Chapter 9
REPORTING AND
ANALYZING LONGLIVED ASSETS
Long-term, or non-current, assets
acquired for use in a business rather
than for resale. Examples include



Property, Plant, and Equipment
Intangible Assets
Natural Resources

Property, Plant, and Equipment--Tangible, longlived assets acquired for business operations.
Depreciation is the process of allocating the
costs of these assets over their estimated
useful lives.
Nature of Operating Assets
• Property, Plant, and Equipment
• Intangible Assets--Intangible long-lived
assets without physical substance that
are used in business. Amortization is
the process of allocating the costs of
these assets over their estimated useful
lives.
Nature of Operating Assets
• Property, Plant, and Equipment
• Intangible Assets
• Natural Resources--Assets that are
physically consumed or waste away in
the course of business. Depletion is the
process of allocating costs of natural
resources as they are mined or
extracted.




Recording asset acquisition.
Allocating the cost of an asset over its useful
life, or depreciation.
Accounting for maintenance, repairs, and
improvements made to the asset.
Accounting for sale or disposal of the asset.
Assets Acquired by Purchase
John Doe purchased a delivery truck to use
in his business. The cost of the truck was
$50,000. What entry will John make if he
paid cash for the truck?
Assets Acquired by Purchase
John Doe purchased a delivery truck to use
in his business. The cost of the truck was
$50,000. What entry will John make if he
paid cash for the truck?
Delivery Truck................................ 50,000
Cash........................................
50,000
Purchased a delivery truck for $50,000.
Assets Acquired by Purchase
John Doe purchased a delivery truck to use
in his business. The cost of the truck was
$50,000. What entry will John make if he
purchased the truck with $10,000 cash and
then borrowed the remaining $40,000?
Assets Acquired by Purchase
John Doe purchased a delivery truck to use
in his business. The cost of the truck was
$50,000. What entry will John make if he
purchased the truck with $10,000 cash and
then borrowed the remaining $40,000?
Delivery Truck................................ 50,000
Cash........................................
10,000
Notes Payable..........................
40,000
Purchased a delivery truck for $50,000.
Assets Acquired by Purchase
John Doe purchased a delivery truck to use
in his business. The cost of the truck was
$50,000. What entry will John make if he
traded a piece of land worth $50,000 for the
truck?
Assets Acquired by Purchase
John Doe purchased a delivery truck to use
in his business. The cost of the truck was
$50,000. What entry will John make if he
traded a piece of land worth $50,000 for the
truck?
Delivery Truck................................ 50,000
Land.........................................
50,000
Purchased a delivery truck for $50,000.
Cost is measured by
• the cash paid in a cash transaction, or
• the cash equivalent price paid when noncash assets are
used in payment.
The cash equivalent price is equal to
• the fair market value of the asset given up, or
• the fair market value of the asset received, whichever is
more clearly determinable.
1

If a building is purchased, but needs
to be readied for its intended use,
cost includes
• expenditures for remodeling rooms or
offices
• replacing or repairing
o
o
o
o
roof
floors
electrical wiring
plumbing
1


All necessary expenditures relating to
the purchase or construction of a
building.
When a building is purchased such costs
include the
• purchase price
• closing costs (attorney's fees title insurance)
• real estate broker's commissions
1
Cost of land includes



Cash price, closing costs, brokers’ commissions,
accrued property taxes, etc.
Can also include costs to raze a building, drain
and fill the land
Proceeds from sale of salvaged materials are
deducted from the cost
1

All expenditures necessary to make the
improvements ready for their intended use
•
•
•
•
Drive ways
Parking lots
Fences
Underground sprinklers
1
Assets Acquired by Purchase


Basket Purchase--The purchase of two or more
assets acquired together at a single price.
Relative Fair Market Value Method--A way of
allocating a basket purchase price to the individual
assets acquired based on their respective market
values.
Basket Purchase
When two or more assets are acquired at a single
price. The prices are allocated on a “relative fair
market value method.”
In the example below, on Oct 31 we purchased
land and building for a total of $360,000.
Basket Purchase
When two or more assets are acquired at a single
price. The prices are allocated on a “relative fair
market value method.”
In the example below, we purchased land and
building for a total of $360,000.
Asset
FMV
Total Value
Cost
`
Land
$100,000
25%
.25 x 360,000 = $ 90,000
Building $300,000
75%
.75 x 360,000 = $ 270,000
$400,000
100%
$ 360,000
When two or more assets are acquired at a single
price. The prices are allocated on a “relative fair
market value method.”
In the example below, we purchased land and
building for a total of $360,000.
Asset
FMV
Total Value
Cost
`
Land
$100,000
25%
.25 x 360,000 = $ 90,000
Building $300,000
75%
.75 x 360,000 = $ 270,000
$400,000
100%
$ 360,000
Journal Entry:
Land............. 90,000
Building........ 270,000
Cash.....
360,000
Basket Purchase
Unless, of course, the intent of purchasing the
building was to demolish it and build a new one.
In which case, the whole
cost, plus the demolition
cost, is the cost of the
land.



Depreciation--A systematic write-off each period of
the original cost assigned to the asset.
Useful Life--The length of time a company expects
to use an asset.
Salvage or Residual Value--What the asset will be
worth at the end of its useful life (net of disposal
costs).


Accumulated Depreciation--The total depreciation
recorded on an asset since its acquisition. It is a
contra-asset account that is offset against the cost
of the asset on the balance sheet.
Book Value--Equal to the original cost of the asset
less accumulated depreciation.
Calculating Depreciation Expense
In order to calculate depreciation
expense, the following information is
needed:



The original cost.
The estimated useful life.
The salvage or residual value.
Depreciation Expense
$24,000
Allocate the expenses (cost) of the asset –
– to the periods it contributes to revenue


The depreciation method in which the cost of an
asset is allocated equally over each period of the
asset’s estimated useful life.
The asset is assumed to benefit all periods
equally.
Straight-Line--Recognizes equal periodic
depreciation charges of the asset’s useful life.
The formula for Straight-Line is:
Straight-Line--Recognizes equal periodic
depreciation charges of the asset’s useful life.
The formula for Straight-Line is:
Depreciation = Cost - Salvage Value
Expense
Useful Life (years)

The following information will be used to
provide an example of calculating depreciation:
◦
◦
◦
◦
Acquisition Cost
$24,000
Estimated Residual Value
$ 2,000
Estimated Useful Life
4 years
This is the second year the asset has
been in use.
Depreciation = Cost - Salvage Value
Expense
Useful Life (years)
Depreciation = Cost - Salvage Value
Expense
Useful Life (years)
Depreciation = $24,000 - $2,000
Expense
4
Depreciation = $5,500 per year
Expense
The journal entry to record depreciation
for 2005 would be:
Depreciation Expense..................... 5,500
Accumulated Depreciation........
5,500
To record depreciation expense for the asset.
$12,000
$10,000
$8,000
Depreciation Expense
$6,000
$4,000
$2,000
$0
2004
2005
2006
2007
1 Straight
Line
2 Units-of-production
3 Sum-of-the-years’ digits
4 Declining Balance
$12,000
$10,000
$8,000
$6,000
Depreciation Expense
$4,000
$2,000
$0
2004
2005
2006
2007
$12,000
Depreciation Expense
$10,000
$8,000
$6,000
$4,000
$2,000
$0
2004
2005
2006
2007
$12,000
$10,000
Depreciation Expense
$8,000
$6,000
$4,000
$2,000
$0
2004
2005
2006
2007
Comparison of Methods
Depreciation Expense
$12,000
Sum-of-the-Years' Digits
$10,000
Double-Declining Balance
$8,000
Straight-Line
$6,000
$4,000
$2,000
$0
2004
2005
2006
2007


If the asset was not purchased at the beginning or
end of the year, then depreciation should only be
recorded for the months the asset was in use.
To simplify the process, some companies take a
full year depreciation in the year of purchase, but
take no depreciation expense in the year the asset
is sold.

The following information will be used to
provide an example of calculating depreciation:
◦
◦
◦
◦
Acquisition Cost
$24,000
Estimated Residual Value
$ 2,000
Estimated Useful Life
4 years
This is the first year the asset has
been in use
Depreciation = Cost - Salvage Value
Expense
Useful Life (years)
Depreciation = Cost - Salvage Value
Expense
Useful Life (years)
= $24,000 - $2,000 = $5,500
4
Depreciation = $5,500 x .5 = $2,750
Expense 1st yr
The journal entry to record depreciation
for 2005 would be:
Depreciation Expense..................... 2,750
Accumulated Depreciation........
2,750
To record depreciation expense for the asset.



Depreciation for tax purposes must be
computed in accordance with federal income
tax law.
Modified Accelerated Cost Recovery System
(MACRS).
Due to MACRS depreciation calculations, the
depreciation expense for federal income tax will
differ from the depreciation computed for
financial reporting purposes.

Ordinary Expenditures--Expenditures for repairs,
maintenance, and minor improvements which
benefit the period in which they are made.

Capital Expenditure--Expenditures that lengthen
an asset’s useful life, increases its capacity, or
changes its use.
In order to classify as a capital
expenditure, three criteria should be
met:
1
2
3
The amount must be significant.
It should benefit the company for several
periods.
It should increase the productive life or capacity
of the asset.
Tool Time paid $3,000 during the year to
maintain the company truck. What entry
needs to be made?
Tool Time paid $3,000 during the year to
maintain the company truck. What entry
needs to be made?
Maintenance Expense........... 3,000
Cash................................
Spent $3,000 to maintain truck.
3,000
Tool Time paid $10,000 to rebuild the engine
in the company truck. It is expected that the
new engine will add 2 years to the useful life
of the truck.
Example: Capital Expenditure
Tool Time paid $10,000 to rebuild the engine
in the company truck. It is expected that the
new engine will add 2 years to the useful life
of the truck.
Company Truck.................. 10,000
Cash.............................
10,000
Spent $10,000 to rebuild truck engine.
 Discarding
 Selling
 Exchanging
for another asset
Example: Disposal
John Doe decided to scrap a truck at the end
of its useful life of 10 years. The original cost
of the truck was $20,000. What entry will
John make to scrap the truck?
Ignore
John’s legal
fees
John Doe decided to scrap a truck at the end
of its useful life of 10 years. The original cost
of the truck was $20,000. What entry will
John make to scrap the truck?
Accumulated Depreciation....... 20,000
Truck…...............................
20,000
Scrapped $20,000 truck.
Example: Disposal
John Doe decided to scrap a truck after
using it for only 9 years of its useful life of 10
years. The original cost of the truck was
$20,000. What entry will John make to scrap
the truck?
Example: Disposal
John Doe decided to scrap a truck after
using it for only 9 years of its useful life of 10
years. The original cost of the truck was
$20,000. What entry will John make to scrap
the truck?
Accumulated Depreciation............ 18,000
Loss on Disposal........................... 2,000
Truck......................................
20,000
Scrapped $20,000 truck.
Example: Sale
John Doe decided to sell the truck after using
it for its useful life of 10 years. The original
cost of the truck was $20,000. What entry will
John make if he sells the truck for $3,000?
John Doe decided to sell the truck after using
it for its useful life of 10 years. The original
cost of the truck was $20,000. What entry will
John make if he sells the truck for $3,000?
Cash….......................................... 3,000
Accumulated Depreciation............ 20,000
Truck…....................................
20,000
Gain on Sale…........................
3,000
Sold a $20,000 truck for $3,000.
Example: Sale
John Doe decided to sell the truck after using
it for 8 years of its useful life of 10 years. The
original cost of the truck was $20,000. What’s
the entry if he sells the truck for $3,000?
Example: Sale
John Doe decided to sell the truck after using
it for 8 years of its useful life of 10 years. The
original cost of the truck was $20,000. What’s
the entry if he sells the truck for $3,000?
Cash............................................. 3,000
Accumulated Depreciation............ 16,000
Loss on Sale................................. 1,000
Truck.......................................
20,000
Sold a $20,000 truck for $3,000.
A contract that specifies the terms under which
the owner of an asset transfers the right to use
the asset to another party.
Depending on the lease
provisions, a lease may
resemble a purchase or a rental
agreement.




Lessee--The party granted the right to use the
property under the terms of a lease.
Lessor--The owner of the property that is
rented (leased) to another party.
Operating Lease--A simple rental agreement.
Capital Lease--A leasing transaction that is
recorded as a purchase by the lessee.
Cancellation
Clause
Specifies under what
circumstances the lease
may be canceled.
Cancellation
Clause
Term
Specifies under what
circumstances the lease
may be canceled.
Delineates time period the
lease is to be in force.
Cancellation
Clause
Term
Bargain Purchase
Option
Specifies under what
circumstances the lease
may be canceled.
Delineates time period the
lease is to be in force.
Grants lessee the right to
purchase the asset at the
end of the lease term for
less than the residual
value.
MinimumLease
Lease
Minimum
Payment
Payment
Rental payment required
over lease term plus any
payment for residual value.
MinimumLease
Lease
Minimum
Payment
Payment
Residual Value
Rental payment required
over lease term plus any
payment for residual value.
Market value of leased
asset at end of lease term.
Lease classification can have a major impact on
the financial statements.
◦ A lease is classified an operating lease if
the criteria for a capital lease are not
met.
◦ A lease is classified as a capital lease if it
is non-cancelable and meets any one of
the following four criteria.
1
2
3
4
The lease transfers ownership of the leased
asset to the lessee by the end of the lease term.
The lease contains an option allowing the lessee
to purchase the asset at the end of the lease
term at a bargain price.
The lease term is equal to 75 percent or more of
the estimated economic life of the asset.
The present value of the lease payments at the
beginning of the lease is 90 percent or more of
the fair market value of the leased asset.
Yes
Transfer of Ownership?
Yes
No
Bargain Purchase
Option?
Yes
No
Term  75% of
Useful Life?
Yes
No
PV Payment 90%
of FMV?
Capital
Lease
No
Operating
Lease
Example: Operating Lease
Bob Jones signed a two-year lease which requires
a monthly payment of $1,000. When the lease
expires, Bob will either move out or negotiate a
new lease. The journal entry is the following:
Bob Jones signed a two-year lease which requires
a monthly payment of $1,000. When the lease
expires, Bob will either move out or negotiate a
new lease. The journal entry is the following:
Rent (or Lease) Expense......... 1,000
Cash..................................
1,000
To record monthly rent on office building.
Example: Capital Lease
Dreams Inc. leased a hotel for lease payments of
$100,000 for 20 years. Since at the end of 20 years
Dreams will own the property, the lease is treated as
a purchase. The journal entries are as follows:
Example: Capital Lease
Dreams Inc. leased a hotel for lease payments of
$100,000 for 20 years. Since at the end of 20 years
Dreams will own the property, the lease is treated as
a purchase. The journal entries are as follows:
Leased Property..................
851,360
Lease Liability................
851,360
To record hotel acquired under a 20-year lease.
Example: Capital Lease
Dreams Inc. leased a hotel for lease payments of
$100,000 for 20 years. Since at the end of 20 years
Dreams will own the property, the lease is treated as
a purchase. The journal entries are as follows:
Leased Property..................
851,360
Lease Liability................
851,360
To record hotel acquired under a 20-year lease.
Lease Liability......................
14,864
Interest Expense..................
85,136
Cash..............................
To record annual capital lease payments.
100,000
Rights and privileges that are long-lived, are not
held for resale, have no physical substance, and
usually provide their owner with a competitive
advantage.



Patent--An exclusive right granted for 17 years
by the government to manufacture and sell an
invention.
Franchise--An exclusive right to sell a product
or offer a service in a certain geographical
area.
Goodwill--An intangible asset that shows a
business is worth more than the net value of its
assets.
The periodic allocation to expense of an
intangible asset’s cost. The straight-line method
is used most frequently.
Example: Patent
Uncle Buck purchased a patent for
$100,000. The useful life was 5 years. What
entry is needed to record the purchase?
Uncle Buck purchased a patent for
$100,000. The useful life was 5 years. What
entry is needed to record the purchase?
Patent..........................................
Cash......................................
Purchased a patent for $100,000.
100,000
100,000
Example: Patent
Uncle Buck purchased a patent for
$100,000. The useful life was 5 years. What
entry is needed to record the patent’s
amortization after the first year?
Example: Patent
Uncle Buck purchased a patent for
$100,000. The useful life was 5 years. What
entry is needed to record the patent’s
amortization after the first year?
Amortization Expense, Patent......... 20,000
Patent......................................
20,000
To amortize patent for 1/5 of the cost.



An intangible asset that exists when a business is
valued at more than the fair market value of its net
assets.
Goodwill should be recorded only if its value can
be objectively determined.
Goodwill is never written up above its original cost.
Example: Goodwill
Bob, Inc. purchased a company for
$200,000. The fair market value was
determined to be $150,000. What amount of
goodwill is recorded?
Bob, Inc. purchased a company for
$200,000. The fair market value was
determined to be $150,000. What amount of
goodwill is recorded?
Purchase Price............................... 200,000
Fair Market Value........................... 150,000
Goodwill
50,000
Example: Goodwill
Bob, Inc. purchased a company for
$200,000. The fair market value was
determined to be $150,000. If goodwill is
amortized over 40 years, what is the journal
entry for goodwill expenses after the first
year?
Example: Goodwill
Bob, Inc. purchased a company for
$200,000. The fair market value was
determined to be $150,000. If goodwill is
amortized over 40 years, what is the journal
entry for goodwill expenses after the first
year?
Amortization Expense, Goodwill........ 1,250
Goodwill......................................
1,250
To amortize Goodwill for 1/40 of the cost.


Depletion--The process of cost allocation that
assigns the original costs of a natural resource to
the periods benefited.
Involves the calculation of a depletion rate for
each unit of the natural resource.
Coal Time paid $1,000,000 for a coal mine.
The mine contained an estimated 250,000
tons of coal. What entry is made for the
purchase of the coal mine?
Coal Time paid $1,000,000 for a coal mine.
The mine contained an estimated 250,000
tons of coal. What entry is made for the
purchase of the coal mine?
Coal Mine................... 1,000,000
Cash.....................
1,000,000
Purchased coal mine for $1,000,000.
Coal Time paid $1,000,000 for a coal mine.
The mine contained an estimated 250,000
tons of coal. During 2005, 30,000 tons of
coal were mined. What is the depletion
expense for 2005?
Coal Time paid $1,000,000 for a coal mine.
The mine contained an estimated 250,000
tons of coal. During 2005, 30,000 tons of
coal were mined. What is the depletion
expense for 2005?
Depletion Expense........... 120,000
Coal Mine...................
120,000
Mined 30,000 tons at $4.00 per ton.