Chapter 9 – Reporting and Analyzing Long-Lived Assets
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Plant assets (Property, Plant, & Equipment) –
 Determining cost of a plant asset
 Accounting for PP&E including depreciation and
disposal
 Analyzing plant assets (ratios)
Intangible assets (no physical characteristics)
 Types of intangible assets
 Accounting for intangible assets
 Financial statement presentation
Determining the cost of a plant asset- Cost includes all
expenditures necessary to acquire the asset and get it ready
for use
Land cost includes purchase price, realtor, attorney, and
other fees associated with the acquisition, removal of old
building, etc. We do not depreciate the land.
Land improvements- driveways, parking lots, fences, outside
lighting, sprinkling systems. Depreciate land improvements
over their useful life.
Buildings- Capitalize the purchase price, closing cost,
remodeling, renovations (everything it costs to get the asset
in place and ready to use.
Trucks, Autos - Cost includes cash price, sales tax, painting
& lettering, special additions to asset
Equipment – Cost includes cash price, sales tax, insurance
during shipping, installation and testing.
To buy or lease? Considerations include obsolescence,
down payment, tax considerations, affect on financial
statements
Operating lease not reported as an asset nor is a liability
reported- Debit Rent Expense; Credit Cash
Capital lease- Record leased asset at present value of lease
payments and credit an account called Obligations under
Capital Lease.
Depreciation- A process of allocating to expense the cost of
a plant asset over its useful life in a rational and systematic
manner.
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Depreciation is a cost allocation process, not an asset
valuation process (i.e., emphasis on getting a good matching
on the income statement rather than a proper value for the
asset on the balance sheet.
Factors needed to compute depreciation:
1. Cost – As discussed on pages 436-437
2. Estimated Useful life – not physical life
3. Salvage Value (aka, scrap value, residual value)
Pie chart indicates that straight-line method is used 83% of
the time.
Straight-line = (Cost – Salvage) / Estimated useful life
Look at Depreciation schedule (Illustration 9-9)
Double Declining-Balance = (Cost – Accumulated
Depreciation) x Twice the Straight-line Rate
See Appendix, page 461 for illustration. You are responsible
for this!
Straight-line rate for a five year life is 1/5, so we’ll use a rate
of 2/5 for the Double Declining-Balance method
Look at Depreciation schedule (Illustration 9-10)
Units-of-Activity = (Cost – Salvage) / Estimated units in life.
Look at Depreciation schedule (Illustration 9-11)
See Appendix, page 476 for illustration. You are responsible
for this!
Illustration 9-12- Comparison of methods.
 Notice that total depreciation is the same over the five
year life.
 What differs is that SL writes asset off evenly, DDB
writes a large amount of the asset off in the early years
 Unit-of-activity methods depreciation differs due to
usage (physical wear and tear)
 Repair Expense increases as asset ages, so total
depreciation under DDB + repair expense might be
similar over the years of the asset use
For tax purposes, taxpayers must choose between straightline and Modified Accelerated Cost Recovery System
(MACRS). But this isn’t tax class!
Disposal of plant asset – scrap, sell, or trade-in
Notice journal entries to record depreciation and sale of
asset: Record cash received, eliminate Accumulated
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Depreciation account, eliminate asset account, and show
balance as a gain or loss.
If the cash received is greater than the asset’s book value,
you have a gain (credit Gain on Sale).
If the cash received is less than the asset’s book value, you
have a loss (debit Loss on Sale)
Analyzing Plant Assets
Return on Assets (ROA) = Net Income / Average Total Assets
Asset Turnover Ratio =
Net Sales / Average Total Assets
Profit Margin Ratio = Net Income / Net Sales
ROA = Profit Margin Ratio x Asset Turnover Ratio
Accounting for Intangible Assets – Patents, Copyrights,
Franchises, Trademarks, Trade Names, Goodwill, Research
and Development costs.
Amortization is the process of writing off an intangible asset.
We depreciate tangible assets and amortize intangibles.
Goodwill is capitalized but not amortized (subject to an
annual impairment test)
R & D is expensed and never capitalized
Compute amortization on a patent- straight-line method
used.
International Accounting Standards differ from US GAAP
 Research is expensed but Development is capitalized.
Appendix 9A. Other Depreciation Methods
Double Declining Balance- Illustration 9A-2
Unit of Activity- Illustration 9A-4
A Look at IFRS (Property, Plant, and Equipment)
Chapter 12 – Statement of Cash Flows
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Topic
We briefly looked at the Statement of Cash Flows in Basic
Training and in Chapter 1.
We know the three sections: Cash from Operating
Activities, Financing Activities, and Investing Activities.
We know that we are looking at sources and uses of CASH.
This statement is necessary because the other three
statements use accrual accounting and don’t necessarily
stress cash.
By looking at comparative Balance Sheets, we can see the
beginning and ending cash for the current year, but can’t
explain the changes to cash.
Usefulness of Statement of Cash Flows:
 Company’s ability to generate future cash
(usefulness in valuation models in Finance)
 Company’s ability to pay debt and dividends
 Opportunity to evaluate differences between net
income and cash from operating activities
 Concise list of cash investing activities and financing
activities
Noncash financing and investing activities:
 Issuance of stock for assets
 Issuance of long-term debt for assets
 Conversion of long-term debt for stock
 Exchange of plant assets (e.g., land for building)
Format of the Statement of Cash Flows
Corporate and Product Life Cycle- Introductory, Growth,
Maturity, and Decline. A Statement of Cash Flows can
provide insight as to the stage of a company’s life cycle.
Usage of Methods – 99% use the indirect method
Information needed to prepare statement the statement of
cash flows– Comparative Balance Sheets, Income
Statement, Other Information
STATEMENT OF CASH FLOWS
Cash from Operating Activities
 Start with Net Income
Assign
Sheet
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 Make conversions needed to change from accrual
basis to cash basis.
 This statement follows the Indirect Method.
Cash from Investing Activities
 Purchase and Sale of Long-term Assets (Investments
and PP&E)
Cash from Financing Activities
 Changes in Common Stock, Preferred Stock,
Dividends, LT Debt, Bonds Payable
Combine OA, IA, and FA to determine change in cash for
period
Add Cash at beginning of period to change in cash to get
Cash at end of period.
Report Noncash Investing and Financing Activities
Examine the Study Aid provided on the Assignment Sheet
Complete P12-9A (Lemere Corp.) together in class
Ratios:
 Free Cash Flow = Cash from Operating ActivitiesCapital Expenditures – Cash Dividends
 Current Cash Debt Coverage Ratio –
Cash from Operations / Average Current Liabilities
A measure of liquidity
 Cash Debt Coverage Ratio –
Cash from Operations / Average Total Liabilities
A measure of Solvency
Statement of Cash Flows – Direct Method
You are not responsible for the Direct Method but look at it
to see similarities and differences with Indirect Method
A Look at IFRS (Statement of Cash Flows)
Chapter 13 – Financial Analysis: The Big Picture
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Topic
Sustainable Income- most likely level of income to be
obtained. That is, income before discontinued operations,
extraordinary items, and other comprehensive income (all net
of tax).
Discontinued operations-division, product line
Extraordinary items- event that is unusual and infrequent such
as a flood or fire, expropriation (takeover) be foreign
government, condemnation
Ordinary items- natural casualty, not uncommon in area, write
down of inventory, loss due to labor strike, sale of PPE
Changes in Accounting Principle (Inventory, depreciation)For consistency, apply new principle to current and prior
period.
Comprehensive income- Gains and losses that are reported in
stockholders’ equity rather than on the income statement
such as gain or loss on sale of available-for-sale securities.
Report on Income Statement after Net Income.
Illustration 13-7- Complete Income Statement including
irregular items.
Comparative Analysis- intracompany (compare current to
prior year), intercompany (compare to competition), industry
averages.
Horizontal analysis of Chicago Cereal 08 & 09 Balance Sheets
Horizontal analysis of Chicago Cereal 08 & 09 Income
Statements
Vertical analysis of Chicago Cereal 08 & 09 Balance Sheets
Vertical analysis of Chicago Cereal 08 & 09 Income
Statements
Ratio Analysis- We’ve seen them in prior chapters
Liquidity Ratios
Solvency Ratios
Profitability Ratios
These ratios are reported on the inside of the back cover of
your text. This page will be photocopied and included on your
final exam so you don’t have to memorize the ratios for the
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743
exam.
Appendix 13A- Comprehensive Illustration of Chicago Cereal
A Look at IFRS (Financial Analysis and Irregular Items)