
The equipment has already been depreciated two years (‘08
and ‘09) at $9,000 per year. So, Accumulated Depreciation
has an $18,000 balance at the beginning of 2015.
Original Cost
Less: Accum. Dep.
= Book value, Jan. 1, ‘2015
Less: Revised Salvage Value
= Remainder to be depreciated
Divided by Remaining life
$55,000
18,000
37,000
-5,000
32,000
4 yrs.
= New annual Depreciation expense $ 8,000
McGraw-Hill/Irwin
Starting in 2015
© The McGraw-Hill Companies, Inc., 2015
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 the company spent $500
cash for routine maintenance on machinery.
Assets
= Liab.
Cash
(500) = NA
+ Equity
Ret. Earn.
+
(500)
Account Title
Repairs Expense
Cash
McGraw-Hill/Irwin
Rev.
–
NA
–
Exp.
500
= Net Inc.
=
Debit
500
Cash Flow
(500)
(500) OA
Credit
500
8-68
© The McGraw-Hill Companies, Inc., 2015
9- 69
Continuing Expenditures
for Plant Assets
l
l
McGraw-Hill/Irwin
Expenditures made to keep
an asset in good working
order are expensed in the
period in which they are
incurred. (normally expected
repairs & maintenance)
Substantial costs spent to (1)
improve the quality or (2)
extend the life of an asset are
capitalized.
© The McGraw-Hill Companies, Inc., 2015
9- 70
Accounting for capital expenditures:
Extraordinary Repairs
Ex: Overhaul
l Extend the life?
– viewed as canceling
some of the previous
depreciation
– journal entry to
reduce (debit)
accumulated
depreciation
– new depreciation
amount will be
calculated using the
revision approach.
McGraw-Hill/Irwin
Betterments
Ex: Attach snowplow to
truck owned for 2 years.
l Improve the quality?
– viewed as an additional
cost of the equipment
– journal entry to increase
(debit) the cost of the
asset
– new depreciation
amount will be
calculated using the
revision approach.
© The McGraw-Hill Companies, Inc., 2015
9- 71
Extraordinary Expenditure
Extend Useful Life
Overhaul
Engine
Eqpt
Cost
Accum
Deprec
Net
Book
Value
McGraw-Hill/Irwin
Improve Quality
Original
Cost
Add
Attachment
10,000
4,000
6,000
© The McGraw-Hill Companies, Inc., 2015
9- 72
Extraordinary Expenditure
Extend Useful Life
Eqpt
Cost
Accum
Deprec
Net
Book
Value
McGraw-Hill/Irwin
Improve Quality
Overhaul
Engine
Original
Cost
10,000
10,000
2,000
8,000
= +2,000
Add
Attachment
4,000
6,000
© The McGraw-Hill Companies, Inc., 2015
9- 73
Extraordinary Expenditure
Extend Useful Life
Eqpt
Cost
Accum
Deprec
Net
Book
Value
McGraw-Hill/Irwin
Improve Quality
Overhaul
Engine
Original
Cost
10,000
10,000 +2,000 = 12,000
2,000
8,000
= +2,000
4,000
6,000
Add
Attachment
4,000
8,000
© The McGraw-Hill Companies, Inc., 2015
9- 74
Natural Resources
l
Assets supplied by nature
– Examples: gold, oil, and coal
l
Presented on balance sheet as
non-current assets at cost minus
all depletion to date.
l
Total cost of the asset is the cost of
acquisition, exploration and development.
l
Cost is “written-off” as “Depletion Expense”
over periods that related revenues are
earned. (Usually, units-of-production method.)
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2015
9- 75
Natural Resources
A depletion rate is calculated using
the units-of-production method.
Depletion Cost Per Unit Is Calculated As Follows:
Total Cost of Natural Resource
Estimated Number of Available Units
of Natural Resource
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2015
9- 76
Natural Resources
Martin Mining Company paid $10,000,000 cash to
purchase land that is expected to yield 5,000,000 tons
of coal. After all coal is extracted the land is not
expected to have any salvage value. During 2006, the
company extracted and sold 500,000 tons of coal.
$10,000,000 – $0
5,000,000 tons
McGraw-Hill/Irwin
= $2.00 per ton extracted and sold
© The McGraw-Hill Companies, Inc., 2015
9- 77
Natural Resources
Martin Mining Company paid $10,000,000 cash to
purchase land that is expected to yield 5,000,000 tons of
coal. After all coal is extracted the land is not expected to
have any salvage value. During 2006, the company
extracted and sold 500,000 tons of coal.
Assets
= Liab.
Cash
+ Coal Mine
(10,000,000)
10,000,000 =
NA
(1,000,000)
NA
NA
+ Equity
+
NA
(1,000,000)
Account Title
Coal Mine
Cash
Depletion Expense
Coal Mine
McGraw-Hill/Irwin
Rev.
NA
NA
– Exp.
= Net Inc.
Cash Flow
–
–
=
(10,000,000) IA
NA
Debit
10,000,000
NA
1,000,000
NA
(1,000,000)
Credit
10,000,000
1,000,000
1,000,000
© The McGraw-Hill Companies, Inc., 2015
9- 78
Intangible Assets
l
Noncurrent assets without physical
substance that confer certain rights and
privileges on the owner of the asset.
– Examples: patents, copyrights, franchises
and licenses, leaseholds, leasehold
improvements, trademarks, and goodwill.
l
Purchased intangible assets are recorded
at cost.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2015
9- 79
Two Categories of Intangible Assets
l
Intangible assets with IDENTIFIABLE useful lives.
– e.g. Patents and Copyrights
They have a legal life, BUT they MAY become
obsolete or worthless before their legal live is over.
l
Intangible assets with INDEFINITE useful lives.
– e.g. Goodwill, Franchise, Trademark
How long will the “name” of a restaurant keep attracting
customers if new owners don’t serve good food and
provide good service?
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2015
9- 80
Intangible Assets with
IDENTIFIABLE Useful Lives
l
Amortize (write-off) over the shorter of their
useful life or legal life.
l
Normally the straight-line method is used and
the asset is reported on the balance sheet at
book value without a related accumulated
amortization account.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2015
9- 81
Intangible Assets: Patents
l
A patent is an exclusive right granted by
the federal government to sell or
manufacture an invention.
l
A patent is amortized over the shorter of
its useful life or 17-year legal life.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2015
9- 82
Intangible Assets with
IDENTIFIABLE Useful Lives
Example: (1) A patent is purchased from a company for $20,000.
(2) When purchased, there were 15 years remaining of the 17
year legal life, but management estimates that new technology
will make this patent obsolete in 4 years. ($20,000/4=$5,000)
INCOME STATEMENT
EQUITY
Accts
Com.
Ret.
+ Patent = Pay. + Stk. + Earn.
=
Cash
BB
1
30,000
(20,000)
2
EB
+
22,000
10,000 + 15,000 =
Cash
McGraw-Hill/Irwin
- Exp. =
8,000
OA,IA,FA
$ amt
30,000 bal.
20,000
(20,000) IA
(5,000)
Patent
Rev.
Net
Inc.
CASHFLOW
STATEMENT
(5,000)
- + 22,000 + 3,000
20,000
5,000
(5,000)
- - 5,000 = (5,000)
10,000 bal.
Amortization Expense 5,000
20000
Patent
5000
© The McGraw-Hill Companies, Inc., 2015
9- 84
Intangible Assets: Goodwill
l
Goodwill is the added value of a business that is
attributable to favorable factors such as a good
reputation, location, and superior products.
l
Goodwill must be PURCHASED by acquiring an
existing business at a cost that is higher than the
Fair Market Value of its physical assets (minus
any liabilities assumed by the buying company).
l
Goodwill has an INDEFINITE useful life, so it must
be tested for IMPAIRMENT each year.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2015
9- 85
Intangible Assets with
INDEFINITE Useful Lives
l
Must be tested for IMPAIRMENT each year.
If the fair market value of the intangible asset is
less than its book value, the value has been
IMPAIRED (reduced).
l
To reduce the intangible asset to its new lower fair
value an IMPAIRMENT LOSS is recorded and
reported on the Income Statement. The intangible
asset is reduced by the same amount.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2015
9- 86
Intangible Assets: Goodwill (Example)
Winona Co. purchased Rushford Co. by paying
$1,500 cash for all of its assets, but also
agreeing to assume its liabilities.
Individual company balance sheets before purchase:
Rushford Co.
Winona Co.
Assets:
Eq.,net
Liab.-A/P 200 Assets:
1000 C.Cap. 500 Cash 2000
Ret.Earn 300 Eq.,net 7000
T. Assets 1000 T. L&Eq.1000 T.Assets 9000
Liab.-A/P 1000
C.Cap. 3000
Ret.Earn 5000
T. L&Eq. 9000
An appraiser says the Fair Market Value of Rushford’s
assets is $1,300.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2015
9- 87
Intangible Assets: Goodwill (example)
Calculation of Goodwill
Cash Paid
+ Liab. Assumed
$1,500
200
= Total cost
1,700
- FMV of Assets Acquired
1,300
= Goodwill purchased
McGraw-Hill/Irwin
$ 400
© The McGraw-Hill Companies, Inc., 2015
9- 88
Let’s Take a Quick Look at a
Chapter 11
Stockholders’
Equity
For
Corporations
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2015
9- 89
Corporations
l
A corporation is a popular form of
business because . . .
It is simple for individuals to purchase
small amounts of stock.
It allows for an easy transfer of
ownership through established markets,
like the New York Stock Exchange.
It provides stockholders with limited
liability.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2015
9- 90
Corporations
l
Because a corporation is a separate
legal entity, it can . . .
– Own assets.
– Incur liabilities.
– Sue and be sued.
– Enter into contracts independent of the
stockholder owners.
l
Many Americans own stock through a
mutual fund or pension program.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2015
9- 91
Ownership of a Corporation
l
Owners of common stock generally
receive the following rights:
– Voting (in person or by proxy).
– Distributions of profits (in the form of Dividends).
– Distributions of assets in a liquidation.
– Offers to purchase shares of a new stock
issue (pro rata basis).
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2015
9- 92
Creating a Corporation
State laws govern the creation of
corporations.
l An application for a charter (or articles
of incorporation) must include the
corporation’s name and purpose, kinds
and amounts of capital (common) stock
authorized, and other detailed
information.
l
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2015
9- 93
Creating a Corporation
Once the state
issues a charter,
the stockholders
elect a board of
directors.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2015
9- 94
Authorized, Issued, and
Outstanding Capital Stock
Authorized
Shares
The maximum number
of shares of capital
stock that can be sold
to the public is called
the authorized number
of shares.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2015
9- 95
Authorized, Issued, and Outstanding
Capital Stock
Authorized
Shares
Issued Unissued
shares
shares
have
have been
sold.
McGraw-Hill/Irwin
never been
sold.
© The McGraw-Hill Companies, Inc., 2015
9- 96
Authorized, Issued, and Outstanding
Capital Stock
owned by stockholders.
Authorized
Shares
Issued
Shares
McGraw-Hill/Irwin
Outstanding
Shares
Unissued
Shares
© The McGraw-Hill Companies, Inc., 2015
9- 97
Authorized, Issued, and Outstanding
Capital Stock
owned by stockholders.
Authorized
Shares
Issued
Shares
Outstanding
Shares
Treasury
Shares
McGraw-Hill/Irwin
Unissued
Shares
reacquired by the
corporation.
© The McGraw-Hill Companies, Inc., 2015
9- 98
Common Stock
Basic voting stock of the corporation
l Ranks after preferred stock for
dividend and liquidation distribution.
l Dividend rates are determined by the
board of directors based on the
corporation’s profitability
and other factors.
l
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2015
9- 99
Chapter 8 (and a little 11)
The End
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2015