Chapter 16
Recording and
Evaluating Capital
Resource
Activities:
Investing
McGraw-Hill/Irwin
Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
Operational investments
• Plant assets
• Natural resources
• Intangible assets
Because of the importance of operational investments, it is
vital that we understand not only what these assets
represent but also how companies record and report their
acquisition, use and disposal
Plant Assets
• Often referred to as property, plant and
equipment (PPE)
• The three steps to consider when
describing the accounting process
 1. acquisition
 2. use
 3. disposal
Acquisition
• Understand the difference between capital
and revenue expenditures
• A capital expenditure creates the expectation of future
benefit that apply beyond the current accounting period.--capitalize or add to the cost of the plant asset rather than
expensing it immediately
• Revenue expenditure (expenses) provide benefit
exclusively during the current accounting period --- Annual repairs, maintenance, utility bills, taxes, day to day
operations
Assets
• Represent economic resources with
expected future benefits become expenses
as they are used up during construction --all normal necessary costs incurred provide
future benefits
• Capital expenditures include labor and material
directly associated with construction --- permits,
architects fees, taxes
 Also, indirect costs – wages paid to security guards,
insurance payments, interest on borrowed money.
 Once completed, it becomes revenue expenditures
allocation
• Page 451 example of allocation
Depreciation
• Expenses associated with using PPE is
called depreciation—it reduces the
company’s assets and owners equity that is
used to generate revenue
• Depreciation Expense 200,000
 Accumulated Depreciation
Equipment at cost
1,000,000
Less: accumulated depreciation
(600,000)
Equipment, Net
$400,000
200,000
What is the Cost of Property, Plant,
and Equipment?
• PPE is recorded as the total amount
required to obtain and get the asset ready
for its intended use
• Last more than one accounting period
•
•
•
•
Purchase price
Sales Tax
Costs incurred to obtain (freight, etc.)
Cost incurred to setup (installation, etc.)
• Land, building, and equipment
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What are the Factors Affecting
Depreciation Calculations?
• Cost
• Useful life---period of time over which a
business expects to obtain economic
benefits or total number of units (total miles)
 Limited due to physical wear and tear or
obsolescence ---changing technology
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• Salvage value—residual value or fair
market value
• Depreciation method—cost minus the
salvage value equals the depreciable value
How is Depreciation Expense Calculated
Using the Different Methods?
• Straight-line
 (Cost – salvage value)/Useful life (time) =
annual depreciation expense
• Units-of-production
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 (Cost – salvage value)/Useful life (units) =
depreciation rate
 Depreciation rate * annual usage = annual
depreciation expense
 Actual usage-benefit is tied to its use. More
accurate—match the amt of expense
recognized with actual rates of usage.
Depreciation Expense Calculated Using
the Different Methods Continued
• Double-declining balance
 2 * straight-line rate = DDB rate
 DDB * carrying value = annual depreciation expense
 Based on a constant percentage of declining balance.
The multiplication of a constant rate by this declining
balance yields the greatest amount of depreciation in
the assets first year of use and a declining amount in
each subsequent year.
 Depreciation ceases when you reach salvage value
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Exercise 1
• Exercise 1
a) Building
b) Supplies or supplies expense
c) Investment in land
d) Office equipment
e) Maintenance expense
Exercise 2
a)
b)
c)
d)
e)
Capital expenditure
Revenue expenditure
Capital expenditure
Capital expenditure
Revenue expenditure
Exercise 5
a) (59,000 – 5,000)/6 = 9,000 per year
b) (59,000 – 5,000)/45,000 = 1.20 per hour
1.20 * 8,000 hours = 9,600 year 1
1.20 * 7,500 hours = 9,000 year 2
c) SL rate 1/6 * 2 = 33.33% doubled straight
line rate
59,000 * 33.33% = 19,665 year 1
59,000 – 19,665* 33.33%=13,110 year 2
What if the Company Doesn’t Purchase
(or sell) the Asset at the Beginning (or
end) of the Year?
• Units-of-production
 Multiple the depreciation rate by the actual
usage
• Straight-line or double-declining balance
 Use the mid-year convention or count the time
that the asset was in use
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Midyear Convention
• Companies making numerous plant asset
purchases and disposals spread out evenly
during the course of the fiscal year
frequently use the midyear convention,
which reflects depreciation expense for
each asset
• as if it were purchased or disposed of
exactly halfway through the company’s
fiscal year.
Illustration --- page 457
• PCs to Go, with a December 31 year-end,
purchases its delivery truck in April 2010
and expects to dispose of it five years later
in April 2015. Straight – line depreciation
for each fiscal year of use would be as
follows:
• Refer to page 457
Revision of Estimates
• A company originally assigns a useful life of
seven years to a computer and, one year
after the date of the purchase, realizes that
it will have to replace the computer after a
total of three year.
• When it becomes clear that they need to
make an adjustment– do the following---
Revision of estimates
• Assume that on January 1, 2010, a
company purchases and begins to use
office equipment costing $12,000, with an
expected useful life of 10 years and a
salvage value of $2,000. Assuming the
business uses the straight-line method of
depreciation for the asset, accumulated
depreciation at December 31, 2012, would
be $3,000
What is the Process Involved in
Asset Disposals?
• Record depreciation to date of disposal
• Remove the cost of the asset (CR) and the
accumulated depreciation (DR) from the
records
• Record the assets received (DR) if
applicable
• Record the cash paid (CR) if applicable
• Record the loss incurred (DR) if applicable
• Record the gain (CR) if applicable
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How Can a Company Dispose of an
Asset Before its Useful Life is Over?
• Discard---it is necessary to record a loss at
the date of the disposal
 Discard equipment that cost 50,000 with a
40,000 of accumulated depreciation at the date
of the last balance sheet. Must pay $1,000 to
have it removed.
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Assets = Liabilities + Owner’s Equity
2,000 =
2,000
Depreciation expense 2,000
Accumulated Depreciation 2,000
Problem continued
• After the entry is posted, the accumulated
depreciation account will have a $42,000
credit balance (previous balance of $40,000
plus $2,000. Second, we must recognize
the removal of the equipment (book value =
$8,000) and cash:
• Assets = Liabilities + Owners Equity
• (8,000) =
(9,000)
• (1,000)
Journal Entry
• Accumulated Depreciation 42,000
• Loss on Disposal
9,000
 Equipment
 Cash
50,000
1,000
Sell
• Sell
Must be sold for equal, less than, or
greater than.
Recall when more net assets are received
than are given up, a gain results. A loss
results when fewer net assets are received
than are given up.
Example
Cost of Asset
$80,000
Accumulated depreciation
(60,000)
through date of sale
Carrying Value at date of sale $20,000
Assets = Liabilities + Owner’s Equity
+20,000
-20,000
Selling for the same amount of net assets
Journal Entry
Cash
20,000
Accum Dep
60,000
Equipment
80,000
Exchange (Trade-In) Example
• We have a computer that originally cost
$6,000 and has accumulated depreciation
of $4,500. We will trade-in this computer
for a new computer with a list price of
$10,000. The computer company will give
us a trade-in allowance of $2,000.
• Book value = $6,000 - $4,500 = $1,500.
• Cash payment required = $10,000 - $2,000
= $8,000
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Trade-in Example Continued
• Computer received = $10,000
Less assets given up = $9,500
Gain = $500
• Entry:
Computer (new)
10,000
Accumulated depreciation
4,500
Computer (old)
Cash
Gain
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6,000
8,000
500
What are Depletion and
Amortization?
• Depletion
 The cost of a natural resource is allocated to
expense
 Typically, units-of-production method used
• Amortization
 The cost of an intangible asset is allocated to
expense
 Typically, straight-line method is used
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