Overview of Long-Lived Assets
• Long-lived assets - resources that are held
for an extended time, such as land,
buildings, equipment, natural resources, and
patents
– These assets help produce revenues over many
periods by facilitating the
production and sale of goods
or services to customers.
Overview of Long-Lived Assets
• Tangible assets - physical items that can be
seen and touched, such as land, natural
resources, buildings, and equipment
– Also known as fixed assets or plant assets
• Intangible assets - rights or economic
benefits, such as franchises, patents,
trademarks, copyrights, and goodwill that
are not physical in nature
Overview of Long-Lived Assets
• Terms for allocation of costs over time:
– Depreciation - allocation of the cost of tangible
assets to the periods in which the assets are
used
– Depletion - allocation of the cost of natural
resources to the periods in which the resources
are used
– Amortization - allocation of the cost of
intangible assets to the periods that benefit from
these assets
Acquisition Cost of
Tangible Assets
• The acquisition cost of long-lived assets is
the purchase price, including incidental
costs required to complete the purchase, to
transport the asset, and to prepare it for use.
Acquisition Cost of
Tangible Assets
• Land
– The acquisition cost of land includes
costs of land surveys, legal fees, title
fees, realtor commissions, transfer
taxes, and the demolition costs of old
structures.
– Under historical cost accounting, land is
carried on the balance sheet at its original cost
even if the market value of the land is many
times that of the original cost.
Acquisition Cost of
Tangible Assets
• Buildings and Equipment
– Costs should include all costs of acquisition and
preparation for use, such as sales taxes,
transportation costs, installation costs, and
repairs to the asset prior to use.
– Costs included in the cost of an asset are
capitalized (added to the asset account), as
distinguished from being expensed
immediately.
Depreciation of Buildings
and Equipment
• Depreciation in the accounting sense is not a process of
valuation.
– Depreciation is a form of allocating the cost of an asset
to periods when the asset is used.
• Depreciation is one key factor that distinguishes accrual
accounting from cash-basis accounting.
– Under the accrual basis, the cost of the asset is
allocated to the periods benefited.
– Under the cash basis, the cost of the asset would be
expensed immediately.
Depreciation of Buildings
and Equipment
• Depreciable value - the amount of acquisition cost
to be allocated as depreciation over the total useful
life of an asset
– The depreciable value is the difference between
the acquisition cost and the predicted residual
value.
• Residual value - the amount received from
disposal of a long-lived asset at the end of its
useful life
Depreciation of Buildings
and Equipment
• Useful life (economic life) - the time period
over which an asset is depreciated
– The useful life is the shorter of the physical life
of the asset before it wears out or the economic
life of the asset before it becomes obsolete.
– The useful life can be measured
in terms other than time. For
example, the life of a truck can
be measured in miles driven.
Straight-Line Depreciation
• Straight-line depreciation - a method that
spreads the depreciable value evenly over
the useful life of an asset
Depreciation Acquisition cost - Residual value

expense
Years of useful life
Straight-Line Depreciation
• A truck with a cost of $41,000 and a
residual value of $1,000 has a useful life of
4 years. Depreciation expense is calculated
as follows:
($41,000 - $1,000) / 4 = $10,000*
*Depreciation is the same each year for the life of the
asset.
Depreciation Based on Units
• Unit depreciation - a depreciation method
based on units of service when physical
wear and tear is the dominating influence on
the useful life of the asset
– A depreciation rate per unit is determined by
dividing the depreciable value (cost less
residual value) by the useful life in units.
– To determine depreciation expense, the actual
usage of the asset is multiplied by the
depreciation rate.
Depreciation Based on Units
• A truck with a cost of $41,000 and a
residual value of $1,000 has a useful life of
200,000 miles. During the year, the truck is
driven for 45,000 miles. Depreciation
expense is calculated as follows:
($41,000 - $1,000) / 200,000 = $.20 per
mile
45,000 x $.20 = $9,000*
*Depreciation over the life of the asset will fluctuate as the
usage of the asset fluctuates.
Declining-Balance Depreciation
• Accelerated depreciation - any depreciation
method that writes off depreciable costs more
quickly than the ordinary straight-line method
based on expected useful life
• Double-declining-balance (DDB) depreciation the most popular form of accelerated depreciation
– It is computed by doubling the straight-line rate
and multiplying the resulting DDB rate by the
beginning book value.
Declining-Balance Depreciation
• Computing DDB depreciation:
– Compute a rate by dividing 100% by the
number of years of useful life.
– Double the rate.
– Ignore the residual value, and multiply the
asset’s book value at the beginning of the year
by the DDB rate.
• Stop depreciation when the book value
reaches the residual value.
Declining-Balance Depreciation
• A truck with a cost of $41,000 and a residual value
of $1,000 has a useful life of 4 years. Doubledeclining-balance depreciation expense is
calculated as follows:
100% / 4 = 25% x 2 = 50% per year
Year 1: $41,000 x 50% = $20,500*
Year 2: ($41,000 - $20,500) x 50% = $10,250*
*Depreciation over the life of the asset declines
each year.
Comparing and Choosing
Depreciation Methods
• Straight-line gives the same
depreciation expense each year
of the useful life of the asset.
• DDB gives accelerated depreciation
expense (more than regular straight-line) in
the first years of the useful life of the asset.
– Companies will often switch from DDB to
straight-line part way through the life of the
asset to compensate for the fact the DDB may
not fully depreciate the asset.
Comparing and Choosing
Depreciation Methods
• Companies do not always use the same
depreciation methods for all types of depreciable
assets.
• The choice of depreciation alternatives comes
from several places:
– Tradition or use by other companies in the
industry
– Better matching of expenses with revenues
– The nature of the industry and the equipment
and the goals of management
Contrasting Income Tax and
Shareholder Reporting
• Reports to stockholders must follow GAAP,
but reports to income tax authorities must
follow the income tax rules and regulations.
– These rules are usually alike, but sometimes
they differ.
– These difference cause business to keep two
sets of books – one for financial statements and
one for taxes.
Financial
Statements
Taxes
Depreciation on Tax Reports
• Tax laws require the use of the
Modified Accelerated Cost Recovery
System (MACRS) for computing
accelerated depreciation.
– MACRS uses tax lives that are much shorter
than the real economic life of most assets.
– These short lives produce very accelerated
depreciation in the early years of the life of the
asset, which lowers taxable income in those
years.
Shareholder Reporting
• Shareholder reporting is driven by efforts to
match the cost of assets to the periods in
which the assets generate revenues.
– Most companies use straight-line depreciation
to accomplish this.
• Companies also want higher earnings in
their financial statements.
– Straight-line produces lower depreciation in the
early years than accelerated depreciation.
Depreciation and Cash Flow
• Depreciation does not generate cash.
– Depreciation allocates the original cost of an
asset to the periods when the asset is used.
– Accumulated depreciation is merely the total
amount that an asset has been depreciated
throughout its life.
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Effects of Depreciation on Cash
• Depreciation has no effect on ending cash
balances because it is a noncash expense.
• Before taxes, changes in the depreciation
method affect only the Accumulated
Depreciation and Retained Earnings
accounts.
Effects of Depreciation on
Income Taxes
• Depreciation is a deductible noncash
expense for income tax purposes.
– If depreciation expense is higher, taxes are
lower, and more cash can be kept for use in the
business.
• Accelerated depreciation generally has higher
depreciation expense.
• Depreciation does not generate cash, but it
does have a cash benefit if it results in lower
taxes.
Contrasting Long-Lived Asset
Expenditures With Expenses
• Expenditures - purchases of goods or
services, whether for cash or on credit
• Asset-related expenditures that will benefit
more than one year are capitalized.
– Capital expenditures add new fixed assets or
increase the capacity, efficiency, or useful life
of an existing fixed asset.
• Expenditures that provide a benefit lasting
one year or less are expensed in the current
year.
Gains and Losses on Sales
of Tangible Assets
• Assets are often sold before the end of their
useful lives.
– When an asset is sold, a gain or loss usually
occurs.
– The gain or loss is the difference between cash
received and the net book value of the asset
given up.
Recording Gains and Losses
• Remember that when depreciation is recorded,
two accounts are affected, Depreciation Expense
and Accumulated Depreciation.
– Accumulated depreciation reduces the book
value of the fixed asset.
• The disposal of a fixed asset requires the removal
of its book value (carrying amount), which
appears in two accounts, the asset account and
Accumulated Depreciation.
Recording Gains and Losses
A piece of equipment with an original cost
of $50,000 that has $20,000 of accumulated
depreciation is sold for $35,000 cash. The
journal entry to record this transaction is as
follows:
Cash
Accumulated depreciation
Equipment
Gain on sale of equipment*
*[35,000 - (50,000 - 20,000) = 5,000]
35,000
20,000
50,000
5,000
Recording Gains and Losses
A piece of equipment with an original cost
of $50,000 that has $20,000 of accumulated
depreciation is sold for $23,000 cash. The
journal entry to record this transaction is as
follows:
Cash
Accumulated depreciation
Loss on sale of equipment*
Equipment
*[23,000 - (50,000 - 20,000) = -7,000]
23,000
20,000
7,000
50,000
Income Statement Presentation
• Gains and losses on sales of assets are
usually insignificant, so they are included as
“other income” on the income statement.